Where do I start?
The first thing you need to do is find out where you are with your finances. Most of the times, people just financially “exist,” moving directionless each day. Accomplishing these three steps will help orient yourself. You can read a more in-depth explanation of each step here.
- 30-day Spend Plan Challenge: For 30days, track every cent that you spend on an excel sheet, app, or anything else. Categorize each expense (i.e., Dining Out, Food, Gas, etc.) to see where you typically spend your money. You can quickly see what you need to cut or how much discretionary money you can start saving.
- Net Worth Calculation: Figure out your net worth by listing all your assets and subtracting them from your liabilities. If you have large student loans or own a home, you may be in a negative net worth situation which is okay. Following the cycle below will help you work towards increasing your net worth.
- Monthly Expense Calculation: A lot of our normal monthly expenses increase without our awareness. We become even more ignorant of expenses with how automated bill paying is now. You need to evaluate your spending and make sure you have a handle on your situation.
Once you complete these three steps, you should know how much discretionary income you have to start saving.
This is a cycle of where to put the discretionary money that you’ve identified above. A common economic term is the “next dollar,” which means you can use this cycle for every next dollar of discretionary money you have. For example, you don’t need to put all your money towards debt, rather you can do these steps simultaneously. Sometimes you’ll need to break from your current step and go back to a previous step.
- Create/Fund an Emergency Savings Account: An emergency savings account consists of 6 months’ worth of expenses. If you have a stable job, then 6 months is perfect. If your job or your income isn’t stable, you may want to save more. Given the current low-interest environment, it’s recommended you don’t have too much money sitting in cash.
- Eliminate/Reduce Debt: Debt typically carries a higher interest rate than savings or investments, so paying eliminating or reducing your debt to a manageable level is always a better Return on Investment.
- Getting rid of debt is a personal choice. Honestly, being debt free is an amazing feeling; however, you must also work towards retirement savings, short- and long-term goals.
- Save for Retirement: This is where you put money in tax-sheltered investments. I recommend maxing out an Individual Retirement Account (IRA), then a 401(k), 403(b), or Thrift Savings Plan.
- After nearly two decades of trying to beat the market, I’ve concluded that 99% of us can’t. As such, if you’re under 55, I recommend opening an IRA with Fidelity or Vanguard and placing all your money in a Total Stock Market mutual fund.
- If you’re not scared of technological advances, you may want to try opening an IRA with Betterment using this link. Betterment uses algorithms to manage your portfolio. You simply need to designate your mix that you’re most comfortable with. I’m comfortable with more risk for the higher reward, so I have a 90% stocks/10% bonds mix. Betterment does everything for you after that.
- Short-Term Goals: Short-term goals are expenses coming in 1-10 years. Common short-term goals are purchasing a car, having a wedding, taking vacations, etc. I recently purchased a brand-new SUV in cash, and it was an amazing feeling. Paying with cash helps you enjoy these purchases and stops the “debt spiral” that most of America finds itself in. You can place this money in the same account as your emergency savings account for short-term purchases.
- Long-Term Goals: These are expenses coming in 10-30 years or are long-lasting costs. Examples of these are house down payments (long-lasting) and saving for a child’s college education.
- The money saved for a down payment can also be placed in your emergency savings account. If buying a house is 10 or more years out, you can place that money in a tax-exempt municipal bond fund with Fidelity or Vanguard. This will reduce your tax burden and has a much higher yield than a savings account.
- For long-term goals like children’s college education, it’s important to look for tax-sheltered options. For example, you can invest in a 529 account (Google it), and save for your children’s education while avoiding penalizing taxes. Some jobs offer High-Deductible Healthcare Savings Accounts which also lets you avoid taxes while investing in your own health insurance.