Six simple steps to improve your personal finance management
Personal finance isn’t a buzzword—it’s the practical ways you manage your money on a daily basis as well as the way you plan for the future. There’s almost nothing as important, but many of us don’t give it much thought. Rather than planning a personal finance strategy, people tend to be reactive, responding to whims and financial pressures without giving much thought to the long-term implications.
Part of the problem is that you can’t build financial security overnight—many financial goals can take years, or even decades to achieve. But that doesn’t mean that you should wait around for things to work themselves out—that’s not going to happen. Instead, you need a smart personal finance plan that includes both long and short-term goals and invests in achieving those goals on an ongoing basis.
Since there are so many things to consider, it can be hard to know where to start—many people give up before they even try taking charge of their personal finances. But it doesn’t have to be that complicated. We’ve put together a few simple steps that can help you improve your financial health and build a more secure financial future.
1. Optimize your mortgage (and consider refinancing)
Whether you own a home or are renting, for most of us, housing is a huge chunk of our monthly budget and therefore is a key component in personal finance. Housing costs have been rising steadily since the mortgage crisis of 2008, and the rent or the mortgage is often our biggest expense. But how much is too much? How much should you be spending on your mortgage? And, most importantly, how can you align this with your personal and business finances so that your investment is risk-free and well-planned (a good first step would be to consult an experienced insolvency practitioner like Hudson Weir)?
Many experts recommend limiting yourself to housing in which the monthly payments don’t exceed 30-40% of your monthly budget in order to reduce risk and maintain financial health. Unfortunately, that isn’t always possible, especially if you live in a big, expensive urban center. If you’re spending more, you may want to consider downsizing. If downsizing isn’t possible, there are other options such as renting out a room in your home to cover some of your costs or refinancing your mortgage that can help you stabilize your personal finances.
Some people are tempted to take out large mortgages because the interest on mortgages is tax-deductible. However, even if you get a 30-cent deduction on every dollar you pay in interest, you’re still paying the additional 70 cents. In addition, if you purchased your house after December 15, 2017, you can only deduct interest for a loan of up to $750,000. Anything over that amount is not tax-deductible, and you pay the interest in full. It’s important to take all of that into account and choose a mortgage that will allow you to achieve both your short and long-term financial goals.
Refinancing
Interest rates aren’t static, and market conditions may have changed significantly since you took out your mortgage. Therefore, you may want to consider refinancing—taking out a new mortgage to pay off your old one. For example, if interest rates have gone down by 2%, refinancing your mortgage could translate into significant savings in your monthly bill. Alternatively, you could continue paying the same amount monthly but shorten the timeframe of your mortgage, freeing you up to make other investments in the future. However, there are significant fees and payments associated with refinancing, so make sure to take the fees into account when deciding whether or not refinancing makes sense for you.
Even if you get a 30-cent deduction on every dollar you pay in interest, you’re still paying the additional 70 cents
2. Borrow smart: payday loans and personal loans
There are a lot of types of personal loans available, and it can be very attractive to take one out when you need to buy a car, remodel your house, or even when you’re planning an exciting trip. Personal loans are heavily marketed, and the marketers make the loans sound irresistible. Despite what they tell you, you should always try to borrow as little as possible. Loans equal debt, and debt is something you want to avoid to maintain financial health and stability. Don’t be tempted to buy things that you can’t really afford. If you need a new car, choose one with fewer frills that will require a smaller loan. Or buy a used car and save the significant depreciation that most cars have in the first years.
If you are taking a personal loan, it’s a good idea to shop around to find the best loan for you. There are huge differences between types of personal loans, so don’t just take the first one you encounter—there might be something a lot better available, especially if you have a good credit rating. And make sure to read the fine print. A loan that looks too good to be true often is.
Payday loans (proceed with caution)
Payday loans are attractive to borrowers in acute need. They feel safe—you know that you’re going to be paid soon, you don’t need to put up any collateral, and the debt won’t stay with you forever. However, payday loans are unsecured and usually charge high, even exorbitant interest rates. They don’t assess your ability to repay the loan and often include hidden fees that can become a debt trap. There are other options available that offer much lower rates and better conditions that could be a better alternative, even when you’re in a pinch.
3. Monitor and repair your credit rating
If your credit rating is low (typically below 670), it can become a major barrier to your financial security. You may not be eligible for many attractive personal loans or mortgages, leaving you with no choice but to take loans with high interest rates that drive you further into debt. It’s a good idea to monitor your credit score regularly, as it isn’t static. If you’re not sure what your credit score is, there are several free websites where you can check it. You should also check your credit report for errors. Credit bureaus make frequent mistakes, and if you find a mistake you can dispute it and possibly boost your score back into the healthy zone.
If your credit score is in fact low, one of the best ways to improve it is by paying your bills on time—your payment history is 35% of your credit score. One good way to make sure that your bills are paid on time is to set up automatic payments for things like utilities. If you’re worried about overdrawing your account, try setting up the automatic payments for after you get paid.
You may also want to keep old credit cards after you’ve paid them off. If the card doesn’t charge high annual fees, by keeping it open you can establish a long credit history, which is 15% of your credit score. Maintaining an old credit card can also improve your credit utilization ratio—the comparison between your credit card balances and your overall credit card limit. Keeping your credit utilization ratio below 30% can make a big difference in your credit score.
Credit bureaus make frequent mistakes, and if you find a mistake you can dispute it and possibly boost your score back into the healthy zone
4. Take control of your credit card debt
Credit card debt can be disastrous to your financial security as interest rates can be as high as 17% on unpaid credit card balances. Therefore, eliminating credit card debt is critical to your financial health no matter what your financial goals are. A good financial discipline not only helps you, but also sets a proper example to younger generations, your children, as they can also be eligible to get a credit card for kids. To learn a balanced financial management from a young age will benefit them for life.
The first step in reducing credit card debt is to reduce your spending. That may seem impossible, but if you want to have money available to pay off your credit card debt, you have no choice but to spend less. If you’re not sure how to reduce spending, try going over your credit card bills for the past several months and marking line items as either essential (things like medical bills) and optional (things like restaurants and new clothes). Total the optional items for the month, and allocate yourself only a portion of that budget for optional items in the coming months. Even items like food and utilities that are essential can be reduced. For example, try opening the windows at night instead of running the AC, skip some of the gourmet, pre-packaged food items, and buy bulk staples instead. There are a lot of amazing recipes online that can be made with inexpensive ingredients. If you commute to work, find a commute partner and save on gas.
If you have a solid credit score, you may qualify for a balance transfer deal to a new card that will allow you to waive interest payments for a certain period of time. That type of interest reprieve can help you get back on your feet and pay off your debt. Another option is to use the “avalanche” method. In that method, you focus on adding money to the card that is charging the highest interest rate on your debt, while paying only the minimum due on your other cards. When the debt in the card with the highest rate is paid off, then transfer your focus to the card with the next highest interest rate, and so on until all of your credit card debt is paid.
5. Save smart
Saving is critical to financial health and smart personal finances. But it’s not enough to simply leave money in your account—you need your money to work for you in both the long and short term. On the most basic level, you want your savings to earn interest. Therefore, it’s not a good idea to leave money in your checking account where it doesn’t earn you anything. Keep the absolute minimum that you need for your ongoing expenses in your checking account, and put the rest of your money into a savings account where at least it’s earning interest.
Then, you want to think about saving for both the short and long term.
Saving for the short term
The first thing you should save for is emergencies. Ideally, you should always have a significant chunk of money in your savings account for unexpected events—they always seem to happen when you’re most strapped for cash. If you don’t have any extras to put away now, try building up your emergency fund over time, for example adding $100 to it every month. You can even put your emergency fund in a separate account that doesn’t have a debit card so that you won’t be tempted to use it for ongoing expenses. It may seem like a tough task, but when you’re hit with an unexpected medical bill, or if your car suddenly needs a new carburetor, you’ll be very glad you have the money set aside.
You may also need to save up for planned expenses like a new car, home improvements, or a trip. If possible, saving for the item is always better than taking out a loan and paying interest. Ask yourself—do you really need the new car or home improvement now, or can it wait a year? Setting aside a set amount in a separate account every month can also be helpful for planned expenses. Missing the extra cash won’t be as painful if you can see the funds accumulating for something you’ll enjoy in the future.
Saving for the long term
It’s also important to save for the long-term for expenses like your kids’ college and your own retirement. While those events may seem far away, the earlier you start saving for them, the better. Experts recommend having a retirement account balance of 2X your salary by age 35, 6X your salary by age 50, and 10X your salary by the time you retire.
Retirement savings plans often offer valuable tax breaks. Your workplace may offer a 401(k) plan to which both you and your employer contribute every month. And even if your employer doesn’t offer a 401(k), as long as you are earning an income, you can and should always contribute to your own individual retirement account (IRA).
In long-term saving plans like a 401k, you benefit from compounding—the reinvestment of your earnings. The longer your earnings are invested and reinvested, the more you’ll have in retirement. In addition, many retirement saving plans are tax-free, making them even more beneficial. So, as soon as you start working, start putting money away for retirement. You’ll be glad you did.
If you have children, it’s very important to save for their education, and like with retirement, there are education savings plans that offer tax breaks for doing so. For example, a 529 plan is a tax-advantaged savings plan designed especially to pay for both college and K-12 education costs. 529 plans include both savings plans and prepaid tuition plans. Like retirement plans, college savings plans benefit from compounding, and withdrawals are tax-free. Alternatively, pre-paid tuition plans allow you to start paying your child’s tuition at designated colleges and universities from the time he or she is born, and locks the tuition costs at the amount that they are when you start the plan. With college tuition skyrocketing, that can be a smart investment.
it’s not a good idea to leave money in your checking account, where it doesn’t earn you anything
6. Invest
If you have money set aside for emergencies and are investing in tax-advantaged retirement and education savings plans but still have additional funds available, you might consider making additional investments. There are endless investment options available, from traditional options like real estate and the stock market, to new venues like cryptocurrency.
When you invest, it’s important to define the right level of risk for you, and the timeframe for the investment. Ask yourself—can you afford to lose this money? If you can, you may consider a high-risk alternative that has the potential for a high return, like cryptocurrency or individual stocks for example.
If you can’t afford to lose the investment, you’re better off selecting a more stable investment that doesn’t put your capital at risk. One option is to buy into a mutual fund or an index fund. Index funds invest in a set list of securities such as stocks of S&P 500-listed companies. Mutual funds invest in a changing list selected by investment managers. While you won’t get rich quick off a mutual fund, over time your investment will grow.
Alternatively, you could invest in real estate. If you have enough set aside to cover the down payment on a rental property, the rent your tenants pay may be enough to cover the mortgage payments. Once the mortgage is paid off, you can either sell the property or use the rent to cover part of your monthly expenses, for example, in retirement.
Take control of your personal finance now
Taking control of your personal finances doesn’t get easier over time, and there’s no better time to start than now. If all six of the tips we gave are too much for you, try implementing one or two and once you get on top of those things, add a couple more. It may seem like a headache, but many people find a renewed sense of tranquility once they know they have a plan for their financial future. Give it a try, you’ll thank yourself later.
