Are you ready to set your financial New Year’s resolutions? This year has been unusual in many ways, but 2020 also offers valuable lessons on how to make your resolutions for 2021 a reality.
Let’s explore six steps you can take before the ball drops on December 31 to help you reach your money goals next year.
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Step 1: Reflect on 2020
Take the time now to review your credit and debit card statements—or annual summaries if you receive them—and check your spending against your priorities and budget.
Consider how COVID-19-related lockdowns and other unexpected events of 2020 have shifted your priorities. Charity organizations reported donation surges in clothing and household items in the spring and summer, suggesting people have spent money on a lot of items that ultimately don’t provide much long-term value.
What have you learned this year about what matters most to you? What financial missteps should you keep in mind for next year?
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Step 2: Revisit and Clarify Your Goals
With a clearer picture of your priorities in hand, list your short-, medium- and long-term goals, and then evaluate them by asking yourself these key questions.
● Does this goal have a clear, specific objective and a time frame? For example, a goal of saving $30,000 by 2027 for a down payment on a home passes this test. It isn’t specific enough to just say you are saving for a down payment.
● Have you accounted for inflation? Even small annual price increases add up over time. Inflation is expected to be under 2% per year for the next few years, but what costs $500 today will, in 15 years at 2% inflation, cost $672.
● Have you tied the goal to specific habits? Doing so makes it easier to achieve your goal, according to a Nobel-Prize winning economist. An easy habit to develop is waiting 24 hours before buying any nonessential item.
● Have you automated as many positive actions as possible? Making a lot of decisions in a short time frame depletes your willpower. Automate saving, investing and other steps so you can preserve your self-control and stay on track.
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Step 3: Prepare for an Emergency
Perhaps the clearest lesson 2020 taught is how important emergency funds are. If you don’t already have a cash reserve, now is the time to open a savings account and start depositing money. Although financial experts have varying views on how many months’ worth of expenses you need to save in your emergency fund, they agree that starting to save and saving consistently matter most.
If you do already have an emergency fund, consider adding to it, especially if you’re likely to face financial ups and downs. Having six months to a full year’s worth of expenses saved in an emergency fund could improve your peace of mind.
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Step 4: Know Your Debt-to-Income Ratio
Many lenders, including mortgage lenders, look at your debt-to-income ratio (DTI) when evaluating whether you’re a good candidate for a loan. To calculate your DTI, add up all of your monthly debt payments, including credit cards, auto loans, student loans and mortgages. Divide that by your gross monthly income, which equals your monthly income before taxes and deductions are subtracted.
Take steps to lower that ratio, especially if it’s over 43% and you want to buy a home. If your DTI is over 43%, you may face obstacles getting a qualified mortgage, which has features that make repayments more stable over time and may save you money on upfront fees.
You can lower the ratio by reducing your debt or increasing your income and being sure to avoid taking on any new debt.
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Step 5: Maximize Your Tax Savings
There’s still time to reduce the taxes you owe for this year, if you act now. Here are a few ways.
● Increase or, if possible, maximize your 401(k) contributions. If you can afford to, and it makes sense tax-wise, consider contributing your entire December paycheck to your 401(k).
● Max out other pretax savings. If you don’t have a 401(k), transfer extra cash to your individual retirement account (IRA) or health savings account (HSA) before December 31. Be aware of the limits that apply to both contribution types.
● Donate money to an eligible charity. Remember, though, that if you take the standard tax deduction (which recently doubled), you won’t be able to deduct individual expenses, such as charitable contributions. Confirm the charity you are considering is listed on the IRS Tax Exempt Organization Search tool.
● Identify tax credits you may qualify for. Credits directly reduce your tax bill, as opposed to deductions, which reduce the amount of income that’s taxed. You could earn a tax credit if you have children, paid for childcare, paid college expenses or bought certain big-ticket, eco-friendly items.
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Step 6: Look Forward to 2021
We all hope life in 2021 looks different than it has this year, but what specific aspects of your life will change? Will you have a new baby? A new home? A new pet? Are you planning to retire or send your last child off to college? Once you identify all the ways—big and small—your life may change, assess how that will change your finances in the coming year.
Then, build your budget for 2021. Be sure to focus on what matters to you and build habits to help you achieve your goals.
Elizabeth Whalen is a freelance writer based in Seattle. She loves writing about business, financial services and sustainability.