Ah, the new year. The perfect time to get your life back on track. If one of your goals for 2010 is to take control of your finances, this crash course in financial basics can help guide the way. Here are ten simple but effective steps you can take to build a better financial future.
Step #1: 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.
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 Wesabe or Mint.
- 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 #2: 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.
Step #3: 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. G.E. Miller just 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 #4: 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 6%.
- 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 #5: 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.
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.
After you’ve saved $1000, then you can attack your debt. 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.
See also: Learning to love the emergency fund.
Step #6: 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 debt snowball. Pay your debts starting with the smallest balance first. Here’s how:
- Order your debts from lowest balance to highest balance.
- Designate a certain amount of money to pay toward debts each month.
- Pay the minimum payment on all debts except the one with the lowest balance.
- Throw every other penny at the debt with the lowest balance.
- When that debt is gone, do not alter the monthly amount used to pay debts, but throw all you can at the debt with the next-lowest balance.
The debt snowball can give you awesome psychological payoffs, keeping you motivated to stay in the game. It’s not mathematically ideal, but it worked for me (and for many others besides). However you choose to get out of debt, stick with it. Don’t give up.
Step #7: Fund your retirement
If you’re young, you probably don’t think you need to start a retirement account. You’re wrong. No matter how old you are, now is the time to begin saving for retirement. The extraordinary power of compound interest favors the young — and in a big way! In The Automatic Millionaire, David Bach writes:
The single biggest investment mistake you can make [is] not using your [retirement] plan and not maxing it out.
After reading The Automatic Millionaire a couple years ago, I opened a Roth IRA at Sharebuilder. It was easier than opening a checking account. I’ve managed to make the maximum contribution since 2006. In 2008 and 2009, I maxed out my 401(k).
If your employer offers any sort of retirement-contribution matching, such as a 401(k), be sure to take advantage of it. It may not be “free” money, but it’s darn close. Also consider starting a Roth IRA.
Don’t understand retirement accounts? No problem. Download the free Get Rich Slowly Guide to Roth IRAs, which explains everything you need to know about these accounts. For more ideas, check out Wesabe’s simple investing group.
Step #8: Automate your finances
For the past three years, I’ve been moving toward a system of paperless personal finance. Along the way, I’m learning the value of automating routine transactions. When you make things automatic, you remove the human element, making it more difficult for you to mess things up.
The classic example is overdraft protection. By tying your checking account to your savings account, you have a safety net if you bounce a check. But there are other ways this can work for you. For example, I’ve set up automatic payments with the gas company, the cable company, and my auto insurance company. I also make automatic deposits to my online savings account.
One terrific advantage to automation: when pay your bills and do your saving and investing automatically, it’s easy to tell how much you have left over to spend at the end of each month!
Step #9: Earn extra money
You can meet a lot of your financial goals by reducing your spending and using the right tools. But nothing supercharges your progress like a boost in income. How can you earn extra money?
- Ask for a raise. Several readers have written to tell me how they’ve given themselves a raise through ambition and ingenuity. Here’s one example. (Don’t know how to ask for a raise? Here’s how to negotiate your salary, either before or after you’re hired.)
- Switch employers. Not every employer is able or willing to offer raises, even when they’re merited. If you’re in a position where a raise isn’t possible, consider finding a new employer.
- Take a second job. Many people find that the best way to get out of a financial hole is to temporarily take a second job. Nobody wants to work more than 40 hours per week, but sometimes that’s what is needed to get out of debt or to save for a house. Just remind yourself that you’re doing this for a short time.
- Use your hobbies. Yes, it’s possible to have money-making hobbies. You’re not going to get rich playing World of Warcraft, but many people use productive hobbies to earn a little extra income.
- Volunteer for medical research. In August 2008, I earned $120 for a couple of hours spent participating in medical research. My colleague Donna Freedman has earned extra cash by giving blood and watching porn (though not at the same time).
- Sell things. When I decided to get out of debt, one of my first steps was to sell a bunch of the stuff I’d bought with that $35,000. I used eBay, Craigslist, garage sales, and the Amazon Marketplace to sell the things I no longer needed or wanted. The money I earned jump-started my debt reduction.
Another effective way to increase your income is to pursue entrepreneurship. While working to defeat my debt, I started a small computer consulting business. It didn’t generate a lot of income, but it did provide $2,000 a year that I wouldn’t have had otherwise!
Step #10: Educate yourself
Knowledge is power. Personal finance doesn’t have to be a mystery. Subscribe to this site. Read other personal finance blogs. I recommend:
- The Simple Dollar
- I Will Teach You to Be Rich
- The members of the Money Scribes network
- The members of the LifeRemix network
Visit your public library. Borrow money books and self-development manuals. Here are four of my favorites:
- If you’re in debt and can’t seem to find a way out: How to Get Out of Debt and Live Prosperously
- If you’d like to know more about investing: The Random Walk Guide to Investing
- If things are tight and you need to find creative ways to make ends meet: The Complete Tightwad Gazette
- If you want a motivational manual to prompt you to pursue your goals: The Magic of Thinking Big
You don’t have to agree with everything in a book to get something out of it. I read a lot of personal finance books — some are good, but many are not. Even the worst books usually have one or two things I can pull from them. Learn how to read a personal finance book so that you can pick and choose those pieces appropriate for your life.
Taking control of your finances can be intimidating — there’s so much to do! — but it doesn’t have to be that way. One effective solution is to take a vacation day from work: designate one specific date as your personal “Money Day”. Use this day to finally set up Quicken on your computer, to open a retirement account, and to call around for a better deal on your insurance.
The good news is that you can get out of debt. You can save for retirement. If I can do it, so can you. Best wishes for a prosperous new year!
Note: This is a new version of an article I share every January. I update it annually, incorporating new tools and techniques.
GRS is committed to helping our readers save and achieve their financial goals. Savings interest rates may be low, but that is all the more reason to shop for the best rate. Find the highest savings interest rates and CD rates from Synchrony Bank, Ally Bank, GE Capital Bank, and more.