In order to be successful in life, one needs to take care of his or her personal finance. This doesn’t mean you need to be rich, just at a comfortable place where money issues aren’t a constant source of stress.
What is personal finance?
Personal finance is such a generic and broad term these days that it seems to encompass almost everything when it comes to money. Wikipedia defines personal finance as “the financial management which an individual or a family unit performs to budget, save, and spend monetary resources over time, taking into account various financial risks and future life events.” However, in my opinion, personal finance can be more simply be divided up into specific categories:
- Credit management and debt
- Budgets and Saving
- Financial accounts and banks
- Retirement and Investment
As you may suspect, each of these categories touches on the other in some form of interdependency. For example, credit management touches on budgets and income. Retirement and investments depend largely on income and budgeting as well as banks.
Credit and Debt Management
While some people say they can live without credit, in today’s environment, it is virtually impossible to escape the influences of credit on your life. Even if you pay for everything in cash, you can’t rent a car, buy insurance, or open a bank account without having your credit run. The state of your credit is going to determine what kind of deal you get on financial products – this will have a direct effect on other aspects of your personal financial picture like savings, the type of accounts you have and where you bank.
Much has been written, here and elsewhere, on how you can take care of your credit. I invite you to read our articles on credit repair and credit management. In general, a simple but effective strategy for improving your credit situation is to is pull your credit report, make sure everything is accurate and pay down your credit card balances.
The root of all credit problems is simply too much debt. The old adage “neither a borrower or a lender be” is always good advice, though it is the rare person who can get through life without borrowing money. The trick is to know what you can afford as far as payments go and if taking out a loan is going to advance your personal financial position. For instance, if you need to commute to get to a well-paying job, getting a car loan is a perfectly reasonable thing to do. Mortgage guidelines generally specify that a person’s debts should make up no more than 36-42% of their income. This seems to be the sweet spot in which it is possible to carry debt and still have money left over for emergencies, utilities, groceries and the all-important savings.
At the heart of all money management is your source of income. Making sure you have enough money for day to day expenses could determine your career choices – should you be a corporate climber or strike out into your own business? Should you be a temp worker, work contract or drive for Lyft? When you retire, you’ll probably need more than social security to keep you going and your head above the financial waters. Making sure you have enough money to live plus a lifelong habit of investing and saving is going to guarantee income after you decide you are no longer part of the workforce. If you’re not earning enough, what can you do to improve yourself, go to school, take on a second job?
If you have gone or are going to college, how you handle student loans is going to have a large effect on your future earnings, savings, budgets, credit management and debt. Unless you’ve been living under a rock you could not have failed to hear about the student debt problem in this country – it’s such a problem that presidential candidates have made it part of their platform to confront the crisis. U.S. students owe more than a trillion dollars in combined debt, the rates of default on student CPN loans go up each year and student loan debt is not something that students can escape: there is no statute of limitations on this debt and it cannot be discharged in bankruptcy. Making smart decisions about taking on student loan debt is going to have a noticeable effect on your income, credit and debt burdens.
Budgets and Savings
If you spend every penny that you earn, you will most likely find yourself in lot of debt and no retirement savings when you are older, making the possibility of your never being able to retire very real. Budgets have a really bad name – just like diets. No one likes to deprive themselves of things and both budgets and diets do just that. People seem even more reluctant to budget than diet – I don’t know about you, but I’m more likely to pay more attention to my diet than my budget. Fortunately, budgets are not that difficult to write or maintain.
The internet is full of resources to help you understand and develop a budget to make sure that your hard-earned cash goes into the right financial bucket. (Check out the ones on our site.) In a nutshell: Find out what you are actually spending now and on what by keeping track of your expenses for one month and see where your money goes. It can be eye-opening. You may only have to go this far in your budget planning to know that you don’t want to spend $700 on groceries every month or take expensive vacations. Knowledge such as this may make you be more conscious of what you spend each month and be willing to cut back. Once you know where your money is going you may want to write out a formal plan, even if you don’t you might try to reduce expenses. One painless budgeting tool is Mint.com – it can help you budget and keep track of expenses. It connects to your bank accounts and can automatically put your expenditures into categories and give you reports on where your money is going.
Having a budget (even an informal one in your head) will ensure you have savings. Savings are so important to your personal financial health. Without them, you will not be able to cover emergency expenses (which could force you to take out a fast high-interest loan) nor have enough to purchase a home or prevent yourself from going into debt to buy some niceties for yourself. Debt is very costly, both to your saving plan but also to your credit.
Financial Accounts and Banks
Where you keep your money can have a big impact on your personal finance picture. If you are spending $35/month on a checking account, you may want to check out a credit union or visit your bank to see if they can offer you a better deal. Some accounts offer free checking merely by having direct deposit of your paycheck – others may offer you free checking if you keep your account above a certain minimum balance each month. Even small savings like this can be important to your budget.
Where you keep your investments obviously is very important, but you may not have a choice if you are participating in your company’s 401K. If you DO have a choice, it’s worth checking out the fees involved with your IRA account or your Roth. You may be surprised at the fees you are being charged.
If you have credit cards, picking the right ones is obviously something you want to consider carefully. It’s not unusual to have credit card interest rates at 13.9% (vs. high interest rates in the 20-percentile range), even if you have bad credit, so it’s worth shopping around.
It’s also important for you to pay your credit cards on time, not just to maintain your credit rating, but also, if you have missed payments, your relatively low interest rate card could jump up to more than 29% (yes, this is legal and is standard in most credit cards). Keeping a tight rein on your budget is important to make sure you have the money to make the payments. And while we’re speaking of payments – making the minimum payments is a way to make sure your credit cards are as expensive as possible and to have the bank love you. Paying the minimum may mean that it will take you years to pay off a $1000 balance.
Carrying a balance every month is one of the worst things you can do, not only does it cost a fortune, but you could be damaging your credit as well if the balances get high enough. The optimal percentage of your credit limit is 10%, but you will probably suffer no ill effects if you go as high as 30%.
Retirement and investments
With interest rates below 2% (sometimes lower than 1%), keeping your money in a savings account can be a not-so-smart decision. For myself, I have my investments in an investment account that pays market returns (compared to the stock market average). However, I do have one smaller saving account that I use for emergency funds. The advice given earlier in this article about checking fees in any investment account you open should be followed. Should you get a financial advisor? I have one and I am happy with him. If you don’t have one, you can still go it alone. One low cost option is to account in an online account like Vanguard will charge you the minimal amount of fees and invest in an index fund. An index fund follows the market closely, so if the stock markets sees large gains, your fund will also (of course, the reverse is also true). With the historical average going 8-10% increases, this is an easy way to put your money in something relatively safe. The stock market is very volatile in the short term, with large swings, so you want to think long term.
One of the most important decisions that needs to be made is exactly when to retire. Should you take Social Security at 62 or wait until 70? Will you have enough to live off of long term, or will you be forced to cut back dramatically on your income expectations and therefore make drastic changes to your budget? The average life expectancy is 78.7 years (2018 estimates) – will your money last that long? What about health care? Even with Medicare at age 65, if you want to cover the cost of prescriptions, your out of pocket cost is still $200-$300 a month. Did you budget for that amount? It’s really worth the time and effort to come up with a plan.
We’ve only scratched the surface here on personal finance, but the overall message should be that personal finance fitness is a lifestyle choice, much like a wellness plan. With a little investment of time to research and plan, your life could be a lot more stress-free.