Many people believe achieving financial security is beyond their abilities and means. Not so. You need to avoid the financial regrets many people have by developing helpful attitudes and behaviors and putting them into practice.
Some things to avoid:
Not having an emergency fund.
Spending that exceeds your income, resulting in building up unhealthy levels of credit card debt.
Failing to take into account the amount of student loans you take out relative to your future career possibilities and your ability to subsequently pay them back.
Paying too much in rent or buying a house that exceeds a reasonable percentage of your income, making it difficult or impossible to allocate your income in productive ways.
Waiting too long to begin saving for retirement, thinking you can make up for the shortfall later.
Some things you can do:
Create and fund an emergency fund.
Ignore most of what you may have read about how much such a fund ought to contain; that depends on factors such as your age, health, and job security. Think of this fund as an insurance policy that pays you when you need it.
Document what your potential exposures are: job loss, health expenses, car repairs or replacement, home maintenance expenses, etc. You want enough money in the fund to avoid catastrophic events such as getting evicted from your apartment, foreclosure on your house, losing your means of transportation, and being unable to pay unforeseen and unreimbursed medical expenses (including pet expenses), to name a few of the critical ones.
It may be helpful to divide your list into known ongoing or anticipated upcoming expenses, and possible unanticipated future expenses. You don’t have to cover every possible catastrophe – start with your biggest exposure and go from there. The point of an emergency fund is to allow you to get back to where you were prior to getting slammed with a catastrophe.
Don’t confuse your emergency fund with a sinking fund. A sinking fund is a special kind of savings fund dedicated to a specific short-term or long-term goal. Examples include a house down payment, a car, a vacation, and everything in between. Keeping this money separate from your emergency fund will help you resist the urge to dip into your emergency fund, use credit cards, or borrow from friends or family.
Determine what your goal is – define a dollar amount for it – and open a separate savings account for it. Online savings accounts are a good choice for this as they generally pay the best interest rates and offer the capability to have multiple accounts.
Live below your means and pay yourself the difference.
This requires separating wants and needs not once but on a continuing basis. If you live paycheck to paycheck you are never going to make any progress.
To make progress, you (and your spouse, if married) first need a quick assessment of where your money is going – what you’re spending it on. Track your spending for a month or two; that will give you a good idea as to what your priorities are as reflected in what you’re spending money on. Many people are surprised and even shocked to find out.
Take the time to make a budget. Pay attention to what constitutes fixed expenses in your budget and what expenses are controllable and discretionary.
Divert a percentage of your income automatically from every paycheck to a savings account. Note this should be considered in addition to creating a separate emergency fund.
Set some financial goals.
Only pick those that are relevant – have good reasons as to why you are choosing and setting each one.
Now put them in categories: short term, medium term, and long term. And then think about which are well-aligned (complementary), and which ones might conflict.
Finally, find a way to make them visible so you are reminded of them and review them periodically.
Budget some money for self-indulgence.
Some would argue this is just part of an emergency fund. I disagree. I think it should be totally separate, and should contain money you put aside to use any way you want, any time you want. This can give you a feeling of freedom that we all need and can help alleviate the ongoing burden of trying to be financially conscientious in every other way.
Do everything you can to avoid going into debt for assets that will do nothing other than depreciate.
Mortgage debt is “good debt” as housing usually, but not always, appreciates in value, although the expected appreciation will not be anywhere near what most people believe to be true.
Car debt is “bad” debt doubled down – you pay interest on the loan to the lender and you suffer instant and continuing depreciation on the asset.
Maybe you’re thinking you can’t possibly pay cash for a car – that idea is simply not realistic. Perhaps not, but you don’t have to succumb to these other behaviors: buying a car that is more expensive than your financial circumstances dictate, buying a car with a 7-year loan when you have every intention of trading it in before the loan period is up, buying a new car when you could buy one that’s 2-3 years old with low mileage at a price that is likely to be 35% lower in price than the same car’s price when new. Be smart and prepared about this, otherwise you are easy marks for salespeople at car dealerships.
Never charge anything that is not a true emergency on a credit card you know you cannot pay in full when the bill comes due.
Ignoring this means you’re investing in your credit card company without the benefit of owning their stock rather than investing in yourself. Would you rather pay a credit card company 24% interest or have an investment that pays you 24%?
Pace yourself – achieving financial security is like running a long-distance race.
Don’t try to implement all the above at the same time; tackle a piece at a time and build on your successes. Millions have succeeded and millions have failed. You only need to decide which group you want to belong to.
How do I know if I’m on track to be successful?
There are two simple but important ways: monitor your debt/income ratio, and keep track of what’s happening to your net worth.
Your debt/income ratio is the total of all your monthly payments divided by your pretax monthly income. It’s a measure, right now, of the role debt plays in your achieving financial success. The lower the ratio the better: below 25% give yourself a pat on the back, over 36% you’ve got a long way to go.
Your net worth is the market value (current market value, not what you paid for it) of everything you own minus the total of everything you owe. Over time (every year), that number should go up. It may be small or even slightly negative when you are in your twenties, but over time it needs to go up. If that’s not happening, you need to examine your spending habits and overall debt. Think of rising net worth as a signpost on the road towards financial independence.