Five Bread-and-Butter Fundamentals¶
Written by Michael Paulding Thomas with care and no A.I.
It took me 37 years to learn what I'll teach you in 15 minutes.
Since 1989 I've been helping families build generational retirement plans and all good plans start with basics that are universal to most, if not all, families. There came a moment early in my career where it dawned upon me that those basics, those boring fundamentals, were truly the keys to success. Below is a condensed overview of my best advice.
1: War Chest / Emergency Fund¶
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“A year's living expenses in a war chest will save you from more bad decisions than you can imagine.” ―Nick Murray
Get year’s living expenses (not necessarily "lifestyle" expenses) in a money market-type fund as quickly as you can, even if you have to live on coffee and rice while you’re saving toward this goal. This will give you piece-of-mind, and let you weather out the “financial storms”, and avoid liquidating your retirement accounts. Cars break down, pipes wear out and break, and kids get sick. Build yourself a “reserve account” to pay for these unexpected events.
Don't be too concerned with the rate-of-return that you're getting on this account. Growth is not the primary purpose ― you just want to make sure it's there when you need it. Even a bank savings account is fine. However, keep it in a separate account from all your other funds.
2: Term Life Insurance¶
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For a deeper-dive read my article Protecting your Family with Term Life Insurance
Life insurance ensures that if a breadwinner passes (and thus their income stops) the family has the funds to continue living their lifestyle and doesn't tap into their retirement accounts.
There are two types of life insurance:
- Term: Pure insurance. Cheaper.
- Cash-Value: Insurance + Savings. More expensive.
Always buy term insurance and invest the cost difference in equity mutual funds. Never, ever buy any form of cash-value life insurance (whole life, universal life, variable life, etc.) regardless of what the insurance salesperson tells you.
How do you know if you need life insurance? Will your spouse/kids will have financial problems if you die? If 'yes' then you need it; if 'no' then you don't.
Run a Free Term Life Insurance Quote
3: Living Trust¶
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For a deeper-dive read my article How a Living Trust Protects Your Family
When you pass away, your estate normally goes through a process called probate, which can be costly and delay the transfer of property to your beneficiaries.
There are only three ways to avoid probate: 1) live forever, 2) don’t own anything, or 3) get a living trust.
Briefly speaking, there are three primary benefits of a living trust:
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Private: the size and distribution of the estate remains private.
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Avoids Probate: saves the beneficiaries time, money and hassle.
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Living Benefits: your instructions regarding your health and finances are followed if you are still alive but become incapacitated.
Don't rely solely on a will. Wills still go through the probate process.
Need a Living Trust?
4: Retirement¶
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For a deeper-dive read my article Income Planning for Your Golden Years
Accumulation Phase¶
Invest 100% in the World’s Great Companies
Most people who invest most of their capital in fixed income investments as they go into retirement will run out of money well within their lifetimes. You are not investing to retirement, but through retirement, and very probably on to the next generation. The right answer is to invest in historically defensible, broadly diversified, equity mutual funds.
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“Equities are the only asset class that fully captures human ingenuity, which is the most valuable asset on earth.” ―Nick Murray
My equity investment management firm of choice is Capital Group / American Funds (all of my family's money is managed by them).
I have a strong conviction in dollar cost averaging.
Sequence of Retirement Accounts
As stated above, always use all-equity mutual funds as the investment "inside" of the tax shelters.
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401(k). Contribute up to the matching point, then stop. Always utilize the Roth version, if it is offered.
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SEP IRA. If you're self-employed and/or get paid via 1099.
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Roth / Traditional IRA. Fully-fund your IRA. Roth is preferable, if you qualify for it.
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Do all of the above for your spouse, if applicable.
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401(k). Go back to your 401k and contribute past the matching point up to the maximum allowed.
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Variable Annuity. If you have additional money available to invest for retirement, use a "stripped down" VA for tax-deferral.
Withdrawal Phase¶
Have an Intelligent Withdrawal Strategy
Americans say that what they want for retirement is safety and income. What they really want is all the income they can get, and the illusion of safety.
In many cases the best vehicle to create a guaranteed retirement income that outpaces inflation is a variable annuity with a guaranteed income rider that is invested in 100% equity mutual funds, and yet provides a minimum 5% guaranteed withdrawal for the rest of your life (you only pay taxes on the withdrawals while the balance remains tax deferred).
When you pass away, the income continues guaranteed for your spouse. When he/she passes your children inherit the account balance.
Tip: When you’re approximately 10-years from retirement consider this product.
5: Minor Accounts¶
Note: just as with the retirement shelters above always use all-equity mutual funds as the investment "inside" of the minor accounts.
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UTMA. When saving for your child for non-education purposes invest in a Uniform Transfer to Minor Act.
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529-Plan. For higher-education / college invest in a 529-Plan.
Tip: put your first $20,000 (approximately) into a UTMA. Any amount above that put it into a 529 Plan. Remember, the first $2,600 of interest earned in an UTMA is tax-free/tax-reduced anyway and it has more flexibility that 529-Plan since it can be used for any purpose, not just college education.
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Minor Roth IRA. As soon as your child as earned-income, such as a summer job, have them invest in a Roth IRA.
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ABLE Accounts. Achieving a Better Life Experience Act allows individuals with mild to severe disabilities to open investment accounts.