New Year’s resolutions—almost everyone makes them; hardly anyone keeps them. Along with exercising more and eating healthier, getting our financial house in order is one of the most common promises we make to ourselves each year–and one that we continue to break. But this is the year that’s going to change. This post is the first in a series that will give you some ideas on how to finally get it done. Getting your financial house is order doesn’t really need to be so hard. If you do a little heavy lifting and get a few of the basics squared away, the smaller details will be a lot easier. For the next few weeks, these posts will focus on some ideas that will help you with those basics.
Spending and Saving
One of the first areas that typically need to be addressed is your spending. I understand that nobody likes to budget, so I don’t recommend wasting the time or energy that it would take to set up a budget. However, understanding how much you are spending is an important part of planning for your financial future. If you know what you are spending, you’ll know whether you are living within your means. And if you are living within your means, you are well on your way to building a successful financial life. Knowing how much you are spending will also begin to give you an idea of what you might need to maintain your standard of living in your retirement years.
Getting a handle on your spending doesn’t have to be hard. There are many online tools and apps that can help. Most credit cards companies offer you a chance to categorize your spending, or you can use account aggregators like Mint.com or Money Center, the tool we provide for our clients. While it helps to see where you are spending your money, an even easier way to know what you are spending is to use a simple calculation. Add up your income and then subtract the amount that you are paying in taxes and the amount that you are saving. The amount that’s left over will be the amount that you are spending. If you need some ideas on how to reduce your spending, here’s an article that can help: “23 Ways to Cut Costs and Save More Every Month.”
Once you have an idea of what you are spending, it’s time to address your savings. No doubt you’ve heard the term “Pay yourself first.” It sounds very basic, but it’s very true. The way to build wealth is to make sure you are setting aside money on a regular basis, like from every paycheck.
When it comes to how and where to save, the most important place to start is with your emergency fund. You should build up your cash savings until you have an amount equal to three to six months of your monthly expenses. This is the money you’ll need if/when something unexpected comes up. These funds should be held in a cash savings account, either at your local bank or one of the online banks offering slightly higher interest rates. Knowing that you have enough cash reserves to keep the bills paid in the event of a major home or auto repair, or an interruption in your monthly income, will provide a level of confidence that will allow you to move to the next step of building your financial foundation.
Once you have a solid emergency fund in place, it’s time to address your long-term savings. This is the savings that you’ll need to accomplish some longer-term goals. Maybe you are saving for the down payment on a house or to buy a new car. You build these accounts the same way you built your emergency fund—a little at a time. If you are going to use the money within two or three years, it should stay in cash, in the highest-yielding savings account you can find. You don’t want to subject short-term money to investment risk. It wouldn’t be good to find the house you want to buy in two years and have a decline in the markets reduce the amount available for your down payment.
Finally, we’ll address even longer-term savings. Most of us would like to retire one day. Building a solid retirement account is the best way to make it happen. There are several types of accounts you can use to build your retirement fund. The most popular are individual retirement accounts (IRAs), either traditional or Roth, and employer-based accounts like a 401(k) or 403(b). Most of these accounts are funded through payroll deductions. They are the best way I know of to “pay yourself first.” The rule-of-thumb says that you should contribute 10% of your paycheck into your retirement account, although with our increased life expectancies, that rule could be bumped to 15%. If you are lucky enough to have a 401(k) or other employer-based plan that comes with a match, it’s free money! At the very least, make sure you are putting enough away to take advantage of the full company match. We’ll discuss how to invest those longer-term accounts in an upcoming post.
Taking control of your spending and getting a plan for your short and long-term savings are a couple of solid steps in keeping that resolution to get your financial house in order. More to come next week. For now, I’ve got to eat these vegetables before heading to the gym.