The sooner you start financial planning, the better, but it’s never too late to create financial goals to give yourself and your family financial security and freedom. Here are the best practices and tips for personal finance.
The 2022 Investopedia Financial Literacy Survey surveyed 4,000 adults and found that most Americans are concerned about personal finance basics, retirement funding, and investing in crypto.
1. Know Your income
It's all for nothing if you don't know how much you bring home after taxes and withholding. So before deciding anything, ensure you know exactly how much take-home pay you receive.
2. Devise a Budget
A budget is essential to living within your means and saving enough to meet your long-term goals. The 50/30/20 budgeting method offers a great framework. It breaks down like this:
- Fifty percent of your take-home pay or net income (after taxes) goes toward living essentials, such as rent, utilities, groceries, and transport.
- Thirty percent is allocated to discretionary expenses, such as dining out and shopping for clothes. Giving to charity can go here as well.
- Twenty percent goes toward the future—paying down debt and saving for retirement and emergencies.
It’s never been easier to manage money, thanks to a growing number of smartphone personal budgeting apps that put day-to-day finances in the palm of your hand. Here are just two examples:
- YNAB (an acronym for You Need a Budget) helps you track and adjust your spending to control every dollar you spend.2
- Mint streamlines cash flow, budgets, credit cards, bills, and investment tracking from one place. It automatically updates and categorizes your financial data as information comes in, so you always know where you stand financially. The app will even dish out custom tips and advice.3
3. Pay Yourself First
It’s important to “pay yourself first” to ensure money is set aside for unexpected expenses, such as medical bills, a significant car repair, day-to-day expenses if you get laid off, and more. The ideal safety net is three to 12 months of living expenses.
Financial experts generally recommend putting away 20% of each paycheck every month. Once you’ve filled up your emergency fund, don’t stop. Continue funneling the monthly 20% toward other financial goals, such as a retirement fund or a down payment on a home.
4. Limit and Reduce Debt
It sounds simple enough: Don't spend more than you earn to keep debt from getting out of hand. But, of course, most people have to borrow from time to time, and sometimes going into debt can be advantageous—for example, if it leads to acquiring an asset. Taking out a mortgage to buy a house might be one such case. Still, leasing sometimes can be more economical than buying outright, whether renting a property, leasing a car, or even getting a subscription to computer software.
On the other hand, minimizing repayments (to interest only, for instance) can free up income to invest elsewhere or put into retirement savings while you’re young when your nest egg gets the maximum benefit from compounding interest. Some private and federal loans are even eligible for a rate reduction if the borrower enrolls in auto pay.
Student loans account for $1.59 trillion of consumer debt—if you have an outstanding student loan, you should prioritize it. There are myriad loan repayment plans and payment reduction strategies available. If you’re stuck with a high interest rate, paying off the principal faster can make sense.
Flexible federal repayment programs worth checking out include:
- Graduated repayment—progressively increases the monthly payment over 10 years
- Extended repayment—stretches out the loan over a period that can be as long as 25 years
- Income-driven repayment—limits payments to 10% to 15% of your income (based on your income and family size)
5. Only Borrow What You Can Repay
Credit cards can be major debt traps, but it’s unrealistic not to own any in the contemporary world. Furthermore, they have applications beyond buying things. They are crucial to establishing your credit rating and a great way to track spending, which can be a considerable budgeting aid.
Credit needs to be managed correctly, meaning you should pay off your entire balance every month or keep your credit utilization ratio at a minimum (that is, keep your account balances below 30% of your total available credit).
Given the extraordinary reward and incentives offered these days (such as cashback), it makes sense to charge as many purchases as possible—if you can pay your bills in full.
Avoid maxing out credit cards at all costs, and always pay bills on time. One of the fastest ways to ruin your credit score is to constantly pay bills late—or even worse, miss payments.
Using a debit card, which takes money directly from your bank account, is another way to ensure that you will not be paying for accumulated small purchases over an extended period with interest.
6. Monitor Your Credit Score
Credit cards are the primary vehicle through which your credit score is built and maintained, so watching credit spending goes hand in hand with monitoring your credit score. If you ever want to obtain a lease, mortgage, or any other type of financing, then you’ll need a solid credit report. There are a variety of credit scores available, but the most popular one is the FICO score.6
Factors that determine your FICO score include:7
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New credit (10%)
FICO scores are calculated from 300 to 850. Here’s how your credit is rated:7
- Exceptional: 800 to 850
- Very good: 740 to 799
- Good: 670 to 739
- Fair: 580 to 669
- Very poor: 300 to 579
To pay bills, set up direct debiting where possible (so you never miss a payment) and subscribe to reporting agencies that provide regular credit score updates. In addition, you can detect and address mistakes or fraudulent activity by monitoring your credit report. Federal law allows you to obtain free credit reports once a year from the “Big Three” major credit bureaus: Equifax, Experian, and TransUnion.
Reports can be obtained directly from each agency, or you can sign up at AnnualCreditReport.com, a federally authorized site sponsored by the Big Three.
Some credit card providers, such as Capital One, will provide customers with complimentary, regular credit score updates, but it may not be your FICO score. All of the above offer your VantageScore.
Due to the COVID-19 pandemic, the three major credit bureaus are providing free credit reports weekly through at least December 2022.
7. Plan For Your Future
To protect the assets in your estate and ensure that your wishes are followed when you die, be sure you make a will and—depending on your needs—possibly set up one or more trusts. You also should look into insurance and find ways to reduce your premiums, if possible: auto, home, life, disability, and long-term care (LTC). Periodically review your policy to ensure it meets your family’s needs through life’s major milestones.
Other critical documents include a living will and a healthcare power of attorney. While not all of these documents directly affect you, all of them can save your next of kin considerable time and expense when you fall ill or become otherwise incapacitated.
Retirement may seem like a lifetime away, but it arrives much sooner than expected. Experts suggest that most people will need about 80% of their current salary in retirement. The younger you start, the more you benefit from what advisors call the magic of compounding interest—how small amounts grow over time.
Setting aside money now for your retirement not only allows it to grow over the long term but also can reduce your current income taxes if funds are placed in a tax-advantaged plan, such as an individual retirement account (IRA), a 401(k), or a 403(b).
While your children are young, take the time to teach them about the value of money and how to save, invest, and spend wisely.
If your employer offers a 401(k) or 403(b) plan, start paying into it immediately, especially if your employer matches your contribution. By not doing so, you’re giving up free money. Take time to learn the difference between a Roth 401(k) and a traditional 401(k) if your company offers both.
Investing is only one part of planning for retirement. Other strategies include waiting as long as possible before opting to receive Social Security benefits (which is smart for most people) and converting a term life insurance policy to permanent life.
8. Buy Insurance
As you age, it's natural for you to accumulate many of the same things your parents did—a family, home or apartment, belongings, and health issues. Insurance can be expensive if you wait too long to get it. Health care, long-term care insurance, life insurance—it all increases in cost the older you get. Additionally, you never know what life will send your way. If you're the sole breadwinner for the family, or you and your partner both work to make ends meet, a lot depends on your ability to work.
Insurance can cover most of the hospital bills as you age, leaving your hard-earned savings in your family's hands—medical expenses are one of the leading reasons for debt.
If something happens to you, life insurance can give those you leave behind a buffer zone to deal with the loss and get back on their feet financially.
9. Maximize Tax Breaks
Due to an overly complex tax code, many people leave hundreds or even thousands of dollars sitting on the table every year. By maximizing your tax savings, you’ll free up money that can be invested in your reduction of past debts, enjoyment of the present, and plans for the future.
You should start saving receipts and tracking expenditures for all possible tax deductions and tax credits. Many office supply stores sell helpful “tax organizers” that have the main categories already labeled.
After you’re organized, you’ll want to focus on taking advantage of every tax deduction and credit available, as well as deciding between the two when necessary. In short, a tax deduction reduces the amount of income on which you are taxed, whereas a tax credit reduces the amount of tax that you owe. This means that a $1,000 tax credit will save you much more than a $1,000 deduction.
10. Give Yourself a Break
Budgeting and planning can seem full of deprivations. Make sure you reward yourself now and then. Whether it’s a vacation, a purchase, or an occasional night on the town, you need to enjoy the fruits of your labor. Doing so gives you a taste of the financial independence you’re working so hard for.
Last but not least, don’t forget to delegate when needed. Even though you might be competent enough to do your own taxes or manage a portfolio of individual stocks, it doesn’t mean you should. Setting up an account at a brokerage and spending a few hundred dollars on a certified public accountant (CPA) or a financial planner—at least once—might be a good way to jump-start your planning.
Comments
Post a Comment