How to Manage Personal Finances

Personal finance management is a subject rarely taught in schools, yet it is a crucial skill that nearly everyone will need to master later in life. Statistics show that about 58% of Americans have no retirement plan or financial management strategy for their senior years. Most people assume they need $300,000 to live comfortably during retirement, but the average American has only $25,000 saved by the time they retire. On average, American households are burdened with $15,204 in credit card debt. If these numbers alarm you and you want to change this trend, read through the following specific, goal-oriented advice to prepare for a better future.

Track all your expenses for one month. You don't need to cut down on spending, but you should have a clear picture of where your money is going each month. Keep all receipts, record your cash expenditures, and note how much you charge on your credit card, then calculate how much money will remain as the next month begins.

After the first month, review all your expenses. Exclude the things you want to spend on and only focus on the things you have actually spent. Categorize your purchases logically. A simple monthly expense breakdown might look like this:

• Monthly income: $3,000
• Expenses:
  • Rent/mortgage: $800
  • Utilities (electricity/water/cable, etc.): $125
  • Groceries: $300
  • Dining out: $125
  • Gas: $100
  • Emergency medical expenses: $200
  • Discretionary spending: $400
  • Savings: $900

Next, create a budget. Based on your actual monthly expenses and spending habits, allocate your income to various categories each month. If you prefer, you can use an online budgeting tool like Mint.com to help with this.

• In your budget spreadsheet, be sure to separate columns for estimated and actual budgets. The estimated budget is the amount you plan to spend in each category; this number should remain the same for multiple months and can be determined at the beginning of each month. The actual budget is the amount you’ve actually spent; this number will vary month to month and can only be finalized at the end of the month.
• Many people allocate a large portion of their budget to savings. While you don’t necessarily need to include your savings in the budget, it’s a good idea to do so. Financial planners often recommend saving at least 10% to 15% of your total income.

Be honest with yourself about the budget. This is your money – there’s no reason to deceive yourself about how much you’ve spent when creating the budget. If you do, you’re the one who loses out. On the other hand, if you don’t know how you’ve been spending, it might take you several months to set up a proper budget. Don’t record estimates until you know the actual numbers.

• For example, if you plan to save $500 each month but realize this is difficult to achieve, don’t write it down. Instead, record the actual amount you can realistically save, then revisit the budget to see if there’s a way to cut down on other expenses and redirect those savings into your savings fund.

Track the budget for a period of time. The toughest part of budgeting is dealing with expenses that fluctuate each month. The great thing is, you will be able to track these changes and know exactly where your money has gone over the course of the year.

• Your budget spreadsheet will show you how much you typically spend if you're still unclear. Many people realize, after setting a budget, that they’ve been spending too much on small, unnecessary items. This insight helps them adjust their spending habits and prioritize more important expenses.
• Prepare for unexpected expenses. As you work through your budget, you’ll also realize that you can never predict when you’ll need to pay for unexpected costs – but these costs can be planned for. While you don’t plan for your car to break down or your child to need a doctor’s visit, setting aside money for such emergencies can be very useful when the unexpected occurs.

Don’t buy when you can borrow or rent. How often have you bought a DVD, only for it to collect dust for years without being used? Books, magazines, DVDs, tools, party supplies, and exercise machines can all be rented for a fraction of the price. You won’t need to worry about maintenance or storage, and generally, you’ll handle items better when renting instead of buying.

• Don’t rent without thinking. If an item is something you regularly use, it’s better to purchase it. A simple cost calculation can help you determine whether renting or buying is the more cost-effective option.

If you can afford it, make a large upfront payment when purchasing a home with a mortgage. For many, buying a house represents the largest and most significant expense of their life. Because of this, it’s important to manage your mortgage payments wisely. Your goal should be to minimize interest and fees while balancing the rest of your budget.

• Pay early. The mortgage rates are often highest during the first 5-7 years. If possible, use your tax refund to pay down part of your mortgage. Early payments can help you reduce the principal by lowering the interest you pay.
• Check if you can make bi-weekly payments instead of monthly ones. Instead of paying 12 times a year, see if you can switch to 26 payments. This could save you thousands of dollars, as long as there are no additional fees. Some banks charge significant fees ($300-$400) for this option, and may only allow monthly payments.
• Talk to your lender about refinancing. For instance, if you can refinance your loan from 6.7% to 5.7% with the same payment terms, you should consider it. This could help you pay off the loan in fewer years.

Understand that owning a credit card is crucial for building credit. A credit score above 750 can help you secure significantly lower interest rates and increase your chances of qualifying for new loans – a benefit you shouldn’t ignore. Even if you don’t use it often, a credit card remains an important tool. If you don’t trust yourself with it, just put it in a drawer and lock it away.

• Treat your credit card like cash – and I mean that. Some people treat their credit cards like an endless cash machine, overspending and only paying the minimum balance each month. If you choose to spend this way, be prepared for large interest payments and fees.
• Try to keep your credit utilization ratio low. A low credit utilization means the balance on your credit card is small compared to your limit. Simply put, if you have a $200 balance on a $2,000 limit, your utilization ratio is very low, around 1:10. However, if your balance is $200, but your limit is only $400, your utilization ratio will be much higher, around 1:2.

Spend only the money you currently have, not based on what you hope to earn. You might think you earn a high income, but if the money you have doesn’t reflect this, you’re living dangerously. The first and most important rule in spending is: Except in emergencies, spend only the money you currently have, not the money you plan to earn. This will help you avoid falling into debt and create a solid plan for your future.

Explore various investment options. As we grow older, we realize that the financial world is far more complex than we imagined as children. There are virtual items bought and sold in real markets; futures contracts betting on things that haven’t even happened yet; intricate and sophisticated stock groups. The more you know about financial instruments and opportunities, the better you’ll get at investing, even if that knowledge simply means knowing when to step back.

Take full advantage of any retirement programs your employer offers. Typically, employees can choose to participate in a 401(k) retirement plan. Under this program, a portion of your salary is automatically transferred into a savings fund. It’s a fantastic savings method because these contributions are taken from your pre-tax income, and many people don’t even notice them.

• Consult with your HR department about employer matching contributions. Some large companies offer programs where they match your contributions to your 401(k) plan, effectively doubling your investment. For example, if you decide to contribute $1,000 per pay period, your employer might contribute another $1,000, bringing your total investment to $2,000 each time you get paid.

If you plan to invest in the stock market, avoid gambling with it. Many people try to day trade in the stock market, gambling on small daily wins and losses. While this can be an effective way to make money for experienced investors, it’s extremely risky and more akin to gambling than investing. If you want to invest safely in the stock market, consider long-term investments, meaning you should plan to leave your investment for 10, 20, 30 years, or even longer.

• Consider the fundamentals of a company (how much cash they have, the history of their products, how they treat their employees, and their strategic alliances) when selecting which stocks to invest in. Essentially, you’re betting that the current stock price is low and will rise in the future.
• For added safety, consider mutual funds when buying stocks. A mutual fund is a collection of stocks grouped together to minimize risk. Think of it like this: If you invest all your money in one stock and that stock crashes, you’ll be devastated; but if your money is spread across 100 different stocks, even if many of them fail, you won’t be heavily impacted. This is how mutual funds help reduce risk.

Get the right insurance coverage. They say a wise person always prepares for the unexpected. You’ll never know when you might need a large sum of money in an emergency. A good insurance policy can truly help you through a crisis. Discuss with your family the types of insurance you might need to prepare for the unexpected:

• Life insurance (in case you or your spouse unexpectedly pass away)
• Health insurance (to cover medical bills and doctor’s fees)
• Homeowner’s insurance (to cover any damages or destruction to your home)
• Disaster insurance (for hurricanes, earthquakes, floods, fires, etc.)

Consider opening a Roth IRA retirement account. In addition to, or perhaps instead of, a traditional 401(k) retirement fund (which can vary depending on the employer and employee), talk to a financial advisor about opening a Roth IRA retirement account. Roth IRAs are retirement accounts that allow you to invest a set amount, and then withdraw the funds tax-free once you reach age 60 (or 59 and a half).

• Roth IRAs are often invested in stocks, bonds, mutual funds, and annuities, offering the potential for substantial growth over many years. If you invest early in a Roth IRA, the compound interest (interest on interest) you receive can significantly increase your investment over time.
• Ask your insurance advisor about income-protected products. With this program, you’ll receive a guaranteed pension for life. This will help ensure you don’t run out of money during retirement. Sometimes, these payments may continue to your spouse after you pass away.

Start by saving as much of your disposable income (the extra money) as possible. Prioritize saving, even when money is tight. Try to save at least 10% of your total income, even when the budget is limited.

• Think about it this way: If you manage to save $10,000 a year — that's less than $1,000 each month — for 15 years, you'll have $150,000 plus interest. This amount would be enough for a child to complete their college education today, but not in the future if your child is still an infant. So, start saving now, and in the future, you'll have a significant sum for your child or to buy your dream home.
• Start saving early. Saving is important, even while you're still in school. People who are good at saving tend to see it as a virtue rather than a mandatory task. If you save early and invest your savings wisely, your small initial amount will grow significantly over time. You'll be rewarded for thinking ahead.

Establish an emergency fund. Saving is essentially keeping aside money that could otherwise be spent frivolously. Having disposable cash means no debt, and no debt means funds available for emergencies. Therefore, having an emergency fund can be quite useful.

• Imagine this: Your car suddenly breaks down and you need $2,000. Because you didn’t plan for this expense, you end up borrowing money. Since your credit is low, you’re forced to pay a high-interest rate. Immediately, you’re paying 6-7% interest on that loan, and as a result, you won't have any money left to save for the next six months.
  • If you had an emergency fund, you could avoid debt and high interest right from the start. Planning ahead is really helpful.

When you start saving for retirement and building an emergency fund, aim to set aside enough money to cover 3 to 6 months of living expenses. Again, saving is about preparing for the unexpected. If you were to suddenly lose your job or if your company experiences a downturn, you would not want to rely on borrowing money to get by. Having enough savings to cover 3, 6, or even 9 months of expenses can help you avoid falling into debt, even in the event of an emergency.

Start paying off debt once you're financially stable. Whether it's credit card debt or mortgage debt, outstanding debts can significantly impact your ability to save. Begin with the debts that have the highest interest rates. (If you have a mortgage, make large payments toward it, but focus on non-mortgage debt first.) Then move on to the second highest-interest debts, and continue paying them off in descending order until all debts are cleared.

Start boosting your retirement savings. If you're approaching middle age (45-50) and haven't started saving for retirement yet, now is the time to begin. Contribute the maximum allowed to your IRA ($5,000) and 401(k) accounts ($16,500) each year; if you're over 50, you can make 'catch-up' contributions to increase your retirement savings.

• Prioritize retirement savings – even more than your children's education. You can borrow money for education, but you can’t borrow money for your retirement fund.
• If you're unsure how much you should be saving, you can use online retirement savings calculators – a helpful tool from Kiplinger here – to assist you.
• Consult a financial planner. If you want to maximize your retirement savings but don’t know where to start, speak with a professional financial advisor. Financial planners are trained to help you invest wisely and often have a track record of investment returns (ROI). You'll pay a service fee, but it’s a fee to help you make money. This isn’t a bad idea.

• When the bank calls offering you a credit card, don't accept their offer, no matter how tempting, as it will only increase your debt. There's nothing more frustrating than getting harassed by the bank for overdue payments you can't afford.