The breadth of information out there regarding personal finance guidance and advice is staggering if not overwhelming. It’s common to hear trends and different pieces of advice constantly shared across groups, social media, podcasts, etc that can be generally accurate, but may not be appropriate for your own goals.
The aim of this guide is to break down some of the 3 most common pieces of advice shared online, and provide a financial planner’s perspective on them.
Roth IRAs
One of the most common pieces of advice I see out on forums is the suggestion of a Roth IRA. A Roth IRA is a tax-advantaged account that is managed individually. One can contribute up to $7,000 per year (2024) with a $1,000 additional amount if over age 50. The funds deposited to the Roth can be invested in marketable securities, mutual funds, ETFs, bonds, and cash and grow tax free. Withdrawals are also tax free generally after a 5 year holding period or once an individual reaches age 59.5 (with some exceptions).
Notably, Roth IRAs have income limitations. While there can be workarounds to this, I often see this investment vehicle suggested as an end all be all. A high income individual on the other hand may find it beneficial to invest in a pre-tax 401(k) or Traditional IRA if the 401(K) is not available and take advantage of the tax deduction when you are in a higher income bracket. Penalties can also apply if one contributes to their Roth IRA while over the income threshold.
All told, a Roth IRA is still an outstanding and tax-efficient account type geared for the long term, but it’s important to consider your income and goals before opting to open one.
Dividends
Dividends are a common pursuit of some looking to build passive income. Many dividend funds aim to capture higher income yields and some fund, covered call funds, promise yields that can often top 10%. Many individuals have a desire to create a passive income stream from dividends, but may not consider the amount of growth needed to get there.
There are a few considerations here that must be noted however. The first is taxability and location of the dividend producing asset. A dividend fund located in a taxable brokerage account may not be as efficient as one located in an IRA or Roth IRA. Generally dividends are taxed at ordinary income rates so one with exceptionally higher income may end up paying more tax in this situation.
Second, consider the net performance of the dividend producing asset and your long term goal. Overall performance of the stock or fund producing the dividend may lag growth given that some of the growth is paid out in the form of a dividend. If you have a long term investing horizon, initially investing in a dividend paying asset may mean a slower journey towards reaching your financial independence number compared to a growth oriented asset that you buy and hold.
Lastly, generally I prefer to stay away from stocks paying substantially higher dividends and mutual funds doing the same, i.e. don’t chase dividends. For example with covered call strategies, the nature of the internal strategy involved usually limits upside but exposes the investor to downside, meaning that with the net dividend, performance usually is lacking a bit in the long term compared to an index fund. A stock with a higher dividend may indicate significant price depreciation too, or potential issue with the company.
Emergency Fund
Having an emergency fund is the baseline and foundation for good financial planning paired with a budget. While the general rule is 3-6 months of expenses, consider the below special circumstances:
A married couple with substantial net income after expenses could lean closer to 3 months of expenses in cash.
Near term goals such as a renovation, car purchase, or other large expense could warrant an increase in cash reserves in the near term.
Consider crafting your own personal rate of inflation and raising your emergency fund each year by that rate.
As you close in on retirement consider increasing your cash reserve as you switch from leaning on income to leaning on savings. I may see retirees keep 8-15 months of cash reserves depending on how heavily they rely on their own savings vs Social security, pensions, etc.
Most of the cash reserve should be kept in a high yield money market or CD. Sometimes I see others keep it within a money market mutual fund held in a brokerage account for a slightly higher rate. Aim to keep around 1-2 months of your emergency fund in checking for quick accessibility.
While there are many fundamental aspects of personal finance, there is never a one size fits all solution. Seeking to understand the why behind implementing savvy financial habits is just as important to doing them in the first place, as it helps you understand what’s appropriate for you specifically. A good financial planner can also help give you validation on your personal finance decisions and investments to ensure you are on the right track.
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