In your 20s, your finances were uncomplicated. You lived paycheck to paycheck, and whatever you had at the end of the week was your fun money. But now, as you have a career and family and are starting to make real money, your finances are more complex. The big picture is harder to understand, making strategic financial planning essential. Here are four steps to help you grasp your big picture and accomplish your goals.
STEP 1: GET A HANDLE ON YOUR MONTHLY INCOME AND EXPENSES
Do you have a general idea of your monthly expenses? This is one of the most important exercises you will go through because where and how you spend your money is the basis of your lifestyle. Even though you don’t have to count every penny, tracking monthly expenses allows you to objectively look at where your money is going. It allows you to ask the question “Am I spending my money where I want to spend my money?”
You can use software such as Mint or use a spreadsheet to help you with this task. Start by including your income from various sources, such as your paycheck, any rental property income, or consulting income. Then input your expenses or allow the software to download them for you. Do not include savings currently as it is not an expense.
This exercise allows you to determine if you are on budget, over budget or under budget. Being under budget is the best scenario. If you aren’t, then ask yourself why. “Where is my money going? Do I agree with how I am spending it, or do I need to make any adjustments?”
STEP 2: PAY OFF CREDIT CARDS & OTHER DEBT
As you review your expenses, you will get a better understanding of your debt, such as credit card debt, student loans, car loans, and mortgages. It is very important to understand how much you are paying for this debt in interest. For example, your credit card could be charging 10-30% in interest per year. Where can you put your money and get a guaranteed 10-30% rate of return? The answer is nowhere. Therefore, paying off high interest debt is a top priority. This applies not just to your credit cards but your other loans as well. For example, you can call your mortgage broker to find out if refinancing into a lower interest rate loan is a prudent move. The same applies for student loans. Call your loan servicer to better understand your payment options.
STEP #3: BUILD A CASH CUSHION
Everyone feels “safe” with a certain amount of money in their bank account. Before doing any expense analysis, ask yourself how much you want to have in your bank account. If you don’t have as much in savings as you are comfortable with, this should be a priority goal after paying off high-interest debt. Most people usually set a goal of 3 to 6 months of expenses for their rainy-day fund.
STEP #4: MATCH YOUR MONEY TO THE RIGHT ACCOUNTS
Cash management is the process of putting your total cash cushion amount into various accounts to optimize your returns. A checking account usually pays no interest. Put the amount of money in it that you need to cover your expenses for the month.
The next step is to open a high-yield savings account or money market fund. These accounts pay more interest though in today’s low-interest environment, it is still pretty low. The trade-off is that you have liquidity and can easily access your savings if needed. It should be easy to move money from this account to your checking account. And there should be no minimum balance required.
Finally, money that you don’t need but don’t necessarily want to invest can be put into a CD (certificate of deposit). You put money into a CD for a certain time frame. Also, with this type of account you need to understand if the money has to be kept in the account for a certain period of time and will there be a penalty for withdrawing money before the CD matures.
You can use www.bankrate.com to better understand the various interest rates each account pays in your geographical areas.
Implementing these steps will better help you accomplish your goals. If your financial picture is more complicated than you have time for, you may want to consider working with a financial advisor. The right financial advisor will provide the expertise to organize and simplify all your financial areas, including investments and taxes so that you can feel more confident about your financial direction.
