Personal financial management is SO important. Our finances affect everything from our quality of life to our health. If you do not have any financial goals, you are lost at sea and probably not properly preparing for retirement.
Disclaimer: This is meant as general information, and is not financial or any other type of professional advice. Always consult a professional in the area for your particular needs and circumstances prior to making any financial or tax related decisions. Please see my Disclaimer for more information.
Most Americans believe that they are doing okay financially, but they are not properly managing personal finances or preparing for retirement. That is really scary!
- According to a report by the Federal Reserve, 75% of Americans say they are doing okay or living comfortably. But according the the same report, 39% of Americans say that if they were faced with an unexpected expense of $400, they would not be able to cover it.
- According to a report by the CFP board, 59% of Americans aren’t tracking their spending, and 40% have never created a written budget.
- According to Careerbuilder, 78% of U.S. workers live paycheck to paycheck, over 25% do not save money, and about 75% are in debt. That is really scary!
Personal financial management can be difficult. It is something you probably didn’t get taught in school, but it is SO important to actively manage your personal finances. Even if you don’t fall into any of those percentages above, we are all always capable of making improvements.
- 1 1. The first step to personal financial management is to shift your mindset.
- 1.1 A lot of those reasons are emotionally driven. If you take the time to figure out what emotions and needs are driving you to want to spend, then you can come up with other solutions that don’t involve money.
- 1.2 There are a few rules of thumb for personal financial management that will help you shift your mindset.
- 2 2. Make smarter purchases
- 3 3. Personal financial management requires a thorough understanding of your current financial situation.
- 4 4. Figure out where you can cut expenses.
- 5 5. Come up with a savings goal and meet it.
1. The first step to personal financial management is to shift your mindset.
This is harder than it sounds. We need to look at why we aren’t practicing smarter personal financial management. Most of us probably want to be healthier financially, so why aren’t we? The exact answer will always vary for everyone. In general, it could be that:
- You want to keep up with the Joneses.
- You are overwhelmed by other things, and think you are doing fine.
- You cannot break free of the cycle of overspending.
- It is more fun to spend your money today than to worry about your financial future.
- You are in such a poor financial situation that you think that you can’t do anything about it.
A lot of those reasons are emotionally driven. If you take the time to figure out what emotions and needs are driving you to want to spend, then you can come up with other solutions that don’t involve money.
I know what that feels like. When I was in my 20s, I had credit card debt. I can’t even tell you exactly how it happened, but I can tell you that I wasn’t tracking my money, I had no budget, and I loved to spend money. All of those things together are a recipe for disaster.
One of the things I loved to spend money on was nice clothes because they made me feel better about the way I looked. I had an emotional need, which was wanting to feel better about my physical appearance. Buying clothes helped me to meet that need.
I didn’t do this consciously, but if I had stopped to ask myself why I was spending the way I was, it might have helped me to come up with a better solution that wouldn’t cost nearly as much money. For example, working out more could have been a much better way to fulfill that need rather than spending tons of money on clothes.
One day I looked around and wondered how I allowed things to spiral out of control. I also realized that it had negatively affected my self-esteem, and created this dark cloud that had been hanging over me the entire time I was in debt.
I had to take back my life and, in order to do so, I had to get out of debt. I actually came up with a budget, and stopped spending money on things that weren’t necessities, and I was able to pay off all of my debt in 6 months.
There are no words to properly describe how free I felt after paying off my credit card. It was one of the BEST FEELINGS I had ever experienced, way better than the high I experienced from making fun purchases.
It’s been years and years and I’ve never had any credit card debt since. The only debt I currently have is my mortgage. That’s it. This was my huge first step towards smarter personal financial management.
There are a few rules of thumb for personal financial management that will help you shift your mindset.
- Do not live paycheck to paycheck.
- ALWAYS live BELOW your means. (some banks thinks 35% is a good debt to income ratio, but I think that’s high)
- Do NOT upgrade your lifestyle when you get a raise or a higher paying job.
- Pay all of your bills on time. Late fees can add up, and being late on your bills can negatively affect your credit score.
- Eliminate all credit card debt.
- Figure out what emotions are driving you to spend, and come up with solutions that don’t cost much or any money.
- Create specific financial goals and come up with a specific plan to meet them.
2. Make smarter purchases
A smarter purchase is when you weigh the cost AND the quality of an item. Most people might automatically think that when you need to buy an item, you should always pick the cheapest option in order to cut back on spending.
Sometimes this is true, and sometimes it isn’t. It’s always going to depend on what the item is, and a variety of other factors. There are times when the more expensive item will have a lower cost per use, and there are times when the cheaper item will have a lower cost per use.
Sometimes if you choose to just buy the cheapest item available, then it may break or not work properly. Then you may end up spending more to fix it or replace it than what you would have spent on a nicer model.
When this is the case, you would have been better off spending more up front on that item because you would have spend less money overall.
For example, I bought an expensive pair of jeans 10 years ago. This may seem like a bad example given the credit card debt I talked about earlier, but this was one of my few purchases that was a truly good investment. They are still in perfect condition today, and still my favorite pair of jeans.
My husband bought a pair of cheap jeans that he loved, but they fell apart after a year. We decided that, even though they had been cheap, they weren’t a good investment because they didn’t last long enough.
The cost of use per wear for his cheaper jeans was WAY higher than the cost of use per wear for my expensive jeans. Additionally, the cost of a new pair of his cheaper jeans every year for ten years was way more than the cost of my expensive jeans. Plus, I bet they are going to last me another ten years at least.
There are also times when the cheaper item is the best investment, and there is no need to buy a more expensive version. It all depends on what you are buying and what you are going to use it for.
For example, my husband is CONSTANTLY losing his headphones. Therefore, the few times that I’ve purchased headphones for him, they’ve always been on the cheaper side regardless of cost per use because I know that there is a good possibility he will lose them.
3. Personal financial management requires a thorough understanding of your current financial situation.
You need to know exactly how much money you make and how much money you spend. This is a key step in smarter personal financial management. Once you have figured those numbers out, you can figure out where you can cut your spending. That includes both fixed and variable expenses.
Fixed expenses are expenses that do not fluctuate each month. For example, this can include your mortgage or rent, loan payments, and subscription services.
Variable expenses are expenses that change over time based on cost and your consumption. This can include things like gas, groceries, and entertainment.
4. Figure out where you can cut expenses.
If you are on a salary or making about the same amount of money every month, then there isn’t much flexibility there outside of raises or getting a higher-paying job. Therefore, cutting expenses is one of the easiest ways to save money.
The lower your debt-to-income ratio is, the better. Your debt-to-income (DTI) ratio is all of your monthly expenses divided by your gross income, or the money you make before taxes and deductions.
According to Wells Fargo, a good DTI is 35% or less. Lenders use your DTI to evaluate whether or not you are capable of taking out another loan. In my personal opinion, I think 35% is actually a little high.
There are so many ways that you can do this. Once our baby arrived, we cut down on our expenses by hundreds of dollars every month.
It may seem hard because you spend money on certain things because you enjoy them. But you’d be surprised how quickly you can get used to your new normal. You might also be surprised by how much you enjoy saving the money.
RELATED: 13 Simple Ways to Cut Expenses
5. Come up with a savings goal and meet it.
After you have cut down on some of your expenses, you can start saving money. How much money you should have saved up is somewhat arbitrary, but a lot of financial experts say that it is wise to have about 6 months worth of expenses saved up. In my opinion, it never hurts to have a little more than that.
Life is ALWAYS going to throw you curve-balls that you didn’t expect. Maybe one day you get sick and now you have an expensive medical bill. Maybe one day your car breaks down and now you have an unexpected car repair bill.
There are so many unexpected things that could and will come up and leave you with expensive, unplanned for bills. That is why it is so important to have a healthy savings account.
How do you manage your personal finances? Please share in the comments below?