These resolutions don’t mean a whit, though, if you don’t have a plan. For the past five years, I’ve shared the following road map, adding one new tip every January. Many GRS readers have used this info to plot a course to financial freedom. Maybe this year it’s your turn.
Here then are eleven simple but effective steps to build a better financial future.
Step #1: Set financial goals
The road to wealth is paved with goals. If you don’t know why you’re doing this — why you’re making sacrifices, why you’re working so hard — it’s too easy to fail. But if you set goals, they can help guide you even when things get tough. When you have to make decision, your goals can help you stay focused on what’s important.
For your goals to be effective, they have to be personal. They have to mean something to you. Right now, one of my goals is to save money for travel. A couple of years ago, my goal was to save for a Mini Cooper. Before that, my goal was to get rid of 20 years of debt.
To keep your focus front and center, you might use web-based tools like Joe’s Goals, StickK, or 43 Things. You might find an accountability partner. Or you might advertise to yourself. And be prepared for setbacks. You’re not going to meet your goals without mistakes. Stuff happens. The best way to deal with problems is to have a plan before they occur.
Step #2: Track every penny you spend
The authors of Your Money or Your Life urge readers to “keep track of every cent that comes into or goes out of your life.”
[This is] the best way to become conscious of how money actually comes and goes in your life as opposed to how you think it comes and goes…This is the step that somehow makes the biggest impact.
Earlier this year, I stopped tracking my spending. I was spending less than I earned, and I figured it was too much work. I regret that. In fact, I’ve vowed to resume tracking my spending again in 2011.
It doesn’t matter how you track your spending — the most important thing is to do it.
- You can use a cash notebook.
- You can use an online tool like Yodlee or Mint. (I tried Mint, but it didn’t work for me. I’m trying Yodlee now.)
- You can use a piece of software like Quicken. (Here’s a list of 16 powerful personal finance programs.)
Whichever method you choose, stick with it. Make it a habit. Don’t fudge the numbers. Record your transactions as soon as possible. Most of all, don’t judge yourself. Tracking your spending is an exercise in data collection; it’s not the appropriate time to change your habits.
Step #3: Develop a budget
After you’ve tracked your spending for a few weeks (or months), use the data you’ve collected to develop a budget. According to The Millionaire Next Door, budgeting is one thing that sets the wealthy apart from the rest of us — 55% of millionaires keep a budget.
Many people — myself included — fail to budget for a variety of reasons: it’s boring, we don’t think we need it, or we don’t know how. But this simple act can provide a roadmap for your money.
There are a variety of budgeting methods you can choose, from Andrew Tobias’ three-step budget to the 60% budget. My recent favorite (and a favorite of GRS readers) is Elizabeth Warren’s balanced money formula: 50% to Needs, 20% to Savings, and everything else to Wants. Simple but effective.
Crave more budgeting tips? Check out this article highlighting 13 tools for building a better budget. Hate the idea of budgeting? Consider the spending plan, a budgeting method for non-budgeters.
Step #4: Review your accounts (and ask for discounts)
At least once each year, you should review the contracts and agreements you have with various banks and service providers. This is also a great time to review your financial accounts to be sure everything still matches your needs.
- Read your credit-card agreements and make sure you understand everything. (If you don’t, then ask questions.) When I read my own agreements, I just dial the customer service line and ask for clarification.
- Check your service levels. We have a tendency to keep paying for the same service we’ve always had, whether it’s with our phone, our electricity, or our gym membership. Now’s a good time to make a quick check to be sure you’re only paying for what you need.
- Ask for lower rates. In 2009, G.E. Miller shared how he cut his cable bill by 33% without losing any service. Many GRS readers reported similar success. Look through your monthly bills to see if there are any you could call to ask for a reduction on.
- If you rent, review your lease or rental agreement to be sure you’re clear on all of the policies. While you’re at it, consider asking for a rent reduction. Sound crazy? If you’re a good tenant and regularly pay on time, it’s not so far-fetched.
- Review your insurance. Are you carrying policies with three different companies? Consolidate them at one place. Check the deductibles on your auto and homeowners insurance. Are they too low? Could you afford to raise them and “self-insure” the first $1,000 of damage? And is your liability coverage high enough?
- Go over your investment accounts. Check your balances and asset allocation. The stock market soared last year — are you now too heavy in stocks for your risk tolerance? If so, shift things around to get to your target allocation.
This task may be boring, but it’s important. Terms change all the time. Your own financial situation changes. Spending one afternoon a year to review your agreements (and ask for discounts) can keep you from getting trapped in contracts you don’t want and save you money in the process.
Step #5: Optimize your accounts
For seventeen years, I was an account holder at a large national bank. I paid an $8 “service charge” every month, as well as many other fees. I received terrible service and earned no interest. Over the last couple of years, I’ve finally begun to optimize my accounts. If you haven’t already done so, consider the following:
- Open an online high-yield savings account. Interest rates are about as low as they can go, and should increase in the months and years ahead.
- Choose a rewards checking account. Believe it or not, it’s possible to find checking accounts that pay interest. The best online checking accounts are paying about 1% right now, depending on your balance. But you can usually find an even better deal through your local bank or credit union. Check out this list of rewards checking accounts for rates of up to 5%.
- Use a rewards credit card. If you have trouble with credit, it’s best to avoid plastic altogether. If you can use credit responsibly, be sure to choose a credit card that pays you. Avoid cards that carry an annual fee. Find a rewards program that matches your lifestyle. But don’t choose a card just because it offers a signup bonus or because it gives you a discount at your favorite store. Remember: your goal is to find a useful tool. Look for a long-term relationship you can live with.
It’s important to choose accounts and systems that work for you. I signed up for a rewards checking account at a local credit union, but the nearest branch is fifteen minutes out of my way. I never used it, so the credit union closed the account. I compromised by opening on online checking account instead. I earn a lower rate, but it’s an account I’ll actually use.
Step #6: Start an emergency fund
For years I lived paycheck-to-paycheck. I spent everything I earned. This worked well until something went wrong. Suddenly I’d find myself without money to pay for a car repair, or facing an expensive doctor’s bill. I financed emergencies with credit cards. Eventually I saw the light and built up a rainy-day fund.
After you’ve optimized your accounts, make it a priority to save for emergencies. In The Total Money Makeover, Dave Ramsey explains why he believes an emergency fund should come before anything else:
Since I hate debt so much, people often ask why we don’t start with the debt. I used to do that when I first started teaching and counseling, but I discovered that people would stop their whole Total Money Makeover because of an emergency — they felt guilty that they had to stop debt-reducing to survive.
Open an online high-yield savings account and add $20 or $50 to your account ever time you get paid. Two years ago, I opened an account at ING Direct, where it’s simple to schedule automatic deposits. After you’ve saved $1000, then you can attack your debt.
See also: Learning to love the emergency fund.
Step #7: Get out of debt
Are you struggling under a heavy debt load from credit cards or student loans? Make it a priority to unload some of this this burden in 2010. At the end of 2007, I said good-bye to 20 years of debt — it feels fantastic to have that weight off my shoulders.
If you have the mental discipline, you’ll save money by paying down your high-interest debt first. But if you’ve tried that method before and failed, consider using a Tip! The perfect is the enemy of the good. When you spend so much time looking for the “best” choice that you never actually do anything, you’re sabotaging yourself. And an ideal solution that you don’t follow through with is worse than a good solution that you’ll actually use. Choose a good option and act.