How to Be Good with Money
No matter how much or how little money you make, knowing how to manage it can make the difference between living paycheck to paycheck and being financially secure. Money management skills are an important part of being independent. To be good with money, you need to create a budget that allows you to track your expenses, establish an emergency fund, and pay off your debts. Then you can begin investing and build your wealth.
Creating a Budget
Figure out your monthly income.This might be a simple or more complicated task depending on how you receive income each month. If you're on a set salary, you probably get the same amount of money every month after taxes. If you're on a freelance salary or paid hourly and don't work set hours, it may be harder to calculate your salary.
- Don't forget to account for other sources of monthly income besides paychecks, including things like rental payments from tenants if you own properties; child support or alimony; social security payments, disability payments, or pension; or income from interest or capital gains if you have investments.
- Add up all the sources of monthly income and write down the total amount. This amount is your total income, and as you create your budget, all of your expenses cannot exceed this amount or you will go into debt. If your expenses are less than this amount, you will have money left over to save.
- Remember that paychecks are after-tax, and so the tax must be added back in to obtain gross income.
Figure out your fixed expenses from housing and debt.Fixed expenses are those bills that come due in the same amount every month like clockwork. When you build a budget, these are the first things that you have to account for, because you can't affect the amount or choose not to pay these expenses.
- Fixed expenses from housing or debt can include your rent or mortgage payment, car payment, child support or alimony payments, or credit card or personal loan debt.
- List each housing or debt expense, and add them up. Housing and debt should account for about 30% of your budget. That is, if your monthly income is ,000, your housing and debt payments should pay for no more than 00.
- Housing and auto expenses should include taxes, insurance, maintenance, and fuel (utilities).
Account for your taxes.Taxes are a huge expense, but many people fail to account for them in their budgets. You should account for state and federal income taxes, local and property taxes, and withholdings from your paycheck such as FICA and Medicare.
- Taxes should account for about 25% of your budget (if your income is 00/month, your taxes should account for no more than 50). For some people, it will be less and the additional money will be put into your discretionary fund to use on living expenses.
- Locate your marginal federal tax rate for the current year by visiting the IRS's website at .
- You can change your tax burden due each year by setting number of dependents to reduce or raise spendable income.
- Alternately, some people have more money taken out for taxes to get a larger, lump sum refund at end of year.
- The method that works best for you will depend upon your budgeting needs.
Record your insurance costs per month.Insurance should include any insurance payments you must make for yourself or your dependents, including health insurance, life insurance, car insurance, and homeowners or renters insurance. However, homeowners or renters insurance is generally included in housing costs, so make sure not to count it twice.
- Insurance should account for around 4% of your monthly budget. If you earn 00 per month, insurance should be 0 or less.
Make a list of your variable living expenses, and put them into categories.Your variable expenses are costs that come up in different amounts each month. Variable expenses can include things like food, entertainment, clothing, pet care, the beauty salon, the dry cleaners, or other places you spend your money. You may also include any money you regularly put into savings or investments in this category.
- For example, if you own a dog, you may typically spend on dog food per month. But some months you may need to take the dog to the vet, groomer, or a boarding kennel, which can add to the expense of having a dog substantially. That makes pet care a "variable expense" for the purpose of your budget.
- The money left after your fixed and variable expenses are paid for is "Discretionary spending." That means this is money that you don't directly owe anyone but can decide what to do with each month on your own. It should be the remaining portion of your budget.
- For example, a variable expense is buying food for the month, whereas a discretionary expense might be going out to eat.
Track your spending for several months.Tracking your spending will help you identify whether you are staying within these guidelines, or if you need to identify places where you can make cuts in your spending. If you spend more than your income each month, you'll go into debt. But if you can come under your budget in any area each month, you'll save money.
- As you track your spending you may find that your budget may need a bit of tweaking depending on your personal circumstances-- for instance, severe medical issues might make it necessary for you to spend more money on quality health insurance. That's ok, as long as you don't exceed your monthly income in expenditures.
Establishing an Emergency Fund
Set a goal for an amount of money to include in your emergency fund.This will vary from person to person, but generally an emergency fund should contain at least enough to cover four months' expenses.If you want to be good with money, you need to have money to cover your unexpected expenses without putting yourself into debt.
- Also, when you decide how much to include, you should take into account any dependents you might have and potential emergency needs they might have.
- However, don't keep too much in your emergency fund. The money in an emergency fund must be liquid and therefore earns less than other investments with longer term. The excess over the emergency funds should be invested at a higher rate.
- For example, if you are single and living a pretty low-maintenance lifestyle, one month's salary might be a good goal for your emergency fund. But if you are the sole bread winner in a marriage with three children, there is a lot more potential for "emergency" expenses among your five family members, so having several months' salary is a better idea.
- Also keep in mind any special needs you or your dependents may have, or any precarious situations that might suddenly turn into big expenses. For instance, if you have an old car that might break down at any time, you are likely to have a sudden emergency expense. If your health or the health of your family members is poor, you might be more likely to have to fund an unexpected hospital stay.
Add any unused money to your emergency fund at the end of each month.If you have extra money at the end of each month, you can put it into the emergency fund as savings.
- If you find that you are able to live within your budget and still have some money left over each month, consider putting that money directly into your emergency fund account each month until you meet your savings goal. You can even set up an automatic account transfer to making saving easier; it will feel like you are just paying another monthly bill.
Decrease your monthly expenses and put your savings into the emergency account.If you have no money left over each month, and you don't have a good way to increase your income, you will need to decrease your monthly expenses in order to fill your emergency fund. This can be hard, but a few months of tight living can really add up in the long run.
- Look for areas in your budget that are discretionary or not necessary for you or your family to live. For example, you may have a substantial entertainment expense that could be cut down, or you may spend quite a bit on fashion, food, or a hobby.
- Try cutting expenses by not eating out as frequently, going to the salon every eight weeks instead of every six, buying less clothing, or not buying new games.
- You can also call service providers and try to negotiate for lower payments. For example, your cell phone service provider may offer you a lower rate if you call their customer service line and tell them you're considering switching service providers.
Increase your income and add that extra income to your savings.If you don't have any money left over at the end of each month to put into savings, you may need to increase your income in order to fill the emergency fund. This can be hard to do, but having an emergency fund is necessary to protect you and your family in an emergency.
- If you work as an hourly employee, consider working a couple extra hours every week, and putting that money directly into the emergency fund.
- If you are salaried, consider whether now might be a good time to ask for a raise in your salary. If you've been working at the same salary for a year or more and doing well at your job, your boss may be happy to comply.Put the extra income into your emergency fund each month.
- If neither of these are options for you, consider whether you might pick up a few side jobs to earn some extra cash. Dedicate your weekends to a part-time job or small business venture, such as lawn mowing or dog sitting. It might seem small, but over time that money will grow to fill your emergency fund.
Open a savings account specifically for your emergency fund.It's important for your emergency money to be kept separate from your normal checking account so that you are not tempted to spend it. It also helps you to be able to keep track of exactly how much money is in your emergency account at all times.
- You can start the account with any amount of money you have available, although many banking institutions will require a specific minimum amount, such as 0. Some credit unions will allow you to start an account with much less, so check there if you are unable to meet the minimum for a savings account at your typical bank.
Don't use your emergency fund for non-emergencies.If you are used to living paycheck-to-paycheck and suddenly have excess money in the bank, it may feel tempting to spend it. But being good with money means knowing when to save and when to spend, and your emergency fund should be saved for true emergencies.
- True emergencies include things like natural disasters, job loss, health problems and hospitalizations, unexpected court costs, funeral expenses, and other unpredictable troubles that could put you in a major financial hole.
- Remember, too, that "unplanned expenses" are not the same thing as emergency expenses. You might have an unexpected invitation to go on an expensive vacation, but that's not a true emergency. If you can't afford it on your regular budget, you should not dip into your emergency fund for anything that is not a true emergency.
Paying off Your Debts
Evaluate your budget to see where you can cut back.In order to pay off outstanding debts, you'll need some extra cash each month so that you can pay more than the minimum payment. Once you've established an emergency fund for your family, you should put any extra money into debt repayment until you are completely out of debt.
- The interest costs on debt is generally higher than what can be received on investments, so makes sense to pay off debt before investing.
- It's ok to live on a tighter budget for a few years in order to pay off debt; living within your means is a huge part of being good with money.You can cut costs on entertainment, clothing, or your food budget. If there are no areas you think you can cut, but you still have significant debt to pay off, consider downsizing your home or trading in your car for a cheaper model.
Prioritize your most expensive debt first.You might have one credit card or student loan debt with a very high interest rate-- that makes it a more expensive debt than another loan with a lower rate, because you are forced to add additional money onto your repayment every time you pay the bill.
- Put your excess money each month into the debt with the highest interest rate until the balance is completely paid off. You will still need to make the minimum payment on all your other debts each month.
- If you only have one major source of debt, then try to put as much extra money into each payment as you can each month. If the payment is each month, try to pay 0 or even 0 or more. The more you pay on each payment, the faster your debt will disappear.
Get government debt assistance.Various government programs can offer you help paying off your debts. Specifically, your student debt might be consolidated or forgiven through the Obama Student Loan Forgiveness program. Under this program, your student loans may be consolidated and refinanced to make payments more affordable. In addition, your loans might be completely forgiven after a period of 20-25 years or as part of public service loan forgiveness.
- The government also has programs to ease mortgage debt, particularly for those affected by the housing crisis.
- HARP helps those borrowers who have experienced a decline in home value, while HAMP helps those who cannot make their monthly payments. Both involve refinancing your home and reducing payments.
Stop building additional debt.While you're trying to pay off existing credit card debt, student loan debt, or any other debt you may have, you might simultaneously be using a credit card or taking out other loans. But this could just be adding more debt to your existing problem.
- Use a cash-only system until your spending is under control. That will prevent you from going into additional debt if you are unable to pay off your credit card statement each month.
Put any unexpected windfalls into your debt.If you happen to inherit a bit of money, receive a tax rebate, obtain a court settlement, or receive a bonus at work, remember your goal of being good with money and getting out of debt. Don't let yourself imagine ways to spend the money; instead, immediately use the money to make a additional payment on your debt.
- While a little vacation or a new outfit might feel nice in the short term, getting out of debt will set you up for success and reduce your longterm stress.
Investing to Build Your Wealth
Wait until you have established an emergency fund and paid off your debts.In most cases, you want to be sure you have a nice safety net in the bank (the equivalent of a few months' salary) before you begin investing money. Similarly, you need to be sure your debts are paid off as soon as possible prior to investing any excess money you may have each month.
- Investing can be a nice way to earn a bit more money, but its only a smart option if you can afford to lose the money you invest. An investment can end up making you money, but it can also end up costing you money, so it is a gamble you have to be able to afford taking.
Save up for your first investment.Most experts recommend that beginning investors start with around 00 on a first investment. That amount will pay a nice dividend if you make a smart investment, but hopefully won't be too painful if you lose it in a bad trade. You can make investments in different amounts, but this is a good amount to start with.
- If you don't think you can spare 00 for investing because you're afraid you might need that money soon, that's a sign you need to build a bigger emergency fund before investing.
Start simple.You might think that you need a fancy portfolio with lots of high-risk individual stocks in order to invest. But that's not true. You can more safely invest money in mutual funds or exchange-traded funds (ETFs). These are simpler and offer less risk while you're still learning the ins and outs of investing.
- The benefit of mutual funds and ETFs is that instead of focusing your money on one stock, which could succeed or fail, they spread your money over many stocks-- sometimes dozens or even hundreds. That means there is a lot less risk for you, since even if some of the stocks fail, you will almost always see some return on your investment.
- Even if you're investing in relatively low-risk securities, you should still diversify your portfolio to reduce your portfolio risk. Diversification involves placing your money in different investments, rather than throwing it all in one or two.
- It may be beneficial for you to engage in dollar cost averaging (DCA) so that you can invest the same amount each month. DCA involves regularly purchasing the same dollar amount of an investment.
- This means that you still invest the same amount each month, regardless of price changes.
Expect to wait a while to earn returns on your investment.Investing is a longterm game, not a way to get rich quick. Some experts refer to a "seven year rule" that implies that you are likely to double your investment every seven years.
- The seven year return is based on a 10% rate of return on your investment, so if your particular investment has a higher rate of return, you'll double your money faster. Of course, that also means if you have a lower rate of return, it will take you even longer-- and you may want to look around for a new investment.
Use a brokerage company, but choose the right one.Some fancy full-service companies will try to get you to put your money into complicated accounts without explaining the details to you. They may be taking advantage of the fact that you're a novice investor, and these types of investments could end up costing you a lot of money.
- It's often a good idea to choose a discount broker with low fees for your first investments. Many of these brokers will be able to offer mutual funds with no commission, which makes the process much more affordable for you.
Managing Risk With Insurance
Get enough insurance.Even if you save carefully and watch your spending, an unforeseen event like a prolonged illness or lawsuit can decimate your savings. Reduce this risks by making sure that your insurance covers you adequately. For example, make sure that your homeowners policy covers total replacement of your home and possessions in the event of loss. In addition, make sure that the liability policy attached to it covers you adequately, because you don't want to be sued over something that happened on your property. financial professionals advise 0,000 in coverage for this purpose.
- The same is true for your auto insurance. If you just purchase the minimum amount of insurance, you will be liable for any settlements or legal costs above that amount.
Reduce your insurance premiums.You can reduce your insurance premiums by increasing your deductible (the amount you pay when you file a claim). This is true for homeowners, auto, and health insurance. This means that you'll be out for more money if you ever do need your insurance, but you'll save much more each month as a result.
- You can also reduce these types of insurance by making yourself a safer "bet" for the insurance company.
- For example, people with good driving records pay less in auto insurance and those with burglar alarms have a reduced homeowners insurance bill.
Drop insurance that you don't need.There are, however, some types of insurance that are basically unnecessary. Extended warranties and credit insurance on loans, for example, are typically not needed, especially if you can cover the loss or your loan payments with your monthly budget.
Video: How to Properly Manage Your Money Like the Rich | Tom Ferry
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