Financial stability isn’t usually achieved by one decision. Rather, it’s the result of a number of long-term, sensible decisions, made over the years.
It’s not necessarily exciting but building your finances over the long-term is more likely to lead to financial freedom than finding the latest fast way to double your money or a great investment. Also in the long-term your expenses will probably have gone up, your priorities will have changed and from time to time you will have an unexpected bill.
Your goal is to create a financial system that will support you through the ups and downs of life. While it is possible to become overly involved in the nitty-gritty details of every dollar you spend, your financial system should still function well even when there are many variables at play.
Start With a Clear Picture of Your Money
The First Step to Improve Your Finances is to Assess Your Current Financial Situation.
Start by totaling up your monthly spending on things like debt payments, regular bills, as well as everyday spending like food, going out to dinner, coffee, shopping, etc. These types of expenses should be tracked to their penny, because many people underestimate the total cost of their typical, everyday spending (e.g., $300/month of food really equals up to the sum of all restaurant bills, and all grocery shopping, plus all of the associated fees for takeout, delivery, and coffee, i.e., upwards of course, over and above the typical assumed costs for all of the typical, common shopping, e.g., typical expected costs for all typical trips to the grocery store for typical items such as produce, bread, etc., etc., i.e., costs of all of typical shopping for things like produce, bread, etc.).
Viewing your bank and credit card statements for several months is far more accurate than viewing the data for just one month. The month you choose may contain unusual costs, and certain costs, such as quarterly or annual fees and expenses for things like car insurance, occur on a periodic basis.
Allocating expenditure to broad categories such as housing, transport, food, insurance, debt repayment, entertainment and saving allows for an easy identification of fixed and flexible expenditures and which areas may require attention in order to effect improvement.
This process can be quite uncomfortable to go through but it will provide you with the most accurate information of where you stand with your finances. Using this information to create a budget is far better than making financial decisions based on assumptions.
Build a Budget That Reflects Real Life
The key to managing your finances is a budget. A budget doesn’t have to be strict, it can also be used to manage your finances so that you can achieve your financial goals and also be able to spend money on things that you want and need.
While some people can adhere to a strict budget, for others such budgets quickly fall by the wayside, since they do not allow for the occasional restaurant meal, purchase of books and hobbies, and the like. Ultimately, the budget has to leave room for error and make provision for the odd expenditure, which at times can seem to undermine all one’s financial planning and prudent household management.
A budget also needs to account for irregular expenses. These are the expenses for things like car repairs, special holiday expenses, medical expenses, trips, and the annual subscription for things like magazines, video streaming, and online storage.
Another way to plan for irregular expenses is to split them into monthly installments over the course of the year. For example, if you are expecting to spend $1,200 in the next 12 months on car repairs and insurance-related expenditures, your monthly savings would be $100. This creates a situation in which an unexpected expense for an irregular purchase is easier to absorb because you have been placing that money in your account on a regular basis.
A second strategy for simplifying your budget is to automate the payments of important financial obligations and also money you need to save for. In other words, instead of having to ‘remember’ to take the appropriate action (which in all probability you will not) you can set-up your financial obligations to take payments and withdraw funds from your bank account automatically.
Create Breathing Room Between Income and Expenses
The financial buffer is the difference between your income and your expenses, and that needs to be sufficient to give you some room between your income and your expenses.
When every dollar of your money is spoken for before it reaches your account, even minor expenses can become major problems. For example, a sudden jump in your electricity bill, a dental visit that was not expected, or even the breakage of a major home appliance can lead to a desire to charge the expense on a credit card and then to try to find a way to pay for that expense a little later.
In addition to reducing expenses and renegotiating with providers for lower service charges or better terms, individuals can also look to cancel memberships and subscription services that they don’t regularly use and establish a weekly limit for flexible, unplanned spending.
Early payment of income into your accounts can also help to improve the timing of your cash flow. For example, some current accounts allow eligible customers to get paid early. This can help to ensure that bills are paid on time, even if they are due to be paid shortly before your next payday, thereby avoiding late payment charges and the risk of you having to resort to short-term, high cost debt.
In summary, however, timing tools will need to support a budget, and in the end, it’s the budget that will need to generate enough of a buffer so that the exact date of a paycheck will become less important.
Manage Debt With a Defined Strategy
Debt can get out of hand quickly when one makes payments without a plan.
One such list of debt (with interest rate, minimum payment, and repayment term) is shown below. Then, after describing the two most common repayment strategies (i.e., debt avalanche and debt snowball) below this list, we can go on to a description of how to avoid adding new debt while you are repaying old debt.
Two strategies to repay debt have proven themselves: The debt avalanche & the debt snowball. The strategy of the debt avalanche first focuses the money to repay the most expensive debt. In the long run this strategy saves the most money, due to the fact that the amount of interest, which has to be repaid, is reduced in the fastest way possible. The strategy of the debt snowball first repays the smallest debt, to clear this quickly, to get success fast. This strategy leads to an emotional high, as the first paid-off debt leads to a first success.
There is no point in following a debt repayment strategy if you are not going to continue paying the minimum on all of your other debts. You need to choose a debt repayment strategy that is going to work for you.
On the other hand, while you are attempting to pay down existing debts, you should refrain from accumulating additional debt. Although on the surface it appears as though you are being successful in paying off your debts, in reality you would be merely trading one debt for another.
Increase Your Savings When Your Income Grows
Lifestyle inflation can quietly weaken your long-term finances.
Instead of allowing your increased income to go towards even more expensive versions of your current lifestyle, be sure to save a significant portion of your earnings. Allow yourself some wiggle room for increased spending from time to time, but not so much that you actually go backward financially.
Saving half of a raise, a one-time bonus, or additional income from other sources can be a great way to keep income from bringing on a lifestyle of increased spending while still enjoying the fruits of your labor.
You can still enjoy the money from your raise as long as you have set aside the required amount to meet your goals. This way, the money from your raise will increase your financial stability instead of increasing your monthly expenses.
Another method for increasing your savings while you are in a higher income status is to automatically increase the amount of your savings. As stated earlier, increasing your savings by a percentage, i.e. increasing your retirement contributions by 2%, automatically saves for you while allowing for some “lifestyle inflation”.
Focus on Progress Rather Than Perfection
Long-term financial control does not require flawless behavior.
You will spend more than you planned for from time to time. You will have emergencies or make poor financial choices. You will have to put your financial goals on hold for a while. However, that doesn’t mean that all of your hard work will have been for nothing.
What matters is how quickly you return to your system.
Developing strong finances requires developing flexible routines and habits around money. Tracking spending, maintaining a realistic budget, having a cash buffer, paying down expensive debt, and saving more as income increases. Periodically reviewing a financial plan to make changes to accommodate new circumstances in life.
Long-term financial control doesn’t have to mean perfect behavior. There are going to be times when you spend more than you’ve set aside in a given month. Emergencies are going to crop up. There will be occasions where you give in to your impulses and you make a whole host of unnecessary purchases. And yes, from time to time, you’ll probably fall off the savings wagon too.
