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Do you work to live, or live to work? As noble as it is to be a dedicated employee, the reason you spend eight to ten hours at work each day is to fund your life. You bring home a salary to put a roof over your head but you also probably have goals for yourself or your family. Having goals in life makes it exciting to get out of bed every day. There are certain steps almost every financially successful person takes to reach their goals. They usually follow these seven steps to financial success.
Step 1 – Get a Picture of Where You’re At
Without having a clear picture of your finances now, how will you get to where you want to be? If you were lost in the city and called your friend for directions, the first thing they’d ask is, “where are you now”?
So, to get to where you want to be financially, you need to know the basics.
- What’s my income – my salary and anything else and how much am I really taking home?
- What are my fixed expenses, like rent, utilities, food, transportation?
- How much debt do I have – credit cards, school loans, car payments, mortgage?
- What am I paying for insurance, like auto, home, and health?
- Where is the rest of my salary – other than bills – going?
You’ll need this information before you can write a budget. A budget is dividing up the pie, but this is figuring out the size of the pie. Get this information on paper, or written in a file. Having a clear picture of what your financial status is right now is essential to getting yourself to where you want to be.
This shouldn’t be a one-time exercise either. Once you’re on a financial path, you’ll want to do regular temperature checks on your finances. You need to know where your money is going.
Take a few minutes either every day or every few days to make sure you know things like:
- What’s the balance in my accounts?
- What bills are due this week?
- How am I progressing on reducing my debt?
- How is the progress on my savings?
Step 2 – Create a Budget – Know Your Expenses
Ben Franklin said, “Beware of little expenses; a small leak will sink a great ship.”
Taking stock of where you are in Step 1 is an overview of what you make vs what you owe. It’ll give you an idea of whether you’re in the black or in the red.
But to make sure you’re aware of where your money is going, you need to drill down a little deeper. Putting together a list of every account is great, but it still won’t give you the whole picture.
You need to know where ALL your money is going. Just listing your accounts won’t tell you how much you’re spending on haircuts, groceries, gasoline, take-out food, subscriptions, sports registrations, convenience stores… well, you get the idea.
This is a real eye-opening step that we all need to do to reign in our spending. Not having a budget is why we ask ourselves the question, “why am I always broke?”.
To set up your budget just use a spreadsheet or download an app that you can update. Print it out and update it by hand or online, whatever method works for you. But decide on a method that you’ll use.
To get a budget that works for you, you’ll need categories that cover every area of your spending.
One way to get it started is to get your blank budget, your last bank statement and your checkbook together. Go through your statement and make sure that every single expense is added to a category.
This is a good method because your statement will include pretty much every penny you spend. All those $3 Starbucks and $4 convenience store charges will probably show up as “POS” or point of sale expenses.
The real eye opener when you start working your budget is probably going to be how much money you’re spending on things other than bills. Things like ATM withdrawals trips to the convenience store, the pizza place or debit card purchases. It’s so easy to let several hundred dollars slip through your fingers every month.
Once you fill everything in, you’ll have a handle on where your money is going. But to make sure, I’d start another budget on the first of the month. Each night of the month, enter whatever you’ve spent for the day. If you miss a day, you can log in to your account and check.
What’s going to come out of this exercise are questions like:
- Am I really spending that much on cable and cell phones?
- How can I reduce my auto or home owner’s insurance?
- I had no idea I was spending that much at the grocery store. How can I cut back?
- I had no idea I was spending that much on take-out food. How can I reduce that?
- Clothing and household expenses really add up. How can I reduce them?
- Debt – car and student loans, credit cards are weighing me down. How can I eliminate them as quick as possible?
Sure, this budgeting exercise will be an extra 10 minutes a night for a month or so, but it’s an investment in your future. Remember, you can’t get where you want to go without knowing where you’re starting from.
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Step 3 – Know Your Credit Profile
Part of assessing where we are financially is knowing where we are in the eyes of credit reporting agencies. We may think we’re reliable bill payers, but everyone misses a beat here and there.
There are three main credit reporting agencies, Experian, Trans Union and Equifax. Almost all merchants report your payment history and your credit limits to at least one of these agencies.
The credit agencies will assign you a score between 300-850. Anything above around 750 is considered excellent.
Late payments affect your score but that’s not the only factor. The agencies also have formulas regarding your debt. The ratio of the credit available to you, compared to how much you’re currently using is a big factor in your score.
Generally, you should try not to use more than about 30% of your available credit. They’ll rate you lower if they consider you over-extended with credit.
If you have several credit cards, all with different limits, it’s easy to lose track of the ratio of your available credit to the credit you’re actually using. Being able to examine your report will show you this.
You need to know what your score is because it will bite you when you least expect it.
If you’re applying for a car loan or a mortgage, you don’t want the salesperson across from you saying, “sorry we could have given you the lower rate but your credit isn’t good enough”. That translates into higher payments. Or worse, a rejection.
You also may see accounts on your credit report that you didn’t even realize you still had open. So you’ll be able to close whatever accounts you no longer use.
You can get one free credit report per year at AnnualCreditReport.com .
If you find that your credit score is low, you can try to dispute things that may be inaccurate. Or you can work to lower or eliminate your debt.
Like creating a budget, getting your credit report is all about making yourself aware and putting yourself in the position to succeed.
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Step 4 – Eliminate Consumer Debt
One of the biggest roadblocks to getting ahead financially is finding yourself in a situation where you’re working just to pay off debt.
Debt payments prevent you from enjoying things like travel, improving your home or having a social life. But more importantly, when a huge chunk of your income is going toward debt, that means it’s not going toward your future.
Your money could be working for you in the form of an IRA, a college fund, a health savings account or an emergency fund.
Some of the ways debt can get out of hand:
- If you haven’t done Step 1 and Step 2 above, then you’re unable to determine whether you can afford a particular purchase. It’s then very easy to over-extend yourself.
- You rely on someone else to tell you whether you can afford something. That brand-new car may be really tempting and the salesman is ready to hand you the keys. But if the payment is going to be 40% of your take-home pay, you can’t afford it.
- You and your spouse have a great marriage, but you each came into the marriage with “a few thousand” in credit card bills. You then charge a honeymoon, buy some furniture for the house, maybe a car for one of you. Within a year, you notice that you owe over $20,000 in debt. The minimum payments are strangling your ability to afford anything else. You’re now behind the eight ball, and all it takes is a job loss or a setback of some kind that could take you years to recover from.
Eliminating debt, especially when it gets out of hand, is hard because it requires you to make some real changes in your lifestyle. Frugality will need to become a habit until you get your debt and your budget under control.
What Steps Can You Take?
- First, make sure your significant other and you are on the same page. You need to be moving in the same direction.
- Once you make the decision to eliminate your debt, no more charging. For anything.
- I like Dave Ramsey’s snowball method of paying off debt. Target your smallest balance first. Then when that’s paid off, take the money you were paying towards the first debt and the second one and put it all towards the second debt. The idea is to create momentum. Pay off the smallest quickly, gain a victory and then roll that money toward the second debt. And if two cards have pretty close balances, pay off the higher interest one first.
- Don’t assume you can only make one payment a month. If you’re paid every two weeks, why not make an extra payment electronically. It’ll reduce that much quicker.
- Be creative. You don’t have to wait for your paycheck to roll in to make a payment. What do you have around the house that you could turn into cash and make a large payment – sports equipment, electronics, books?
- Once you do pay off your debt, order another credit report and make sure it’s reflected there also.
- Consider a balance transfer to a lower rate card. But be sure to throw every available cent at the debt if the introductory rate will expire.
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Step 5 – Establish an Emergency Fund
The first thing to do once you get out from under any credit card debt is to establish an emergency fund. Concentrate on building it to equal three to six month’s expenses. Remember the ones you determined back in Step 2?
You need to have some liquid cash available for when curve balls hit you – like an unexpected $900 car repair, a new clothes washer, a medical payment. You get the idea.
Not having an emergency fund, and having to pay for emergencies on a high-interest credit card is a big reason your debt gets out of hand.
Once your debt is under control, I’d open an account dedicated to your emergency fund and have an amount direct deposited there. You want to make it automatic.
Once your emergency fund has enough in it, then you can direct that money toward other savings like your IRA or 401K.
Trying to put away three to six months of expenses may seem daunting, but even $1000 will help. Just try to regularly direct money into your fund and in time you’ll get there.
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Step 6 – Put a Retirement Plan Together
Once you’ve eliminated the drain of credit card debt and have an emergency fund, now it’s time to build a retirement fund that will enable you to do the things you’ve dreamed of doing once you retire.
What’s the best way to do this?
The amount you contribute to your retirement fund will depend on your age and how much you already have invested. If you can afford to have 15% direct deposited, that’s a good target amount. If you can’t afford it yet, you should try to work up to it.
How should you invest it?
If your employer has a savings plan available, see what options the plan offers. Many employers offer both a 401k and a Roth IRA. If the employer offers to match your contributions in the 401k, then contribute at least that amount, and then put the rest into a Roth IRA.
For instance, if your employer offers to match your contributions with fifty cents for every dollar you contribute, up to 6%, then contribute 6% and they’ll kick in 3%. Right off the bat, you’re getting 50%. How can you leave that on the table?
Then if you can afford another 9%, put that into a Roth. The attraction of the Roth is that you’ll be contributing after-tax dollars so when you withdraw the money years down the road, you won’t owe any additional tax on the income.
If you can’t afford a certain percentage, work your way up to it but the important thing is to get the account opened. If you wait until you’re in your 50’s to contribute to a retirement fund, you’ll really be playing catch-up.
How Can You Tell How Much You’ll Need?
One method to get an idea is to use the 4% rule. The idea is that for whatever amount you have saved, you can afford to withdraw 4% per year without draining your fund.
Suppose you have $800,000 saved for your retirement. If you withdraw 4% the first year of your retirement, that’s $32,000. Now combine that with any other retirement income you’ll have, like Social Security or any pension.
Will the total amount be enough to live on? If it’s not at least 75% of your working wages, then you’ll need to fine-tune your plan. Either try to save more, increase your income or adjust your retirement plans so you’ll be able to live within your means.
Note: If you haven’t already, it’s a good idea to contact Social Security and get an estimate of your earnings. They’ll give you projections depending on your retirement age. This is key information to help you plan accurately.
Step 7 – Insurance Coverage
Ok, this isn’t the sexiest of subjects, but if we’re talking about financial security, insurance is something we have to consider. When you work hard trying to put away something for your future you don’t want an injury. illness or accident to wipe out everything you’ve worked for.
There are a few types of insurance that you do need to have. Your health is probably the most important asset you have so you need to protect it. Health insurance covers the major emergencies, but also your basic checkups, prescriptions, dental and eye care.
Hopefully, you’ll have coverage through your employer, your spouse’s employer, a labor union or through the federal marketplace.
Disability insurance would provide you with supplemental income if you’re hurt and unable to work for a short or a long period of time. If disability insurance is offered through your employer, you absolutely should take advantage of it.
If you own a home and have a mortgage, then you’re required to have homeowner’s insurance. But if you happen to pay off your home, don’t let it lapse. You still need to protect your belongings in the event of a fire or other disaster.
If you’re a renter you’d still be wise to have renter’s insurance to protect your belongings. A renter’s policy could cost around $100 per year but there may be a way to pick this up free.
Since renter’s insurance is not a big money maker, some insurance companies will include it with your auto policy. I’ve heard of some companies that will even lower the policy price just so they can include renter’s insurance.
Like health insurance, you’ll probably also be able to get life insurance through your employer. Its purpose is to make the lives of your spouse and children easier in the event of your death. You’ll probably be offered a policy that pays a percentage of your annual salary with the option to buy more.
If your family has assets that would be lost without your income, life insurance is a must. The amount of life insurance you’ll need depends on your own situation. Do you have several children and a large mortgage? If you do, you’ll want enough coverage to help them to pay for funeral costs as well as to recover financially in the event of your death.
Summing it Up
You wouldn’t set out on a multi-state driving trip without an idea of the route you’ll take. And you wouldn’t build a house without a set of tested, engineered blueprints.
Many of us spend more time planning our next vacation than we do making sure we have a plan in place to secure our financial future.
Spending some time to create a financial plan helps us to see the big picture. And it enables us to reach long and short-term life goals. When you have a financial plan you’ll find it easier to make decisions and stay on track to meet your goals. And you won’t realize, in your 50’s or 60’s that you’re far short of what you’ll need to retire.
Take a little time to go through these 7 steps to put your foundation in place. You’ll be glad you did!