Aside from gladly receiving my weekly allowance (and promptly spending it), I didn’t get much by way of financial education growing up. My first major financial responsibility came when I turned 16 and got a car. Suddenly I had to pay for gas and insurance, and that money had to come from somewhere. To sustain my new-found lifestyle, I got my first job. It seemed the money came out of my account just as fast as it went in. It was fun to have money I could spend on anything I wanted, no questions asked.
As I got to my 20s, though, the responsibilities compounded, and I realized I had a lot to learn. Rather than being focused solely on instant-gratification, I started thinking about longer-term goals and priorities. Wanting to build a healthy financial life for myself, I learned as much as I could about personal finance. I found then that understanding basic financial priorities is the first step to achieving financial freedom, and I hope this is helpful for you, as well.
Here are the basics to getting your financial ducks in a row:
Step 1: Pay off high interest debt. Before you can start planning for the future, you need to stop bleeding money (by way of high interest rates) now. What is high interest? I would argue it’s anything that’s higher than the average long-term return of the stock market, around 7% (for an explanation of where that number comes from, see this article on The Simple Dollar). If you have any debt with an APR higher than 7% – except perhaps your mortgage – you should first prioritize paying it off. Look for a future post where I’ll talk about specific strategies for paying off your debt (and staying out of debt).
Step 2: Save for an emergency. If the 2008 recession taught us anything, it’s that we need to be prepared for the worst. What would happen to your finances if you or your spouse suddenly lost a job? Would you be able to pay your bills, especially the critical ones like mortgage/rent, utilities, and groceries? This is where an emergency fund is essential. Most financial experts recommend having 3-6 months of expenses saved, and I would argue for the higher amount. To get this number, you can use the Personal Finance Worksheet I provided in a previous post. Simply add up 6 months of “actual” amounts from the “Total Spending” row. Keep this money in an accessible, low-risk account like a savings or money market account.
Step 3: Save for short and long term goals. Do you want to take a dream vacation next summer? Or perhaps you have a teenager and are focused on saving for college. Once you are debt-free and have 6 months of expenses stashed away for an emergency, you can start looking at your savings goals. This is where things get more fun as you’re watching your money grow, but also more complicated because you need to make decisions about what goals are top priority for you. I will talk more about goal setting in a future post, but some saving buckets to consider include short term goals like vacations or a wedding and long term goals like retirement and college savings.
Great! Now you have an understanding of the basics. Next week, I will dive more into each of these topics, starting with tips for paying off your debt. Until then!
Please note: I am not a financial expert and speak to financial topics from my own personal experience. Please consult a financial professional before making any of your own personal financial decisions.