Personal finance can seem like a complicated and intimidating topic. There is a lot of information out there and sifting through all that can get overwhelming. But personal finance really isn’t that difficult. For beginners, planning for your financial future can come down to just a few basic points. So if you’re looking to get started on managing your money, here are the top ten basic personal finance tips to help you on your way to financial success.
1. Set financial goals
Every worthwhile pursuit or endeavor in life starts with setting goals.
Goals are important. Goals give you something real to aim for. Setting goals essentially means defining your destination – where you want to be and what you want to achieve. It also means defining the journey – what you need to do in order to fulfill your objectives, and how long will it take you to get there. Having clear goals keeps you focused, ensures you are always on track, and allows you to measure your progress.
It is no different with personal finance. You also start by setting goals. Whether it is buying a car or a house, paying off all your debts, saving for a year-long vacation, or retiring at an early age, establishing your financial goals is akin to laying the foundation of your financial success.
Generally, there are three types of financial goals – short-term, long-term, and mid-term goals. Short-term goals are your more immediate objectives, those that you want to achieve in a shorter time frame which can range anywhere from a few months to a couple of years. These goals include buying a new smartphone, building an emergency fund, paying for minor home improvements, or paying off monthly credit card balances.
Long-term goals take much more time, from upwards of a decade to most of your lifetime, even! These are often the larger and more important milestones in your life, like paying off your mortgage, starting a business, or saving for a retirement plan or your children’s college education.
In between short- and long-term goals are mid-term goals. These are the goals you want accomplished within three, five, or even ten years. These include buying a car or saving for a down payment on a house.
When setting your financial goals, arrange them according to priority. Some goals need immediate attention, while others may be saved for later. Make sure your goals are specific, workable, and measurable. Establish a realistic time frame for each, and estimate the amount of money you think each goal will cost you.
Keep in mind that your financial priorities might change over time. Some of the goals you set today might not have the same relevance ten, twenty, or thirty years down the road. But while goals may change, their purpose stays the same. Remember to continuously review your goals and determine what changes you need to make in order to keep moving towards financial success.
2. Know your net worth
Your net worth is a snapshot of your financial status at a particular moment. It is a gauge of your financial health and a measure of your wealth, and can be used to track your financial progress. Simply put, calculating your net worth gives you an idea on where you are right now financially, and what you need to do in order to reach your financial goals.
Your net worth is simply the difference between the total value of your assets and the total value of your liabilities. In short, it is what you own minus what you owe. It is the amount left over if, theoretically, you sold all of your assets to pay for all of your debts.
To compute for your net worth, make a list of your assets and calculate their total market value, or the price your assets would fetch in the marketplace. Some of your assets have definite and easily obtainable market values. But for others, you need to make estimates. Remember to make your estimates as conservative as much as possible.
Start with your liquid assets – those that can be easily sold and converted to cash without losing value. These include checking, money market, and savings accounts, and cash. Add the value of your investments – stocks, bonds, mutual funds, Certificates of Deposits (CDs), and otherwise. Then add the value of your other assets such as your house, car, and personal properties like jewelry, art pieces, and furniture. Include also the cash value of your insurance policies.
Once you have computed for the total value of all your assets, do the same for your liabilities. Your liabilities are your outstanding debts, including your mortgage, car loan, student loan, and credit card balance.
Now, subtract the value of your liabilities from your assets. The difference is your net worth. If your assets exceed your liabilities, you have a positive net worth. Conversely, if your liabilities exceed your assets, you have a negative net worth.
Ideally, you should aim for a positive and increasing net worth. That means you need to work towards acquiring more assets while paying your liabilities. If your net worth is negative right now, don’t worry. It’s simply a starting point. Remember to calculate your net worth every year so you can keep track of your progress.
3. Track your expenses
Tracking your expenses helps you keep a firm control over your finances and ensures that you avoid overspending. When you have an idea of your spending pattern and the nature of your expenses, you can make prudent decisions on how you spend your income. You understand what expenses are essential and what are not, and so know what expenses to prioritize and what to cut back on.
To monitor your spending behavior, you can begin by listing all your expenses in a typical month. That means every bill you pay and every purchase you make. Collect all your monthly bills – utilities, cable, phone, Internet, mortgage or rent, insurance premiums, car loan, credit card billing statement, and otherwise – to help you catalog your monthly spending. Collect every receipt if you have to.
Include your day-to-day expenses, no matter how small and unimportant these might seem – remember, all these add up. Don’t forget to factor in the expenses that occur regularly but not necessarily every month, such as car maintenance.
Once you have a complete list of your expenses, arrange these according to categories like housing, utilities, transportation, food, clothing, entertainment, etc. Then total the amount for each category.
Now that you can see where your money is going in a typical month, you can pinpoint categories where you have spending issues and make adjustments accordingly. You can determine expenses you can cut back on and by how much. Perhaps you’re spending too much on your daily morning caffeine hit. Or maybe paying hefty subscription fees on magazines you don’t even read might not be viable anymore.
Remember, your spending is made up of fixed expenses and variable expenses. Fixed expenses usually cost the same each month, like rent, mortgage, insurance premiums, and debt payments, among others. Conversely, variable expenses are costs that change each month. These include gasoline, groceries, electricity, phone, etc. You might find it easier to make adjustments on variable expenses than on fixed ones.
Keeping track of your expenses might seem like a lot of work, especially if you are only trying it for the first time. But it’s certainly worth it. And it need not be that difficult. There are plenty of computer and mobile apps that can help you monitor your spending habits and manage your finances.
4. Stick to a budget
If there is any one single most effective tool to help you manage your finances, it’s undoubtedly a budget.
A budget is essentially your spending plan. It’s your strategy for how and where you want to spend your money. It allows you to make the most out of your income by ensuring that every dollar is spent the way you want it. Contrary to popular belief, a budget is actually freeing, not restricting – it frees up your money so you can spend it on things that matter most to you.
To create a budget, you can begin by calculating how much money you actually have available for spending in a typical month. That corresponds to your monthly net income – your take-home pay – plus additional income, like pension, alimony payment, or child support, if you have any.
Once you have figured out your budgetable income, you can begin dividing and allocating it according to your expenses. Remember, an ideal budget ensures that you always have money for the things that actually matter.
So, allocations for essential needs – food, housing, utilities, transportation, and basic clothing – should be a priority, as well as savings and debt payments, if you have debt. Once all of these are taken care of, only then can you apportion money for nonessential expenses, such as entertainment, vacations, and otherwise.
Your budget should help you avoid overspending. Look for expenses that you can reduce, or if possible, completely eliminate. Do you really need to pay $5 for coffee every morning? Why not pack your own lunch instead of eating out every time? Since you never watch TV anymore, maybe it’s about time you ditched your costly cable subscription?
But your budget should be realistic, too. Bear in mind that you actually have to live on and by it. It makes no sense when you make your budget too harsh – you’re only setting yourself up for failure. So don’t be too hard on yourself. As long as you are prioritizing your essential expenses, there’s no reason to not allocate money towards having fun in your budget!
5. Spend less than you earn
Part of successfully managing your finances is knowing how to live within your means. This includes keeping track your expenses, creating and sticking to a highly realistic budget, and spending less than you earn.
Spending less than you earn is a simple and straightforward concept. You spend less than your income, and save what is left over. In fact, it even falls within common sense. Unfortunately, it’s not common practice.
A lot of people are completely unaware of their financial situation and tend to live a lifestyle beyond their means. Because of this, they struggle to make their paychecks last long enough for the next one. And when their paychecks can no longer finance their lifestyle, they resort to debt to cover spending gaps.
Frugality is a key concept in personal finance, albeit one that is often ignored or even derided. Many people think of frugality as obsolete. Others think it is even tantamount to deprivation.
But being thrifty doesn’t mean you have to stop enjoying life. It’s simply about understanding the nature of your expenses – knowing what expenses are essential and what are not, and what expenses need to be prioritized and what can be reduced or even completely eliminated.
Besides, adopting thrift need not involve drastic changes in your life. You can start with small and simple adjustments here and there. Identify expenses that you do not really need to be paying. Think about all the luxuries you spend money on and decide if you can do without them. Put in the time and thought to all your purchases so you avoid impulse buying.
Spending less than you earn, however, goes beyond cutting back on costs and adopting a frugal lifestyle. It’s also about figuring out ways to increase your income. After all, there are only so many spending cuts you can make. While saving is crucial to building wealth, you do not want to become so fixated on saving alone that you neglect what is even more important – increasing your earnings. So don’t worry too much about running out of money. Focus instead on how to make more.
6. Start an emergency fund
An emergency fund, or a rainy day fund, is money set aside for financial contingencies, either to cover temporarily lost income or to pay for unexpected but essential purchases. With an emergency fund, you reduce the need to resort to debt.
Imagine needing major repairs for your house, but you will not be receiving your paycheck for another week or so. Imagine getting sick all of a sudden, but your insurance will not cover your medical costs. Imagine losing your job – your only source of income – one day, and you know it will take you weeks, maybe even months, to find another job.
An emergency fund helps you prepare for just such contingencies. It is your safety net against unexpected expenses that could leave you financially worse off. Knowing that you have an emergency fund to tide you over should the worst happen affords you peace of mind and a sense of security.
Ideally, your emergency fund should have enough money to cover at least three to six months of your expenses. It should be placed on an account separate from your regular checking and savings account. That way, you reduce the temptation to spend it on non-emergencies. Remember, out of sight, out of mind – until the need arises.
Make sure you always have quick and easy access to your money, so avoid putting it on high-risk or non-liquid investments. Instead, a high-yield savings account should be your first choice. You can also invest in a money market account. In both options, not only are you guaranteed immediate access to your money, your emergency fund can keep growing until the moment you need it.
You can also choose to invest your emergency fund in Certificates of Deposit (CDs). These can offer you an opportunity to earn more than high-yield savings or money market accounts, but the drawback is that you might incur a penalty fee if you withdraw your money too early.
7. Save for retirement
How do you see yourself after retirement? Sipping margaritas on a tropical island paradise? Sunbathing on a yacht in the Mediterranean? Traveling to a new country every month? Starting your very own business? Or perhaps living a pleasant life in a quaint country house by the lake? However you envision your life after retirement, you need money to make it come true.
Saving for retirement is one of the most important financial goals you can have. You’re essentially preparing for that part of your life when you finally stop working and enjoy your remaining years. To start saving now is to ensure a more comfortable retirement.
Unfortunately, a lot of people delay or even disregard saving for retirement. To some, retirement is still a long way off, and there are plenty of better things to spend money on now. Others are choosing to leave it to chance, betting that the future will sort itself out anyway.
But saving for retirement is more important now than ever. The cost of living is always rising. People have a higher life expectancy and thus need more money to see them through their latter years. The cost of healthcare is higher during retirement since older people tend to have more health problems. Add to all these the fact that fewer employers are offering defined benefit plans, which means relying on pensions is becoming less and less viable for retired employees.
Your age when you start saving and the amount you set aside largely determine how much income you will have during retirement. Saving for retirement relies on the miracle of long-term compound interest. When you deposit money on your retirement account, not only do you earn interest on your deposit, you also earn interest on the interest! So, your retirement savings account can grow increasingly faster over time. And the more time you allow your savings to grow, the more you accelerate your earnings.
Because of this, younger people have a greater advantage when it comes to saving for retirement. The younger you start saving, the more likely you will secure a comfortable retirement.
8. Pay off debt
There are two kinds of debt – bad debt, and good debt. Bad debt is debt you incur for no real financial gain. It is debt you spend on things that will lose value over time, which will neither generate you income nor increase your net worth. Bad debt is money you borrow even if you have no realistic plans for paying it back.
In contrast, good debt is debt taken on that has the potential to increase your income and build wealth. For this reason, good debt is considered as an investment that might become profitable in the future. Good debt is usually incurred when you have a clearly defined purpose for the money you are borrowing, and a workable plan for paying it back as quickly, consistently, and cheaply as possible.
But debt is still debt, whether you think of it as good or bad. And with debt, the sooner you pay it back, the better off you are. Not only do you rid yourself of a financial liability, you also relieve stress and gain peace of mind.
There are several strategies to paying off debt. One such strategy is known as the debt snowball method. With this method, you settle your debts according to their size, regardless of interest rates. You pay off debt with the smallest balance first, while making only the minimum payments on your other loans. By settling smaller loans first, you can clear several of these early on.
Once your smaller loans are paid off, you can then devote more and more money to clear your larger balances, until you finally settle your largest loan. The debt snowball method can cost you money in terms of interest. But its biggest advantage is psychological. Seeing your progress “snowball” as you clear your loans from smallest to largest is empowering and can keep you motivated to work your way through to your last debt.
In contrast, with the debt avalanche method, you prioritize paying off debt with the highest interest first while making only the minimum payments on the rest of your loans. Once you have cleared your highest interest rate debt, you move on to the next highest interest rate, and so on and so forth. With this method, you can save money from reduced interest rates.
9. Look for investment opportunities
If you’re looking to get rich, penny-pinching can only get you so far. The better approach to building wealth is to increase your income, and investing is one way to do it.
Investing involves committing money into a venture or a vehicle in the expectation of gaining some profit in the future. Simply put, investing is lending your money out to an individual or an institution in the hopes of making even more money. It’s really about making your money work for you.
Your aim in investing is to make your money grow by purchasing assets that might generate income for you, and/or increase in value in the long run. You may earn dividends from investing in stocks, interest from bonds, or even rent from real property you lease out. Over time, your investments that have grown in value can then be sold at a profit.
Unlike saving, investing always involves risk. There is no guarantee of a return. You may lose some or even all of the money you invested. But the greater risk is offset by the possibility of greater earnings. As a general rule, the more risk there is to an investment, the higher the potential return, as well as the possibility of loss.
While it is true that there is no guarantee of financial gain from investing, putting in some effort on your part can improve your odds of success. To temper the inherent danger of investing and actually turn a profit, mastering the principles of risk management is crucial.
There are different types of investment vehicles and understanding the nature of each type is critical to your success. You need to know what investment vehicles are best suited to your financial goals. Before you invest, devote sufficient time to thoroughly analyze and research on the advantages and disadvantages of each type.
Investing is all about growing your money, but you must invest cautiously. As the old adage goes, do not put all your eggs in one basket. In finance that means you need to diversify your portfolio. To help minimize potential loss, spread your money across different types of investments. In the event that one of your investments incurs a loss, your other investments could help offset it by earning you a positive or higher return.
10. Get insured
We cannot predict the future, but we can do the next best thing – prepare for the unexpected. An emergency fund is set up for unexpected expenses that can leave you financially worse off. But it’s just a start. The next thing to do is to get insured.
Insurance is essentially a promise of protection from financial loss. Basically, when you buy insurance, you are buying a promise that you will be paid for when certain things happen to you or your possessions.
Of course, insurance is more complicated than that. When you buy an insurance policy, you enter into a legal agreement with the insurance company. In this, you pay the insurance company money called the premium. In exchange, the insurance company guarantees you financial compensation in case of contingencies in which you incur a loss. What these contingencies are depend on the type of insurance that you are paying for. It can be your death, or damage to or destruction of your property.
There are numerous types of insurance. These days, you can get almost anything and everything insured. It all depends on what you need. However, in most cases, there are only several important types that you need to seriously consider. These include life, health, disability, auto, and homeowner’s insurance.
Because your greatest asset is none other than yourself, getting yourself insured first, over anything else, is important. Health insurance can help ease the burden of medical expenses should you get sick or injured. Disability insurance can cover lost income in the event that you are unable to work and earn money due to a disability. Upon your death, life insurance can help provide some financial security to those you leave behind.
Meanwhile, auto insurance can help you mitigate the costs resulting from auto accidents or other vehicle damage. Homeowner’s insurance can compensate you if your house is damaged or destroyed.
While insurance cannot completely cover all of your unexpected expenses, it can help ease the burden of financial difficulties. Having reliable insurance can give you peace of mind and a sense of security, knowing that you are prepared for the unexpected.
One final thing…
All of the above personal finance tips are basic and general advice. In fact, all fall within common sense. But just because it’s common sense doesn’t mean it’s common practice. All these personal finance tips sound simple and easy in theory, but become a different matter altogether when put into practice. Personal finance is about starting and sticking to good money management habits for life, which will take time, discipline, and consistency. Sometimes some habits will work for you, other times they won’t. It’s really all about finding what works best for you. That’s why it’s called personal finance.
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