It’s tempting to think that journalists who write about money for a living have all the answers. (Ugh. You should see my checkbook.) By way of analogy, I’d like to suggest a different way of thinking.
We all know Steven Spielberg ranks as one of the all-time great film directors. But when Spielberg needs fabulous special effects, what does he do? He calls his buddy George Lucas. Why? Because the “Star Wars” director is the undisputed king of special effects. It’s an area Spielberg appreciates, but doesn’t know nearly as well as his colleague.
It’s that way with money as well: We get wiser (and richer) when we learn to lean on the wisdom of the financial sages around us. This week, I introduce you to a pro ideally situated to give you some great advice, because he has three kids in their twenties.
Cliff Caplan is founder and president of Neponset Valley Financial Partners in Norwood, Mass. With more than 30 years experience as a financial planning practitioner and 20 years as a Certified Financial Planner, Caplan has proved an invaluable source as I’ve worked personal finance stories for Reuters Money. Where many in the money world talk jargon and nonsense, Cliff speaks from common sense and sound knowledge.
In reaching out to Caplan, I asked him to think not just of the advice he’d give Money Under 30 readers, but also his three adult children (two of whom work in the financial services industry). Here’s what he had to share with us:
1. Get disability insurance
It’s easy to think that when you’re in your 20s or 30s, disaster can’t strike. But by some measures, as many as one in three employees will at one time or another experience some form of disability. Even if your employer provides some form of disability coverage, chances are it’s partial and will only cover about 60 percent of your salary. “For a single person, it’s important, and I would strongly urge them to buy long-term disability insurance,” Caplan says. “Working for a company for 30 to 35 years doesn’t happen any more, and when you move from job to job, you can’t take [employer-provided] disability with you.”
2. Look at life insurance
The topic of life insurance among 20-somethings often has all the appeal of math homework for a grade schooler. But if you want to pass the financial savvy test with flying colors, Caplan says you need to study this building block.
Here, we need to make an important distinction between term life insurance and permanent life insurance. Term life insurance only lasts for a fixed period that expires and can provide for your depedents in the event you die during the term. Term insurance is relatively inexpensive. Permanent life insurance accrues a cash value over time that’s paid out at the end of the policy. Caplan recommends the latter.
“Buying a life insurance policy is a good start,” Caplan says. “[Y]our health changes, and I’ve had this pay off over the years. But it has to be permanent insurance; what we’re talking about hereis future planning.”
3. Match that retirement contribution at work
For too many young workers who sign on with an employer, the retirement account is just a nice perk — something you don’t have to think about because retirement is decades away. But as any financial pro will tell you, the magic of building wealth through a retirement account starts with compound interest. And that account explodes in value later on when you front load it over time with lots of money — especially free money.
Did someone say free money? You heard right: Many employers will match your retirement contribution provided that it reaches a certain threshold. But it’s amazing how many young workers don’t know about this valuable benefit. “Matching a 401(k) is free money,” Caplan says. “Take it and run.”
4. With 401(k) accounts, think Roth
A 401(k) is a 401(k), right? No. In the world of retirement accounts, you have the traditional 401(k) and — at an increasing number of employers — the Roth 401(k). With the former, contributions aren’t subject to federal and state income taxes for the year during which you make the contributions; you pay when you withdraw your accumulated contributions plus investment earnings in retirement. In a Roth, it’s the other way around; you pay federal and state income taxes the year you make the contributions, but not in retirement. So if you expect your income tax rates to rise over time — often the case with younger workers — a Roth sets you up for major riches in retirement.
“If you’re 25 years old, you’ve got 40 years for it to grow tax free,” Caplan says. “I’m a big fan of it. You’re setting yourself up for a huge bonanza. Here’s the key: If you have the cash to pay the taxes up front, it makes sense.”
5. When you invest, use dollar-cost averaging
Here we’re going to explain a term that many of you might not know. It’s simple once you hear the definition: Dollar-cost averaging involves buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. The theory behind it is that while share prices may fluctuate over a a year — sometimes wildly — you’re building an investment up over time, regardless of short-term turbulence.
“A few hundred hundred bucks a month can result in a few hundred thousand dollars over 10 or 15 years,” Caplan says. “But make sure to max out your Roth IRA first.” Currently, the Roth contribution limits are $5,500 annually.
6. Establish credit as soon as possible
Though the two things may be equal in some folks’ minds, establishing credit isn’t the same as getting a few credit cards and going on a shopping spree. It means responsibly proving to the three reporting credit bureaus that you can pay utility bills, loans and credit card statements on time, every time. Even if you have to start with a higher-interest credit card, you can establish good credit (and avoid pesky finance charges) if you pay off the full balance every month.
“Establish credit immediately, but monitor your credit report and stay current,” Caplan says. “If they have misinformation there, it’s very hard to get it corrected. It’s a lot more imperative that you stay current, especially since 2008. Credit standards are much more stringent. But remember that some credit history is better than no credit history.”
Imagine getting fabulous advice and direction like this on a regular basis. One way to do that, of course, is to keep reading the work of my Money Under 30 colleagues. Another is to find yourself your own financial mentor. In future columns, I’ll write about how to find a money mentor to teach you the fine arts of building wealth and managing your finances, and the items to put on your checklist when searching for a financial advisor.
What do you think of Cliff’s advice? Are you six for six?