I know when you’re just thinking about where to start with your personal finances, or when you find yourself drowning in debt it can be hard to see there IS a light at the end of the tunnel.
Have no fear! I’m going to help you get started on this journey. Just by searching for help you’ve taken a big step forward on your journey! It might not be an easy one, or a quick one, but it will be a worthwhile on.
This post will not be intended to be a full financial plan that will be all you ever need, but what it should be, is a great starting part to get you from feeling lost, to seeing real progress.
Step 1: Track Your Expenses (and Income)
Part of solving any problem is taking inventory of the full situation, collecting data. I know you don’t want to even look at where you money is going, but consider how long have you been avoiding this crucial step? It’s going to be painful, but beyond the pain, is progress towards a better life! A life of less stress. A life of real planning for the future. A life you deserve!
You’re going to want to track your expenses for an entire month. Download your activity from your bank, save your recent bank statements. And if you’re a cash spender, carry an index card or your phone with you and write down every single expense for the entire month. Every expense, no cheating! No more running from this problem, you’re going to face it head on, and open and honestly. If you had a friend who constantly lied to you… eventually you’d stop believing in them right? Well, you can do that to yourself too when you find excuses to ignore the truth about your situation, so now I want you to own it! It’s OK!!! Don’t worry, nobody is judging you. In fact, give yourself some credit for deciding to grab the bull by the horns and take ownership of where you are now and for the success of where you WILL be going!
So, track every single expense for a month!
You can use an application like Mint, Excel, or even pen and paper; but you must track every cent honestly for a month!
…. I’ll wait …
OK. Now that you have that, categorize what you spent; and what you made. You should have categories for: Income, Rent, Fixed Expenses, and Variable Expenses. Under fixed expenses, have sub-categories for things like Utilities, Internet, Phone, Gym, Car, Insurance, etc…. things you pay a fixed amount for every single month. Under variable expenses you’ll have sub-categories for things like Groceries, Entertainment, Restaurants, Gifts, Household Goods, Shopping, Travel, Medical, Transportation (Fuel, etc…), and Other.
Any surprises? Are you spending more in any one category than you thought? Keep those in mind for Step 2.
Step 2: Create a Budget
Next, it’s time to start planning for those expenses, instead of just tracking them. You’re going to create a budget. Take all of those categories from step 1, and plan out how much you’re going to spend in them next month / for an average month.
I still want you to track your expenses, because you need to try to stay within your budget, thus you need to know how much you have left for every single financial decision this month. Running low on entertainment budget? You’re going to have to make some choices and say ‘No’ to some things this month. Saying ‘Yes’ too many times before got us into this mess, so now it’s time to change those choices!
A few points of note:
- If you have a once-a-year charge $60 charge, budget $5 for it every single month to set aside. (I know, I know… it’s tough to set it aside, but at least budget for it!)
- Now is a great time to realize where you’re overspending, and pledge to honestly do better. Spending too much eating out, or on entertainment? Make a reasonable budget for that category and stick to it! Eat at home more, look for cheaper fun activities, make it fun and try something new!
- It’s also a great time to re-evaluate some of those fixed costs. Do you really need cable or all of those subscription memberships? Decide what you can live without and cancel them!
- Evaluate your loans. Is it possible to refinance and get a better interest rate?
- Can you comparison shop for things like insurance?
- Can you sell a car that’s costing too much and buy something cheaper to free up money each month?
- Bike to work?
- Credit cards aren’t part of your budget… don’t start finding excuses to use them! You’ve been outspending your means far too long. Stay strong!
You get the point. As you budget for next month, look for ways to reduce your expenses and soon you’ll might find that “extra” money that you didn’t think you had to apply towards the next steps and use them as tools to dig yourself out of this hole!
After a few months of doing this, you’ll start to get the hang for it, but don’t wait to continue on to step 3, you’re going to want to start that as soon as possible, even budget for it!
Step 3: Build an Emergency Fund
The ideal emergency fund is 6 months of expenses. So, if your budget above is $3,000 then ideally you’d have close to $18,000 saved up. It’s ok to subtract non-essentials from this though, as if the worst comes and you lose your job, you’re going to be cutting back! I know right now that figure might seem impossible. So for now, I want you to have an emergency fund of 1 month of expenses, and $1,000 minimum.
Your emergency fund is to be used for true emergencies. Your car had trouble, and if you can’t get to work you’re going to lose your job. The power is going to get shut off. Your going to die if you don’t go to the doctor. The refrigerator went out. Etc… This is not a slush fund. This is NOT to be used for conveniences. A toaster quitting is not an emergency. A friend’s birthday celebration is not an emergency. Being “uncomfortable” is not an emergency. Don’t cheat yourself out of a financial future because it’s uncomfortable.
If you spend your emergency fund and a TRUE emergency comes up, you’re going to be kicking yourself. This is your lifeline, treat it as such! Save up this E-Fund as soon as you possibly can and don’t touch it! Ideally, recognizing where you were overspending before and changing those habits via budgeting, you should be able to find some money to save this up somewhat quickly if you’re serious about it.
And, if you’re at this step and still feeling hopeless, and still haven’t found extra money to save for this… I want you to start seriously consider ways to gain extra income. Can you take on a second job? Has it been awhile since you job searched and tried to get a raise? Do you have items around the house of value you can sell? Really… increasing your monthly income can be a huge boost, so think hard about legitimate ways you can do that!
Step 4: Don’t Walk Away From Free Money!
If your employer offers a 401k match, you’re going to want to put in the amount need to get the full match. For most, this is going to be somewhere between 3% and 6% of your salary, but it could be more or less. That match is FREE money, 100% profit! Not only will you be saving a little bit for your retirement, but it will immediately be increased by the match! Those contributions will compound over time and grow like crazy. Every extra $100 you save today will have grown to $400 in 20 years. Now, think of that constantly compounding and increasing with new contributions every single month. I know it’s tough when you feel like you need every dollar you can get paid, but to walk away from that FREE money is a sacrifice you really can’t afford to take.
Step 5: Tackle High Interest Consumer Debt
Hopefully, at this point you have your budget going and are getting better at staying within it. You’ve stopped the bleeding by not overspending. You’ve got a small emergency fund, and are ready to start tackling that debt. High interest debt is any debt at an interest rate > than 4%, and many of you might have interest rates on debt as high as 20% or even 30%.
There are two main methods for tackling this debt.
The Snowball Method
With this method has you pay the minimums on all of your debts, and then put all extra money towards the debt with the smallest balance to get it paid off the quickest. As soon as you’re finished paying that off, you now take all of your extra money (including the minimum payment for the now finished debt) and apply it to the newest smallest balance, and so on. The payments you’re making on the smallest balance card get larger and larger as they collect not only the extra money, but the money previously allocated for those minimum payments and grow like a snowball.
The Avalanche Method
The avalanche method is, from a financial standpoint, the best method here. With this method, you pay the minimums on all of your debts, but apply all of your extra money to the debt with the highest interest rate, regardless of balance. This is because for every $100 of debt, and every 1% interest, you are paying $1 a year more than you borrowed, thus the plan is to pay off the debt that is costing you the most money for the privilege of having borrowed it. After that debt is paid off, you take all of the money you were paying on it, and add it to the minimum payment of the next one. This really starts to show some movement after you get going, because the debts are getting easier and easier to pay off as the interest rates get lower and lower.
Which method is right for you?
Pick the method that you personally will feel better at seeing progress. Some people are happy knowing they are making the best decision, but some people really like seeing those low balance debts get wiped out quick! At the end of the day, you are paying off your debts, so you can’t lose! You’re future is WINNING!
Step 6: Finish That Emergency Fund
It’s time to revisit that emergency fund and get it up to the full 6 months of expenses. By now, you should have a great handle on all of your monthly expenses, and the extra money you have that you were previously using to pay off those high interest debts. Take all of that newly freed up extra money and save it in your Emergency Fund until you have 6 months worth of expenses. It’s worth noting that his money should be relatively easy to access should you need it, and not be invested in stocks, etc… This is because if the economy starts to go bad and the market tanks, that’s going to be time people start losing jobs and the exact time they will need their emergency fund. If you’re invested in the market right when this happens, you might see your fund cut in half at the exact time you need it. Keep it in high interest saving accounts, or a serious of rolling CDs. If that’s too advanced for you for now, just keep it safely in a savings account until you finish these first steps!
Step 7: Start Retirement Savings
At this point, you’re going to be ready to start saving for retirement and you’re going to do a few things.
- If you have access to an HSA (Health Savings Account), now is a great time to max it out, as they are very good savings vehicles that you can use for medical expenses, or retirement income if you don’t use it all by the time you retire!
- Learn about IRAs (Individual Retirement Accounts). There are two kinds Roth vs Traditional, and there is a limit how much you can put in ($5,500 per year at the time of this post).
- Pick the best IRA for your situation, and work at maxing it out.
- Save for any large required purchases such as education that will increase your income, or a car that is about to die (but don’t buy a brand new one!)
- Strive to hit the 15% of your income in retirement savings, go back and put more in your 401k until you hit the max limit and/or the 15% of your income mark.
Step 8: Continue Learning About Personal Finance!
Congratulations, you’ve made it this far and have come a long way! Your situation now should feel light years ahead of where it was when you started this journey. It’s time to continue your education and learn about investing in other mechanisms such as stocks, real estate, 529 plans for the children, other goals you have like buying a house, a dream vacation fund, or a little bit nicer car for a change!