A fear of opening up about finances and a lack of financial literacy has made keeping a check on one’s financial health and habits an intimidating task for some people. Without a working knowledge of how to go about planning their personal finances, people end up making financial decisions that may not be in their best interest, and are rarely able to break the habit of poor choices with money. Ignoring finances, practicing poor spending habits, and a lack of proper financial planning can lead to dreaded financial conditions. Given the lasting effects our financial decisions and habits have on our lives, it is important to have a clearer picture of where to begin and what aspects to focus on when organizing your personal finance.
In this article, we will cover what personal finance encompasses, as well as key tips on how to get your personal finances organized.
What is Personal Finance?
Personal finance consists of managing your money and meeting your financial goals – both short-term and long-term. This includes investments, day-to-day expenses, saving for your house, your child’s college tuition, retirement, etc. Drafting a financial plan that suits your financial needs involves taking into consideration your income, lifestyle, and financial goals and desires.
sooner you embark on the journey of understanding your personal finance, the
better it is, as this gives you more time to earn interest on your savings and
grow it into a large corpus. That said, it is never too late to start something
beneficial – and starting out your personal finance journey is no different.
The security and freedom a good personal financial plan is capable of providing to you and your family cannot be measured in numbers alone.
Personal financial planning is largely about prioritization. You should be able to look at your finances, assess your monetary inflow, discern your major expenses, focus on savings, and try to stick to your goals.
5 Tips to Help you Plan your Finances
In this article, we have streamlined how to go about personal financial planning. Let us understand all the steps involved in the process:
1. Practice budgeting and timely reviews of your finances
While tracking our income is easy, we tend to avoid calculating our expenses and rarely factor in the piling credit card bills. Over the years, our money goes into expenditures that could have been easily avoided.
If you find it difficult to keep track of the income and expenditures yourself, try a personal budgeting app on your phone that keeps track of your spending habits. This way, you can track every dollar spent and get better control over your funds. In the long run, this can help you avoid wasteful spending.
Here are four steps you can follow while creating a personal financial budget:
a. Calculate your net income: This should not be an estimate, but a calculation. Add all the money you get from various sources such as your salary, rent, and interest that your investments earn. Don’t forget to subtract your deductions for Social Security, taxes, and 401(k). The final money remaining in your hands is called net income, and this is the primary number you should use when creating your budget.
b. Track your spending: Keeping track of where your money is going is very helpful. You can identify your major expenses and identify some areas for cutbacks. Separate your expenses into fixed and variable expenditures. Rent, mortgages, and monthly bills are fixed expenses, while expenses that change every month are variable. This includes groceries, entertainment, and gas. It is also recommended that you go through your credit card statements to categorize your expenses.
c. Set your financial goals: Ensure that you have clarity about what you want to achieve with your budgeting activity. Make a distinction between your short-term and long-term goals. Also, remember that nothing is set in stone, so don’t be too hard on yourself.
Want to set your financial goals and distinguish between short-term, medium-term, and long-term goals? Read our article How to Set Short, Medium, and Long-Term Financial Goals on the Paladin Registry blog.
d. Conduct periodic reviews of your budget: Periodic reviews of your budget is a necessity, as it helps you stay on track and tweak your financial plans if the need arises. Changes in your income or spending, such as a raise or the purchase of a new house are also taken into consideration in the process.
A simple and effective budgeting strategy to keep in mind while managing your finances is the 50/30/20 rule:
- 50% of your take-home pay or net income (after taxes) can account for your living essentials, such as rent, utilities, groceries, and transport.
- 30% can go to discretionary expenses, such as dining out, vacation, and shopping for gadgets, clothes, electronics, etc.
- 20% must be contributed towards the future—establishing emergency funds, paying debts, and investing towards future goals, retirement inclusive.
2. Build and maintain an emergency fund
Life is uncertain, and things we don’t plan for happen all the time – be it a health emergency or a flat tire. Hence, an emergency fund is a necessary part of a good financial plan. Think of this as paying yourself before you pay somebody else. You should be ready with at least 3 to 6 months of emergency funds. This money will help see you through the difficult times and function as a shock absorber for unexpected expenses. The key to saving up for an emergency fund is to keep adding to your fund at regular intervals. Ideally, you should treat this as a monthly fixed expense until you reach your desired goal. If you have no money stashed away for a rainy day at the moment, there is no better day than today to begin creating your emergency fund.
Money market funds and high-interest savings accounts are good options you could explore to begin saving for your emergency fund. It is recommended that your money is saved in a safe and liquid investment option so that it’s easily accessible at the time of need.
3. Deal with debts on time
As simple as this tip sounds, limiting your debts is one of the most difficult activities to follow. To save more, you have to spend within your means. A primary step towards this is limiting your use of credit cards. Credit cards are a major debt trap as you are essentially spending money that you don’t own yet. According to a study by Comet Financials published in Forbes, for most Americans, the biggest source of debt is credit card debt, quickly followed by mortgage debt and student loans. That said, saying that you shouldn’t own any credit card or debt at all is unrealistic in today’s world. Hence, practicing mindful spending becomes essential while dealing with debt.
One of the best practices while using a credit card is to pay your full balance monthly or to keep your credit utilization ratio at a minimum. It is also important to not mix too many cards and to pay your bills and EMIs on time. If you are careless with the timely payment of bills or you skip paying your EMIs – your credit rating will be adversely affected.
If you’re already under debt, it is advised that you do not accumulate more of it. Take a break and relook at your situation from a fresh perspective. Also, find out if your creditor can offer you a lower rate of interest. If you have unpaid student loans, consider ways to pay them off. If you’re stuck with a plan with a high interest rate, try paying off the principal amount first. Minimizing repayments can help free up a major part of your income, which can be utilized elsewhere. Some private and federal loans are also eligible for a rate reduction if the borrower enrolls in autopay.
Paladin Registry’s free matching tool can connect you with the right kind of financial advisor you are looking for to meet your financial needs. Answer a few simple questions and get access to background verified financial fiduciaries. Interview them and also verify their certifications before engaging.
4. Practice mindful living by being aware of your needs and wants
Once you’ve documented your income and expenditure, you’ll see there are certain categories you may be able to cut back on. Maybe you could try cooking for yourself once in a while for a few months, or skip that store-bought coffee you may be picking up on your way to work everyday? Try to adjust your expenses to get closer to your financial goals and let go of certain habits that do not benefit you in the long run.
It is vital to spend time understanding the differences between your needs and wants. Needs are things you have to have for survival. This includes food, shelter, healthcare, transportation, clothing. Wants are things you desire to buy but don’t necessarily require.
Warren Buffett famously said, “If you buy things you don’t need, soon you may have to sell things you do need.”
A useful tip: Many people include savings as a need. This means that savings are a fixed expense they book each month, setting aside the percentage of money to add to their savings jar.
That said, we acknowledge it is challenging to label needs and wants – they differ for every individual. Sometimes people mislabel their wants as needs, and once this becomes a habit, the spending can spiral out of control quickly. Try not to justify your spending as a need. The purchase of a home would serve as a good example. A home is a necessity and a potentially good investment. But one does not need a 5 bedroom mansion for a family of 2. While real estate is expensive as such, you may do well to invest in a 3 or 4 room house if you are expecting the family to expand, and put the remainder of your money into an investment towards your retirement, for example.
Most people end up spending more money if they have more of it. People advance in their careers, and with each pay raise, there often comes a rise in expenditure. This is called lifestyle inflation. While you might comfortably pay your bills, lifestyle inflation can prove to be quite damaging in the long run. Sabotaging your finances to keep up with the Joneses depletes your wealth.
Hence, it is important to find the right balance in your spending habits based on your unique financial situation. Your needs should be the priority in your budget, followed by your wants.
Plan and save for retirement
Financial experts say that we will need 80% of our current salary after retirement. Hence, the sooner you start saving, the better it is for your money to grow. This way, you could reap the full benefits of the compounding effect, i.e., the process by which smaller sums of money grow over the years into a large corpus.
Saving for retirement helps you take care of your retirement and reduces your current taxes. If you have signed up for a tax-advantaged plan, such as an individual retirement account (IRA), a 401(k), or a 403(b, you can certainly take a tax benefit. If your employer offers a 401(k) or 403(b) plan, start contributing towards it right away, especially if your employer matches your contribution. If you’re not doing so, you’re giving up free money. Take some time and learn the difference between a Roth 401(k) and a traditional 401(k) if your company offers both. Also, be mindful of RMDs – Required Minimum Distributions from your retirement accounts.
Investing is only one small part of planning for retirement. Other strategies include waiting for the maximum time before opting to receive Social Security benefits and converting a term life insurance policy to a permanent life one.
Don’t wait until it’s too late. You could end up losing several hundreds of thousand tax dollars and without a substantial retirement fund to back you up alongside the cost inflation, things could get tough when you no longer have a salary. Build your passive income and establish revenue sources while you are young and in the working ages.
The Bottom line
Planning and sorting your finances isn’t an overnight activity. It requires sustained dedication and effort. But, once you’ve decided to actively manage your finances, you should look forward and work towards building your habits to accomplish your financial goals.
Always look at the bigger picture – it is more important that you cultivate a healthy financial habit rather than adhere to adages. Personal financial planning is an excellent tool to achieve your goals, but don’t be too hard on yourself. Weigh in on the circumstances. Your choices, be it saving, investing, or spending, should be well thought through. The key is to strike a balance, not let your spending control your financial situation, and to develop a healthy financial decision-making ability.
If you are looking for an experienced fiduciary financial advisor who can help you with financial planning, retirement planning, tax planning, wealth creation or preservation, estate planning, etc., use Paladin Registry’s free matching tool. Find and compare vetted CFPs that are best suited to your financial needs and goals, and also use our system to verify their certifications.
To learn more about the author William Hayslett view his short bio.
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The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice. A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.