Broadly speaking, personal finance is the way you manage your money and plan for your future. All the financial decisions and activities you undertake will have an impact on your financial wellbeing. It’s important to think about what we can do, in general, to help improve our financial health and habits. Here are ten general personal finance rules that can help you achieve your financial goals.
Know Thy Budget
The most important money move that people can make is to take stock and make sure they know themselves in terms of how much money they need and how much they have.
“Always start with a basic budget,” Dan McElwee, a certified financial planner with Ventura Wealth Management, said. “It is critical.”
Budgeting is the first step to success because it allows you to be thoughtful about your spending, borrowing and saving.
If you’re slow to invest, think of the benefits: being able to afford more rounds of beers and enjoying them more in the future.
“It really is psychologically powerful to be able to say, ‘I’m in control and know what I’m spending,'” McElwee said. “A lot of time people feel helpless, and when you’re using a tool to budget, it helps you feel like you’re in control.”
Calculating A Personal Budget
It is just as important to develop a personal budget or spending plan. This is a financial tool that helps you plan for future costs, reduce unnecessary spending, save for future goals, and prioritize where you put your money.
There are many ways to create a personal budget, but all require estimating income and expenses. Common income categories include:
- Alimony
- Bonuses
- Child support
- Disability benefits
- Interest and dividends
- Rents and royalties
- Retirement income
- Salaries/wages
- Social security
- Tips
General expense categories include:
- Childcare/eldercare
- Debt payments (car loan, student loan, credit card)
- Education (tuition, daycare, books, supplies)
- Entertainment and recreation (sports, hobbies, books, movies, DVDs, concerts, streaming services)
- Food (groceries, dining out)
- Giving (birthdays, holidays, charitable contributions)
- Housing (mortgage or rent, maintenance)
- Insurance (health, home/renters, auto, life)
- Medical/Health Care (doctors, dentists, prescription medications, other known expenses)
- Personal (clothing, hair care, gym, professional dues)
- Savings (retirement, education, emergency fund, specific goals such as a vacation)
- Special occasions (weddings, anniversaries, graduation, bar/bat mitzvah)
- Transportation (gas, taxis, subway, tolls, parking)
- Utilities (phone, electric, water, gas, cell, cable, internet)
Nurture That Credit Score
It’s important to develop credit history through on-time payments to improve your credit score. Otherwise, you’ll end up paying more for things like your mortgage, car, and loans.
If you’re wanting to be plastic-free and have a low credit score, the best thing to do is get a secured credit card and pay the balance off each month.
It will take some time, but if you pay off your balance each month and keep your credit use low (not close to your credit limit), you will improve your credit score.
Build And Maintain An Emergency Fund
An emergency fund is a savings account that you use for unexpected expenses, like a job loss, a major appliance repair or other unforeseen circumstance. It can help you pay for things like car repairs or an emergency trip to the dentist. It can also help you pay your regular expenses if your income is interrupted.
The traditional guideline for saving up an emergency fund is three to six months’ worth of living expenses, but this amount wouldn’t cover a big expense or a loss of income for many people. In today’s economy, it’s advisable to save up at least six months’ worth of living expenses, if not more.
Remember that creating an emergency fund is an ongoing task. It’s likely that you will need to use it for something as soon as you have it saved up. Instead of feeling disappointed about this, be grateful that you were financially prepared and start the process of saving again.
Get The Right Skills For The Right Price
If you want to make more money, you’ll need to acquire some skills that are in demand.
You should improve your digital skills, look for jobs that will still be around in the future, and develop skills that can be turned into a career.
If you’re looking to grow as a worker, you might be best off avoiding graduate school, according to Gian Gonzaga, a psychology Ph.D. who runs data analysis for online lender Earnest. It’s not always worth the financial commitment or debt. “Our psychology is really biased to short-term thinking,” Gonzaga said. “People go to grad school because they love that subject.”
Gonzaga states that if you can make a living by doing what you love, then going to graduate school can be a great idea. However, if you will have to take out loans for a degree that will not help you make more money, it is risky and potentially unnecessary.
Although many high-paying jobs do not require a graduate degree, not all higher education will result in premium pay.
Recognize Needs vs. Wants—and Spend Mindfully
It’s better for you to be aware of the difference between things you “need” and things you “want”. Needs are what you have to have to stay alive: food, housing, healthcare, a way to get around, and some clothes. A need would also include putting some money into savings, investing and giving each month.
So something that’s a want is something you would like to have, but don’t necessarily need for survival. Something that may feel like a need, but is actually a want, is something that’s part of your daily routine but not essential.
The line between “wants” and “needs” is blurred for essentials when there is no defined level of either. A car is a good example. Depending on your city’s public transportation, you might be able to make the case that a car is a “want”. However, for the many of us that consider it a “need”, what type of car is appropriate? What is an appropriate balance between a higher car payment and a nicer vehicle?
Your personal budget should give top priority to your needs. Only after your needs have been met should you allocate any discretionary income toward wants.
Always Be Saving (10-25%)
Once you have a great job and a sensible budget, you can start taking steps to ensure you’re not working forever. Retirement is possible if you start saving money now.
“10% of your salary per year minimum” is the right amount to save, McElwee said. “That is critical to hitting your future financial goals.”
If you don’t enjoy saving money by spending less, set up an automatic deposit that takes money straight out of your paycheck.
You can’t spend what you don’t have.
Anyone can start saving for retirement at any time and may still reach their retirement goals. Although this may be technically true, it is better to start saving as early as possible. The reason for this is because of the power of compounding.
Compounding refers to the reinvestment of earnings and is most successful over an extended period of time. The longer earnings are reinvested, the greater the potential value of the investment and the larger the earnings could be.
Starting early is important because if you want to save $1,000,000 by the time you turn 60, and you can earn 5% interest, compounding monthly, the earlier you start the better.
- If you start saving when you are 20 years old, you would have to contribute $655 a month—a total of $314,544 over 40 years—to be a millionaire by the time you hit 60.
- If you start saving when you are 40 years old, you would have to contribute $2,433 a month—a total of $583,894 over 20 years.
- If you start saving when you are 50 years old, you would have to contribute $6,440 each month —a total of $772,786 over 10 years.
If you start saving now, it will be easier to reach your financial goals in the future. You will need to save less money each month and contribute less money overall.
Keep Your Cool in Good Times And Bad
While it’s important to stay calm during a market downturn, it can be difficult to do so. Your emotions can work against you during tough times like the bear market that started in 2007.
“People make bad financial decisions when they’re under financial stress,” McElwee said. “And in a bad market, people make bad decisions because they’re emotional. It’s not because they’re dumb, it’s because their fear of loss is so much greater than their desire for gain.”
This means that investors tend to overreact to bad news and good news.
Buying and selling your investments in your 401(k) frequently in an attempt to time the market is a risky strategy that usually ends up being unsuccessful, and also ends up costing you a lot in fees. It’s much better to invest for the long term and only make adjustments as your risk tolerance changes.
Stay Goal-Oriented With Every Account
If you have more money saved up than you do owed on your credit card, you are doing better than most Americans. According to a February survey from Bankrate, more than half of Americans owe more on their credit card than they do in emergency savings.
You will need to put in more effort and do more planning to turn your good savings habits into real wealth. To be better than most people, you will need to be thoughtful about how and where you save and invest.
The University of Toronto’s research suggests that if you try to save for too many things at once, you’ll likely never save anything. It’s better to bundle your savings goals together and rename your savings account something like “Dream home fund” to keep yourself motivated.
Recognize and Manage Lifestyle Inflation
As people earn more money, they often spend more money due to something called “lifestyle inflation.” This means that as people’s salaries go up, their spending often does as well.
Even if you can currently afford your lifestyle, it may be harmful in the long term because it stops you from accumulating wealth. Every extra dollar you spend now reduces the amount you will have later in life, including during retirement. Just because you have more money to spend now doesn’t mean you will have more money in the future.
As your situation changes over time, you might find that you need to spend more money. For example, you might need to buy new clothes for a new job, or you might need a bigger house as your family grows. With more responsibilities at work, you might find that it makes sense to pay someone to do some of the work around your house, so that you have more free time.
When you reach different stages in your life, it’s a good idea to go over your budget and make sure that it still accurately reflects your life. This means taking a close look at your expenses and deciding which ones are truly necessary and which ones you can live without.
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