Steps for Organizing Your Spending, Saving and Investing
If you’ve recently experienced a divorce, you may be overwhelmed by the process of restarting your financial life. However, regardless of your new financial situation, having an organized financial life is key to achieving your long-term goals. Now’s the time roll up your sleeves, reevaluate your new normal and focus on getting your financial house in order. The following steps can help you get started.
Step #1 – Create a budget
The most important first step in getting your financial house in order following a divorce is to identify how much money you expect to spend each month and compare that to your earnings and income, including income from work as well as any alimony or childcare payments you receive from your ex-spouse. There are several ways to do this, all of which look at two types of expenses, fixed expenses and discretionary expenses. Fixed expenses are those you must pay each month. Examples include:
- Minimum credit card payments
- Car payments
- Utility bills
- Cell phone
- Alimony and/or childcare (if you are paying these to your ex-spouse)
Discretionary expenses are costs you choose to take on that are not essential for living your life. These are wants, not needs. Examples include:
- Eating out
- Movie and concert tickets
- Streaming TV subscriptions
Once you have added up your fixed and discretionary expenses, identify areas where you can cut back. It will likely be much easier to cut from the discretionary expense list, since these are wants, not needs. Do you really need to eat out four times a week, or if you can cut back to one or two times per week? When was the last time you used your monthly streaming subscription? Can you save some money by taking a vacation closer to home instead of flying to a far-off destination? While each of these decisions involve short-term sacrifice, they have the potential to pay off over the long term.
The next step is to identify how much income you bring in after taxes and withholdings. Your budget should allow you to have money left over after paying your fixed expenses. Some of that money can go toward discretionary expenses, and the rest should be used toward the steps below.
Step #2 – Prioritize debt payoff
There are many types of debt. Consumer debts, such as credit cards often have high interest rates or a zero percent rate for a period of time. Student loans can be federal or issued from a private institution. Mortgages can be fixed or variable.
As a general rule, it’s wise to pay off the high-interest-rate debt first so that you pay the least amount of interest over time. Prioritize your highest-interest-rate debt and get it paid off as soon as possible. Once you’ve completed that debt payoff, move to the next highest-interest-rate debt and pay that off as soon as possible. Having a plan for tackling debt can make it seem less overwhelming, and you’ll have a sense of accomplishment with each loan you pay off. Just remember that missing payments can hurt your credit score for years, so be sure to continue making all your minimum payments while you’re paying extra on some debts.
Quick tip – Consider refinancing your home or performing a balance transfer on your credit cards to take advantage of the current low interest rates.
Step #3 – Establish an emergency fund
Once you have made a budget and started paying down your debts, the next step is to save in an emergency fund. The purpose of this fund is to allow you to keep up on your fixed expenses should you lose your job or have another type of unexpected financial setback. As the sole income owner in your household, you should strive to save up to six months of fixed expenses in this account.
Notice that paying off high-interest-rate debt comes before establishing an emergency fund. That is because paying high interest rates reduces your ability to save.
Quick tip – If you have already an emergency fund in place, consider using it to pay off any high-interest-rate debt. If you encounter an emergency before you have a chance to replenish your emergency account, you can resort to using the credit card again if necessary, while saving considerable money on interest payments in the meantime.
Step #4 – Save for your future
Regardless of your age or vision for retirement, saving money for the future is best started early and done consistently with a specific goal in mind. If you want to purchase a home or car in the next year or so, begin researching how much cash you will need and how much you plan to borrow. Money you plan on using for purchases over the next year or less should be kept in a checking or savings account. This ensures that, regardless of market conditions, the money will be available for your purchase.
For long-term goals, remember that things become more expensive over time. For example, years ago, new cars only cost a few hundred dollars, while today, they cost tens of thousands of dollars. Saving cash in a savings or checking account is not ideal for long-term growth. Instead, you’ll want to invest this money to earn a rate of return and allow the funds to compound over time.
For example, say you anticipate that in 10 years you will need $100,000 for a down payment on a second home. If you save $51,000 today in an investment account that grows by 7 percent annually, you would have more than $100,000 in 10 years. If, on the other hand, you leave that $51,000 in a savings account earning 1 percent annually over that same 10-year timeframe, you would only have $56,335. That’s a loss of more than $40,000 just because you did not invest appropriately.
An easy way to save is through your employer-sponsored retirement plan. As an added bonus, many employers offer matching contributions to employees who participate at a certain rate. For example, your employer may offer a match on any contribution you make to the plan up to 3 percent. If you are not contributing 3 percent, you are essentially walking away from free money. Regardless of your goals for the future, consider contributing at least the minimum amount to receive your employer’s full matching contribution.
Step #5 – Protect your loved ones
The next step in getting your financial house in order is making sure you have the correct legal and risk management precautions in place. Regardless of whether or not you have children, you should, at a minimum, have the following:
- Disability insurance – replaces lost earnings in the event you are unable to work due to a disability
- Home/renters’ insurance – protects your primary residence
- Auto insurance – protects you and other drivers in an auto accident
- An umbrella policy – protects your savings and investments against personal liability claims
If you have children, there are two additional items you should immediately address:
- Estate and guardianship documents
- Life insurance
While it can be difficult to face your own mortality, these documents play a vital role in protecting those who depend on you for care and financial support. Take some time to understand the financial impact your unexpected death would have on your family and protect your loved ones with an appropriate temporary life insurance policy.
Also make sure that if anything should happen to you, you have made guardianship arrangements for your children. This can be accomplished through your estate planning documents. A licensed attorney can help you make sure all necessary legal protections are in place.
Quick tip – Be sure to check on your current beneficiary designations for all accounts and insurance policies. If you pass away, those accounts would be paid out according to the designations on file, so it’s important to keep them updated, especially if you recently finalized a divorce and still need to remove your ex-spouse as a beneficiary.
As you work to get your financial house in order, you may discover that each of the steps above comes with its own complications and potential roadblocks, but don’t let these challenges deter you. Start with a rudimentary plan to begin the process and revise it along the way as you progress through each of the steps. If you do become overwhelmed, consider working with a financial advisor who can guide you through the process.
At Creative Planning, we understand how emotionally draining divorce can be, and we help clients through every phase of getting their financial houses in order following a divorce.