Tip 1: Spend Less than You Earn
This may seem like a no-brainer, but many people struggle with the concept of spending less money than they earn. Too often, people overextend themselves with credit card purchases, houses they can’t afford, or fancy cars with high monthly loan payments. In order to protect your financial future, you must save some money EVERY MONTH. And that means spending less than you earn. Here are some examples of what saving as little as $100 each month can do for you (you can also use a retirement calculator):
- At an interest rate of 5%, saving $100 every month will accumulate to over $6000 in five years, $15,000 in ten years, and $41,000 in 20 years.
- Bumping up the hypothetical interest rate to 8%, and saving the same $100 each month, you’ll have over $7000 in five years, $18,000 in 10, and $58,000 in 20 years.
- At a 10% interest rate, your $100 a month savings will net you $7700 in five years and a whopping $75,000 in 20 years!
The trick to saving money each month is to treat it as a fixed expense, just as you do with your mortgage or rent or car payment. Pay yourself whatever you can afford — $100, $250, $1000 – and put that money into a savings or investment plan of your choice. You can even automate this process by setting up an automatic payroll deduction. Of course, as your salary increases, you can (and should) increase the amount of money you save each month.
Tip 2: It’s Time to Make a Budget and Stick to It
It may sound boring, but creating a budget is a time-honored way of tracking finances. With computer-based spreadsheets and accounting software, this process is easier than ever, too. At a glance, you can see where your money is going – what you’re buying, what’s coming in, and how much is left once everything is paid for. Before setting up a budget, however, it’s a good idea to take a hard look at your current spending and saving habits. Sweat the details, too, and don’t forget to look at small expenditures like lunches, entertainment, movie tickets, and school-related activities for your children. This will give you an idea of where you need to cut back and how much you might be able to save once you establish your monthly budget. You can also prepare for and track those expenses once you develop your own personal budget.
Once the budget is set, you must stick to it. No cheating! There will be times when you go over your spending limits on certain items, such as an emergency home or car repair. However, the closer you stick to your established budget, the closer you will be to future financial security.
Tip 3: Financial Literacy is Key
As you begin to explore the steps needed to ensure a sound financial future, you may run across some terms that are unfamiliar. It’s time to brush up on these terms; you don’t have to become an expert, but you should develop a working knowledge of major financial concepts, particularly:
- Compound Growth – this is a term that simply means any earnings paid on previous earnings, such as a growing investment. The trick to compound growth is that it is better to start saving early in a retirement plan or other long-term investment than waiting until you are older. For example, if you were to invest $100 a month for 20 years in a row starting at age 25 and ending at age 45, and then not investing a single dollar after that, compound interest (based on an assumed 8% annual return) turns that $24,000 investment into $275,000 by the time the person reaches the age of 65. The more you invest and the longer you do your investing, the bigger that account will grow, even if the markets do not always perform at a great interest rate.
- The differences between saving and investing – a savings account is just a place to store money until a later point in time. Some savings accounts offer a nominal interest rate, such as 1.5% or less. While money does accumulate due to that interest, investing outperforms savings by a long shot. Investing is the key to long-term financial security. Yes, investing has its risks, but over the long term, even serious downturns in the markets won’t make much of a difference, and the returns can still be impressive.
- Risk vs reward – here, there are many potential risks to both saving and investing. The risks of investing can be worth it, as the returns may prove beneficial over time. An investment advisor can help you find plans and strategies to help you minimize the risks you take with your hard-earned money.
- Diversification – rather than putting everything into one account, it is always better to diversify. This means investing in stocks, bonds, mutual funds, real estate, and other programs and assets as your budget allows. If something happens to one asset, like a market downturn, you can still rely on growth and performance of the others.
- Dollar cost averaging – this is another term used in the financial world, and simply means a strategy by which funds are invested at regular intervals over a period of time. This strategy helps to avoid the ups and downs in stock prices, averaging out share costs and taking advantage of markets’ upward-moving trends over time.
Tip 4: Create and Move Toward Financial Goals
Ok, you’ve set up a budget, and now you are familiar with some of the major financial terms. Next up is to establish some financial goals. These goals fall into three major areas:
- Short-term financial goals – things like paying off your credit card bills, establishing an emergency financial fund, or saving up for that special vacation you’ve always dreamed about.
- Intermediate-term financial goals – these are goals you wish to meet over the next five to 10 years, such as purchasing a home, getting the funds together to launch your own business, and saving up for educational expenses like college.
- Long-range financial goals – the most important goal in this category is funding your retirement with a combination of investments in areas like stocks, mutual funds, or employer-matched retirement programs.
Once you’ve established your goals, it is critical that you monitor your progress as you work towards achieving them. Be ready to make adjustments as circumstances change.
Tip 5: Funding an Emergency
Life often throws a curveball when we least expect it. Think of things like a vehicle breakdown or a burst water pipe in your home – these situations demand fast repair, and you obviously need money to pay for those emergency repairs. Or, imagine yourself having a serious illness or accident and are unable to work for several weeks or even a few months. How will you pay for your expenses? Racking up credit card debt to pay for emergencies is not the answer!
Financial experts the world over know that having an emergency fund is crucial to long-term financial survival. In a perfect world, this fund will have six to 12 months’ worth of living expenses set aside for those unexpected situations. At a minimum, try to set aside at least three months of expenses. A simple savings account or a money market account is a great place to store this money.
Tip 6: Needs vs. Wants
This is a concept many people struggle with – even those who are more money-savvy. Simply put, this means that you must evaluate your expenses at every step. Financial needs are things we can’t live without transportation, housing, food, and clothing. Financial wants are those things that help us enjoy our lives: travel expenses, dinners out on the town, or that shiny new bike you’ve had your eyes on.
It is important to remember that you don’t need to deny yourself the occasional “want”, but it is critical that you’ve accounted for that expenditure in your financial plan. Take care of funding your emergency savings and your routine monthly savings first, and if money is left over, you can splurge a bit.
Tip 7: Be Careful with Credit
Credit cards sure are convenient. Don’t have the cash on hand for a purchase? Whip out the plastic and pay as you go!
Unfortunately, many people have difficulties with credit card debt. That convenience can come back to bite you with high-interest rates and monthly debt payments, derailing your hard-fought financial plans. While having credit is important in the overall financial picture, you must be responsible with it. Paying off the full debt each month is a smart move if you can. Otherwise, minimize the use of credit cards and only make purchases you have the cash for. Again, an emergency financial fund is the best way to avoid having to resort to credit card use when an unexpected expense occurs.
In our next blog post, we will finish out these tips for financial security. Stay tuned for more.
We’ve covered the first seven tips on securing your financial future – including setting up an emergency fund, being smart with credit cards, understanding needs versus wants and getting familiar with common financial terms. Let’s finish things off with several more tips that will help you thrive as you establish a solid financial future.
Tip 8: Free Money May be Available
Many employers offer retirement plans to their workers. These plans, in particular, 401(k) accounts, often have “matching contributions”. In other words, for every dollar an employee puts into the account, the employer will also contribute. In many cases, this is a dollar-for-dollar direct match.
This is free money, and employees should take full advantage of these retirement programs. As part of your monthly budget, set aside as much as you can to fund the employer-sponsored retirement plan if available. This helps reduce your own out-of-pocket expenses, provides a bit of a tax break, and gets you on the road to a stable financial future once you retire.
Tip 9: It’s Time for an IRA
One of the most popular (and effective) means of funding a retirement is through an Individual Retirement Account, known as an IRA. This is a great choice for anyone who dreams of a stable financial future and is available to anyone. If you already contribute the maximum to your employer-sponsored 401(k) plan and have money left over, or your employer does not offer a retirement plan, an IRA might be right for your needs.
There are two major types of IRA: the Traditional and the Roth. The Traditional IRA allows for tax-deductible contributions and is taxed once distributions are made at retirement age. A Roth IRA, on the other hand, is funded with after-tax dollars, meaning that distributions are tax-free once retirement age is reached. A person can make unlimited contributions to a Traditional IRA over its lifetime, while Roth plans have a maximum contribution cap based on income. Both are great tools in the arsenal of funding a healthy and secure retirement.
Tip 10: Diversify Your Portfolio
If you’re following along with these tips, the previous steps we’ve discussed have gotten you well-prepared for a great financial future. Now it’s time to mix it up a bit, and we mean diversification. We discussed the concept of diversification in #3 when we talked about common financial terms.
Have you ever heard the expression “Don’t put all your eggs in one basket?” This is true for finances as well as in other aspects of life. Spreading savings and investments over a broad range of accounts helps minimize risks, such as a market downturn or other situation where assets may lose value. First off in diversifying is to establish retirement accounts such as IRAs or enrolling in an employer-matched 401(k) plan. Next, there are equity accounts, stocks and bonds investments, and even real estate to help you “spread the wealth”. A financial planning professional can help you to determine what risks each have, and will also help you figure out your own personal tolerance for risk. By diversifying, you can tap into different markets, each of which has its own performance ups and downs. If you wind up losing value in one account, you may very well regain or even surpass that lost value when another account is performing better. Remember also that retirement savings is a long-term venture; if you start early, you have time on your hands and the power of compounding interest to help your assets grow.
Tip 11: Insurance Can Protect Your Assets
The world of insurance is complex. There are many different types of insurance policies, each with their own benefits and drawbacks. For the purposes of your financial future, there are five major types of insurance policies to be aware of:
- Life Insurance – if for some reason you should die, this type of insurance helps protect your loved ones from the financial hardships associated with your death.
- Health Insurance – often provided by employers, health insurance covers direct costs associated with medical care, routine checkups, and many treatments.
- Property and Casualty Insurance – these insurance policies protect you from financial difficulties arising from the loss of your home and vehicle. They also protect you against liability should you cause an accident or if someone is injured on your property. Most states require these insurance policies if you own a home and/or car.
- Critical Illness Insurance – health insurance is great, but it is only designed to provide coverage for direct medical expenses. A serious illness, such as a heart attack, cancer, or a stroke, can cause you to become disabled. Critical illness insurance provides funding in a lump-sum form, helping you to pay for indirect expenses such as specialized treatments, home health care, transportation, and household expenses. It is not a replacement for traditional health insurance; rather, it can supplement medical insurance.
- Long-term Care Insurance – the elderly often rely on the assistance of a care facility, such as an assisted living facility or nursing home, for round-the-clock care. Becoming disabled through injury or illness can also require long-term care. Health insurance may not cover the expenses associated with this type of need; therefore, long-term care insurance can provide a financial solution.
Insurance professionals can help you determine which types of insurance coverage are right for your current and future needs. Speak to one as soon as possible as you lay the groundwork for your financial future.
Tip 12: Prepare a Will
If you have anyone in your life that you care about, you need a will. A spouse, your children, or anyone who depends on you can face an uncertain financial future if you should die unexpectedly. A will helps protect finances by specifying who gets your assets after you pass away. Without a will, your estate (the assets you own or control) will have to pass through a lengthy probate process, and the courts will ultimately decide how your assets are distributed to your dependents. Even if you don’t have children, a will is critical – draw one up or visit a lawyer for assistance on this critical piece of the future financial puzzle.