3 Pillars of Financial Wellness

Key Takeaways

• What exactly financial wellness means and why it’s an important topic for all investors to discuss.
• Finding a balance between building an emergency fund and investing.
• What to do with funds after tackling high-interest debt.

Christine Benz: Hi, I’m Christine Benz from Morningstar. What are the key steps on the road to financial wellness? Joining me to discuss that topic is Maria Bruno. She is head of U.S. Wealth Planning Research for Vanguard.

Maria, great to see you.

Maria Bruno: Thanks, Christine. Thanks for having me.

Benz: So, Maria, I think many of us have some understanding of what financial wellness means. Can you talk about why it’s such an important topic?

Bruno: Christine, this is a very important topic for many investors regardless of where they are in their investing journey. We know that households today more than ever are balancing how do they save for their goals, and also are carrying a lot of debt. That inherently leads to a lot of stress. When surveyed, we find that—there are some surveys that show that upwards of two thirds of Americans are dealing with financial stressors and it’s impacting their well-being, it’s impacting their quality of life. So, it’s really important to not only discuss these issues, but also help investors to take action and control and get progress towards financial independence.

What Are the Three Pillars of Financial Wellness?

Benz: So, the road to financial wellness, I think, can seem long and complicated. You have created a guide to help break it down and make it more manageable, and you’ve grouped it into three main clusters of jobs, starting with things that are really basic and kind of foundational. Can we start there? If someone is just trying to make sure that their plan is on track, what are the key boxes that they should have checked?

Bruno: Sure. When we think about there are three pillars, Christine. The first one really is to focus on your finances. Take control of your finances. So, the first step would be to have a budget if you don’t already have one. Look at the inflows; look at the outflows. And that’s pretty easily done today through digital avenues.

The next thing would be—if you have a 401(k) plan, for instance, an employer-sponsored plan that offers a 401(k) match, make sure that you’re making full use of that. Now, we talk a lot about that. But even within the participants that we do record-keeping for here at Vanguard, we’re finding that almost a third of participants aren’t contributing the max, and they’re leaving money on the table. So, it’s very important for individuals who have that company match to take full use of that. Otherwise, you’re leaving money uninvested.

The next thing would be to think about debt. If you have debt, make sure that you’re making the minimum debt payment. There’s a couple of reasons for that. If you miss a payment, it can actually, one, not only increase the amount of debt that you’re paying over the long term, but it also can have adverse impacts on your credit score, and this can have implications down the road if you need to take credit or interest rates that you may pay later. From there then, really think about the debt that you have and pay down high-interest-rate debt. Now, there isn’t a clear-cut definition on what high-interest-rate debt is. But think about those dollars and if you invest that in the market, are you paying a higher interest rate than you would have if you were fully invested? These are things like credit cards, consumer-type debt where the rates can average between 18% to 25%. Those are really, if left unchecked, problematic. So, you really want to be surgical and go through that type of debt first. And then, as you do that, avoid getting back into the trap. If you need to think about taking on debt, look at things like personal loans or home equity loans that may be more advantageous from a rate standpoint. But be mindful once you pay down this debt, how you incur future debt if you need to.

Benz: OK. So, that’s kind of the first bundle of jobs, very foundational sorts of jobs. The next cluster of tasks that people should make sure that they have undertaken is preparing for the unexpected. So, let’s talk about what falls under that heading and why that’s so important.

Bruno: The things that fall into that column, Christine, would be first and foremost emergency savings, making sure that you have funds prepared in case of any type of emergencies. The other thing would be insurance. Think about the risks that you might face and make sure that you have the right level of insurance. These are things like health insurance, life insurance, disability insurance, which is important for many of us, to consider along with the more typical ones like auto, house, or rental-type income. So, we provide some information in our guide in terms of how to think about those risks and the important considerations that you are thinking through. From there, you want to think about what are the types of documents that you would need to have in order—in case something were to happen. These are things like, first, if you have accounts, think about account titling or beneficiary designations. The other thing is documents like wills or power of attorneys or living wills. These are critical to make sure that if something were to happen to you, the contingencies are set in place so that bills continue to be paid or your directions are fulfilled by someone who is acting as your proxy.

Building an Emergency Fund That Works for Your Investments

Benz: An important set of considerations there for sure. I want to follow up on this whole emergency funding thing, Maria, because people really struggle with this. They have trouble figuring out how much to set aside. You like this idea of what you call a “tiered approach” to emergency funding. Can you talk about that?

Bruno: There’s a common rule of thumb in the industry, Christine, and that’s having three to six months’ worth of expenses in cash. And while this is a good starting point, for many, it may not be realistic, and there may be a huge opportunity cost of not being invested. So, we actually like to reframe that and think about household liquidity.

So, first, think about spending shocks that you might incur. These tend to be more frequent, less severe. Maybe it’s a car repair or a house repair, and there you want to make sure you have ample amount of cash. We like to suggest starting with about $2,000 worth of expenses in a cash account or maybe half a month’s worth of your expenses. This is ready accessible cash that you can tap into if you need to in a pinch.

The other is to think about income shocks. These are things like unexpected job losses. These are less frequent, but if they do happen, the impact is more severe. So, generally, here is where you want to have the three to six months’ worth of money set aside, but in accessible assets. So, these could be taxable accounts like brokerage accounts or even Roth IRAs, where you can access the contributions income-tax-free and penalty-free as well. So, this gives us a really good way to think about household liquidity without having all this unnecessary money in cash.

Benz: That’s a good framework. Now I want to talk about this third pillar of financial wellness. Assume someone has gone through the jobs we’ve talked about so far and they just want to make sure that they’re on track. Let’s talk about what they should be thinking about and specifically, how they should be approaching their various investment opportunities.

Bruno: So, this is a really good situation to be in. So, first and foremost, you want to make sure that you’re maximizing your tax-advantaged accounts. So, these could be the 401(k)s, the IRAs for retirement, but also things like health savings accounts or 529 college savings plans if you’re investing for college. So, making full use of these tax-advantaged accounts wherever possible. And then, from there, flex with taxable accounts. So, brokerage accounts. So, that money can be there for general investing and there’s many advantages to doing that. The key there is really to make sure that you’re investing tax efficiently in those types of accounts. But a lot of versatility in taxable brokerage-type accounts. From there, you want to think about paying off low-interest debt. And then, the next and last step would be thinking about gifting, whether it’s charitable giving or lifetime giving to individuals. This is a very good way to think about how you can allocate your money towards these other types of goals that are more longer-term in nature.

Benz: Well, Maria, it’s great to hear about your work on financial wellness. It’s always great to get your insights. Thank you so much for being here.

Bruno: Christine, thank you. Thanks for having me.

Benz: Thanks for watching. I’m Christine Benz from Morningstar.