On a day to day basis, money occupies most people’s minds. It’s natural in our working society, where we have families, houses, student loans, and many other forms of debt that weigh on our daily thoughts. Money is such a powerful force in our lives that it can drag down longtime friendships, family, and even marriages. This is the reality we live in, and everyone needs to be adequately knowledgeable on how to manage their finances. Imagine how much time you would have to focus on other more important things if you didn’t have to worry about money? Just the idea of that brings excitement to most people. So how do you get there? There is definitely a solid basic financial plan that can help you steadily get to where you need to go financially. Is it quick and easy? No, definitely not. But if followed diligently, it can help you to build a strong financial base that can improve your situation, and give you options in the future to do the things you want in your life. This road map to financial freedom consists of the following steps:
- Stop living paycheck to paycheck
- Create a savings plan
- Get out of debt
- Save for retirement
- Invest your money
- Go for your dreams
Stop living paycheck to paycheck
Usually the hardest part of any plan is starting it. The same rule applies for your finances. The first step to getting financially healthy is to stop living paycheck to paycheck. When you are struggling financially, it’s easy to fall into the trap of spending all of your paycheck every 2 weeks. It’s a constant cycle that makes it hard to progress financially. The longer you wait to start saving your money, the longer it will take you to get away from depending on every single check and rushing to get your bills in order. The first step in not living paycheck to paycheck is to organize your finances and create a budget. Once you are able to analyze your financial situation, you can find places where you can cut unnecessary expenses and hopefully start saving some of your money.
Create a savings plan
Once you consistently have some extra money coming in from your paychecks, it’s time to start putting it away. Doesn’t sound very fun, does it? Actually, building your savings up is one of the most important and liberating parts of getting your finances in order. Many advisers recommend you keep about 3-6 months worth of living expenses in savings. Personally, I recommend aiming closer to the 6 month end of the spectrum, only because I believe having a more conservative plan gives you more flexibility in the long run.
So, where should you put your savings? It’s important to balance liquidity of your funds and getting a good interest rate. In general, you should consider high interest savings accounts, money market accounts, and CDs (certificate of deposit). Savings accounts offer the most liquidity of all, as they are just a deposit account that allow you to access your money instantly. Traditionally, the downside of normal savings accounts was that they offered very low interest rates (.5% - 2%) even with high balances. Nowadays that is not the case, with many banks offering online savings accounts well above 4%. Money market accounts usually offer a little higher interest rate that most savings accounts, and they offer much of the same availability as a savings accounts. However, you must understand that you can have a money market deposit account or a money market mutual fund. A money market mutual fund is not FDIC insured, and can take a little longer to get access of funds, but they usually have a higher interest rate than a deposit account money market. CDs are timed accounts that offer a locked interest rate for a given amount of time. The catch with CDs is that you do not have access to the funds until the end of your term unless you want to pay a penalty or give up some of the interest you have accrued. So while the interest rates can be attractive, they don’t offer the liquidity of the other options.
There are a lot of savings mediums available to make your emergency savings work for you as much as possible. You just need to research what options are available to you and pick the one that fits into your plan best. The Motley Fool website, which always has great articles on financial management, has a nice rundown of what to do with your short-term savings, so make sure to check it out for more details on handling your situation.
Get out of debt
Now that you’ve organized your finances and managed to save some money, you’re probably feeling pretty good. It’s amazing how seeing a little progress can completely inspire you to keep going. Once you have your emergency savings it really takes a lot of the every day stress that comes with financial responsibility off your shoulders. Having that security blanket in the bank makes you worry less about the “what ifs” like losing your job or having to take on a little extra expenses. The next step to growing your finances is to get out of debt, and make sure that any debt you are carrying is “good debt”.
The basic principle of reducing the right debt is to eliminate high interest revolving debt first. This means that those high rate credit card balances should be first on your list to pay down. There are many different ways to attack your debt, from choosing to pay off the highest interest rate debt first, to paying off the lowest balances in a snowball method. Whichever method you choose, the key is to find something that works for you and continues to keep you motivated.
Save for retirement
Saving for retirement is a crucial part of any financial plan. The younger you can start putting money away for retirement, the better off you will be in the long run. MSN Money has a great article outlining the importance of contributing to your retirement, and the benefits of putting more money away into your retirement accounts early and often. There are many different ways to save for retirement, including 401(k) accounts, IRAs, and Roth IRAs. Some employers are now also offering a Roth 401(k) option.
One thing that you definitely want to do first is maximize any employee match into a 401(k). If you don’t, you’re basically giving away free money. After that, the best option will depend on your individual situation. If you qualify for a Roth IRA, most people agree that it’s a slam dunk. You can withdraw your contributions at any time (so it can double as an emergency savings account), and your earnings can be tax free if a qualified distribution. You’ll need to examine your situation, including your current income and tax rate and estimate what it will be when you retire. That way you can decide whether a tax-deferred or tax-free option is more advantageous to you.
Invest your money
There are two phrases about money that ring so true. The first, let your money work for you. By investing your money, you give yourself the ability to gain interest and hopefully a nice return. Investing can mean many things however, and is just not confined to the stock market. For instance, a lot of people have made a ton of money investing in real estate. Others have decided to invest in businesses. Whatever you decide to invest in, make sure you do your homework. There’s nothing worse than losing your hard earned cash by making a bad investment.
The second phrase about money that holds true is that it takes money to make money. The more you have, the easier it is to make more. As you start to invest successfully, you’ll be able to grow your investing acumen and see opportunities to expand your portfolio. If you are able to have some success just make sure to be careful. You must analyze each opportunity like it was your first, and don’t let previous wins make you lazy.
Go for your dreams
Once you’ve built your rock solid financial foundation, it’s time to have some fun! The benefit of having all of the above savings mediums in place is that it allows you a little more freedom and flexibility with your extra money each month. If you dream of owning your own business, you can work towards that. If you always wanted to buy an old beat up car to fix up, you can do that. Once you don’t have to worry about your day to day finances, and hopefully your retirement nest egg, it allows you to concentrate on the things that interest you. Building a solid financial foundation takes discipline, but will give you a strong piece of mind and ultimately more time to focus on what you love most.
March 5th, 2008 at 9:54 am
I agree that we have to SAVE for retirement, however there are some supposed “moguls” and “rich dads” out there they are teaching that one will never save enough money to retire and that a comfortable retirement will only be achieved through investing in risky property acquisition and sales.
And because of this I don’t think people that are at the early savings age (25-35) are taking the inevitable seriously. They are of the mind that one day their ship will come in and when it does not it will be way too late to start saving.