In 2017, Helaine Olen and I published The Index Card: Why Personal Finance Doesn’t Have to be Complicated, which argued that the key things you must know about handling your money fit on an index card. As frustrating as tax season can be, the same principle holds.
Here are some specific things you can, and should, do:
Check your spending and credit card statements for easy wins, high-interest debt, and sludge
Saving and investing are more fun when you control your spending.
Your credit card statement is a target-rich saving zone. Paying down or eliminating your credit card balance is the best single investment in the known universe. That’s a risk-free, tax-free return of 15% or more. No other investment comes close. If you owe more than you can comfortably pay, a credit counselor may help. They may also have tips to reduce the interest rates on what you owe.
Sludges include recurring charges that hold little value to you, but that you haven’t had time, energy, or attention to address. These include auto-renew subscriptions to magazines you don’t read, perhaps that gym membership you haven’t used since Covid. I’ve been sludged many times because I’m too impatient to spend 45 minutes listening to annoying hold music or to navigate a complicated website to cancel a worthless $10 monthly charge. That’s of course the business model for many sludge services.
Comparison shop. When was the last time you comparison-shopped your home and car insurance? See how much you’d save by raising your deductible. This will lower your monthly premium—because you’re now lumped in with other price-conscious consumers who don’t expect to really use these policies.
Seek easy wins. During Covid, I bought a coffee maker and a minifridge for my workspace. My savings on non-purchased $3 coffees and $6 lunches were noticeable. (Unfortunately, so was my overeating.) Make sure that you’re spending your money on stuf you really value, rather than dribbling it out on stuff you really don’t.
Should you prepay your mortgage? If I were writing this column last year, another easy win would have been to refinance your mortgage, with a low-rate 15-year refi. Unfortunately, this window has recently closed for most people due to 2022 interest-rate increases. What about making extra payments to draw down your mortgage principal? That’s equivalent to a tax-free, risk-free bond with higher returns than standard Treasuries. It’s also incredibly satisfying to owe less on your home. Be careful, though. Right now, prepayment probably earns lower returns than you’d get from Treasury Inflation-Protected Securities (TIPS) or I-Bonds.
Check your retirement investment mix against reputable target-date funds
You don’t have to be Warren Buffett to sensibly save and invest. Thank goodness–because neither you nor I are. Resist the temptation to make speculative investments or to plunge into crypto or some other recent fad. Contra Matt Damon, fortune favors the methodical more often than fortune favors the brave.
As Olen and I outlined in our book, low-fee stock and bond index funds ultimately outperform pretty much everything else. So the centerpiece of your retirement saving and wealth accumulation is to set aside as much as you can in such index funds through your 401(k) or equivalent. For tax year 2021, workers up to age 50 can contribute up to $19,500. Older workers can contribute $26,000. If you start early and come anywhere near these limits over time, you’re virtually guaranteed to be a millionaire at retirement.
How should you split your assets between stocks and bonds? My current thinking is more stock-heavy than when we first wrote. One reasonable approach is to track your overall investment mix to reputable “target-date” funds that match the year you plan to retire. As shown below for Vanguard, target-date funds are mostly in stocks, even for people nearing retirement. If you were born after 1970, at least 80% of your holdings should be in stocks.
Use the magic of Roth IRAs—at any income level.
Roth IRAs provide a powerful, tax-advantaged way to save for retirement. They also provide useful reserves since you can always withdraw the principal (though not your investment gains, until age 59½) with no tax or penalty. There’s no immediate tax break for Roth IRA contributions. But your earnings are never taxed. If you’re under 50, you can contribute up to $6,000 every year, $7,000 if you are older than age 50. For tax year 2021, you can feed your Roth with low-fee index funds right up until tax-day. A huge win.
Blame the game not the player: A back-door Roth IRA. High-earners can’t straight up contribute to a Roth IRA. For tax year 2021, eligibility phases out at $140,000 of Modified Adjusted Gross Income for single people, $208,000 for married couples filing joint returns. What do you do if your income exceeds these thresholds? Well, you can still contribute, using a goofy mechanism called a backdoor Roth IRA.
Here’s the basic idea. Everyone is allowed to contribute to a conventional IRA, though there’s no immediate tax break for high-income filers. And everyone is also allowed to convert a conventional to a Roth IRA. So you can contribute that same $6,000 or $7,000 to a conventional IRA. You can then roll this over to a Roth IRA. You’ll take an immediate tax hit on whatever gains you rolled over in your conventional IRA. But then you’ll have the Roth’s tax advantages from this point forward.
You might say: Wait-what?? This makes no sense. Indeed it doesn’t. You’re exploiting a ridiculous (uh, “backdoor”) loophole that should be closed. Use your untaxed gains to help someone or to support good causes. And talk with an accountant to make sure you execute the details right.
If you are married or otherwise partnered, use tax season to openly discuss your finances
Tax season is a great time to have those awkward relationship-financial conversations we all tend to avoid. Maybe one of you partakes in retail therapy, overspends on cameras, bitcoin, or clothes, or somehow hasn’t mentioned that big credit card charge. Maybe one of you is nervous about your work situation but hasn’t found the right time to mention this. It’s important to talk these things out—not to mention practical stuff like making sure you have a will and a good plan for whatever family issues you face.
Consult an accountant and an hourly fee-only hourly fiduciary advisor
Accountants and hourly fee-only fiduciary advisors are great helpers in these conversations. An accountant can help you maximize tax-advantaged investment accounts, prevent unforced errors. An hourly fee-only fiduciary advisor can review your investments, discuss your long-term goals and obligations. Maybe you need advice about your kid’s college savings account. Maybe you or a loved one live with a disability, and you must navigate the financial practicalities. They can discuss contingency plans for family emergencies or job challenges, what you should and should not do to help a struggling relative or adult child.
About that financial advisor… You come to a financial professional seeking unbiased advice, not a sales pitch. So you should be the only person paying here. Of course, nobody works for free. Be prepared to pay $300 per hour straight-up for these conversations. Ask your advisor to commit–in-writing–to a fiduciary standard in all their dealings with you, not merely about your retirement accounts. Be careful of financial professionals with titles like “counselor,” or “consultant.” They’re consciously avoiding the term “advisor,” which brings specific protections. Be wary of someone who promises to beat the market. If she were that sure, she wouldn’t be wasting time with you. And check the fees on recommended investments against similar products offered by Vanguard or other vendors. High fees for commodity products are red flags for other problems.
Know yourself—your strengths, vulnerabilities, and foibles
Whatever these are, they will appear in your money management. Maybe you avoid looking at your credit card bill that shows over-spending. Maybe you thrill to the chase, and jump on shiny-object speculative investments hawked on financial TV. Maybe you’re prone to panic selling, or follow an overly aggressive or overly-timid investment strategy. Be self-aware about your vulnerabilities. Discuss them with your partner and with an hourly fee-only fiduciary advisor.
Leverage your strengths, too. Maybe you’re a single mom with modest resources. Passing a store window with your daughter, you might say: “You see that $70 sweater. That would look great on me. But I’m not going to buy it, because we need that $70 for your college account. Someday, you’ll do the same for your child.” You’ve turned a difficult moment resisting temptation into a gratifying parenting moment that’s worth far more than another sweater.
Saving and investing aren’t a sprint, but a long-distance run
We all get lucky or unlucky. We all make various stumbles along the way. Tax season is a great time to review where things stand. Put this time to good use. Button some things up, as you methodically pursue a sensible financial plan.