Financial Planning: Prioritizing Your Path to Success

My fiancé, Sam, and I recently moved into a new place. The process was filled with excitement and chaos, which got me thinking about the similarities between moving and financial planning. No matter how much we prepare, life rarely goes exactly as expected. During the first night of moving in, after a long day of packing, I realized that we had forgotten to label the boxes containing our bathroom toiletries. It turned into a long search through a sea of boxes. This small setback made me realize that in any process, some things should always be prioritized to make life easier—whether it’s moving into a new home or managing your finances.

Understanding Cash Flow

One of the most fundamental aspects of financial planning is understanding your cash flow. This refers to the tracking of your monthly income and expenses, ensuring you know exactly where your money is coming from and where it’s going. At KWB, we help clients build financial plans that include detailed cash flow analysis. This helps us evaluate income, taxes, monthly bills, debt payoff strategies, and other essential expenses. What surprises many people is how little they know about their monthly spending. Without knowing your cash flow, it’s hard to prioritize saving and planning for financial goals. Tracking your income and expenses helps clarify your financial picture and ensures you're prepared for upcoming goals.

The Importance of Savings

Everyone knows that savings are important, but how much should you have saved? The ideal amount varies, but a good rule of thumb is to have anywhere from 3 to 12 months’ worth of living expenses set aside for emergencies. The key is understanding your cash flow first so you can determine how much you need to save. If you don’t know how much you spend each month, it’s difficult to know how much to save. Ensuring that your savings align with your monthly expenses is crucial. Emergency savings provide financial security, but they also give you the flexibility to make larger financial moves when opportunities arise.

Setting Realistic Financial Goals

A critical component of financial planning is setting realistic financial goals. At KWB, we encourage clients to break down their goals into short-term (1-3 years), medium-term (3-10 years), and long-term categories. By doing this, we can create a comprehensive financial plan that helps achieve those goals step-by-step. Taking time each year to reflect on your goals—whether independently or with an advisor—helps ensure you are on the right track. Setting clear, actionable financial goals is essential to building wealth over time.

Allocating Income: Where Does Your Money Go?

Once you understand your cash flow and savings needs, the next step is deciding how to allocate any extra income. After covering necessary expenses, where should leftover funds go?

One common approach is to pay down debt. While eliminating debt is an important milestone, it’s also important to prioritize which debts to pay off first. The general rule is to pay down high-interest debt before focusing on low-interest debt. For example, many people want to put extra money toward paying off their mortgage. However, did you know that 60% of current mortgages have interest rates below 4%? In this case, it might be better to invest extra funds into the market, where long-term returns tend to outperform the interest savings on a low-rate mortgage.

Historically, the S&P 500 has had an average return of about 11% annually since 1980. So, prioritizing investing over paying off low-interest debt could be a better path to financial growth over time. Of course, paying down high-interest debt, like credit cards, should still be prioritized, as the interest on those debts compounds quickly.

Liquidation Strategy: How to Fund Your Lifestyle

Knowing when and how to access your wealth is another crucial part of financial planning. This involves understanding how to withdraw from your savings, retirement accounts, or non-retirement assets to fund your lifestyle. Each type of account comes with different tax consequences.

First, using cash or savings accounts is usually the best option for immediate needs because they’re liquid and don’t incur taxes when you withdraw funds. However, if you’re in a high tax bracket in a given year, you might choose to use cash savings rather than withdrawing from taxable investment accounts.

Non-retirement assets, like Transfer on Death (TOD) accounts or Trust accounts, are subject to capital gains taxes when sold. If you’re in a low tax bracket, this may be an ideal time to access these accounts, as you may pay little or no capital gains tax. On the other hand, withdrawing from retirement accounts like IRAs or 401(k)s involves paying ordinary income tax, which is typically higher than capital gains tax. In some cases, you may be required to withdraw a certain amount from these accounts (such as with Required Minimum Distributions or inherited IRAs), so these accounts may be the first place to pull funds from.

Roth IRAs: The King of Accounts

Roth IRAs have become increasingly popular because they grow tax-free, have no Required Minimum Distributions (RMDs), and are inherited tax-free. Because of these benefits, it’s often best to leave your Roth IRA untouched as long as possible. Instead, consider using other retirement funds first. Roth IRAs are designed to grow over time, and by leaving them to continue growing tax-free, you maximize their long-term benefits.

Roth IRA conversions, where you convert traditional IRA funds into Roth IRAs, have become an increasingly important strategy. This allows you to take advantage of tax-free growth, but it’s important to understand when it makes sense to convert and how this decision might impact your taxes.

Achieving Your Financial Goals: A Process of Checkpoints

Think of financial planning like climbing a mountain. In a show like The Summit, participants must overcome physical challenges and reach checkpoints to succeed. Similarly, financial planning involves setting clear goals with timelines and meeting smaller milestones along the way. Every year, you should check in on your progress and adjust your plan as necessary to stay on track.

At KWB, we help clients develop comprehensive financial plans with achievable checkpoints, ensuring they’re working toward their long-term financial goals. By reviewing your plan regularly and adjusting it based on changes in your financial situation, you can steadily move toward your financial summit.

Final Thoughts

Financial planning, like moving into a new home, involves a lot of planning, organization, and sometimes unexpected challenges. However, by prioritizing the essentials—such as cash flow management, savings, goal setting, and smart asset allocation—you can navigate the complexities of life and finances more effectively. With the right planning and the guidance of a financial advisor, you can stay on track to achieve your financial goals and build long-term wealth.

 ~ Claire Olmstead

This material is for informational purposes only and should not be considered investment, legal, or tax advice.