Managing your money can be difficult, especially if you’re living paycheck to paycheck and having difficulty paying down your debt. So what are the five basics of money management? And how can they help you?
The First Basic Rule – Know What You have
One of the first steps to building a stable foundation for your financial life is understanding what you have. That means assets, income streams, and debts. This means you need to build a budget.
You should write down the income you received over the past few months, and average it out. Then you’ll want to take a look at what you’re spending every month, these are your expenses and they should be categorized based on your level of need. Rent should be listed as your number one need; this is because it’s one of the most difficult expenses to actually reduce.
Utilities are number 2, they’re also important, but you could probably stand to reduce your expenditure without impacting your quality of life too greatly. Then start moving line-by-line, and figuring out what you need and what you don’t. You should also take note of any debts you have, including their interest rates, and any information about penalties that may apply if you fail to make payments.
Once you’re well aware of what you have, it’s time to move on to step two.
The Second Basic Rule – Cutting Costs
Cutting costs in your life can be a difficult thing at first. Purchases often seem necessary at first, but in retrospect, you might find there were other options you could’ve considered. One such case of this can be found at the grocery store.
When you’re filling up your cart, what are you filling it up with? And I don’t mean what specific items. I mean what brands? What’s the price per ounce? Are you buying in bulk? Did you spend extra on something you could’ve got a dollar cheaper at another store with a coupon? You don’t have to get incredibly granular, but putting some extra thought into your purchases, and paying attention to details on the price tags, can save you a lot of money over time.
And, allow you to either start building up savings or start chipping away at your debts. You could also consider turning the A/C up 2 degrees in the summer, or turning the heater down the same amount during the winter, as your A/C bill can take up a substantial portion of your electricity costs.
The Third Basic Rule – Only Take Loans that Increase Your Ability to Make Money
Loans. To most people, they look like a one-way ticket to debt and obligation. And for most consumers, that’s true. Businesses and the rich, however, see it differently. For them, loans are a way to leverage their future earnings in a way that allows them to increase their profits in the future.
So how does this apply to you? Well, let’s think of a few examples of “Good Loans”. A mortgage, it’s a loan you take out for a place to live. While you slowly pay down your debt, you have access to a living space that allows you to perform the daily functions needed to hold down a job. You sleep there, you shower there you keep your valuables there. So as long as the mortgage terms are good and don’t exceed your means, this type of loan increases your ability to earn an income.
Another example is car loans.
If you’ve ever been poor, you’ve likely driven a car that cost at most $1500. And you know exactly how reliable those are. While a $15,000 dollar vehicle might cost a lot more, and put you in a lot of debt, over the long run, you’ll have a vehicle that is far more reliable.
That means fewer trips to the mechanic, less time missing work, and likely an increased fuel economy over the 15 or 20-year-old scrapheap you’re used to driving.
While taking on any large loan like that is a big decision, and requires a lot of research, there are ways to leverage your future earnings potential to increase your ability to earn.
The Fourth Basic Rule – Pay Down Your Most Expensive Debt First
One of the main topics in Dave Ramsey’s book, which you can learn more about the 7 Baby Steps from Bills.com, paying down your most expensive debt first can help you massively.
What does that mean exactly? Say you have one debt that totals $1000 dollars, and another that’s only $100 dollars, which debt is more expensive? If you said, “There’s not enough information to know”, congratulations, you’re correct! What’s important to know is the interest rate on that debt, the fees associated with it, and how often the debt is compounded.
Say you have $100 of credit card debt, and missing a payment activates a late fee of $35 every month, with 2% interest on top of it all. This debt should take precedence over, say, a $1000 dollar debt with 3.5% interest, but a 3-month grace period on late fees. By focusing on the debt that costs more over time, you lessen both your current and future financial obligations, and it helps you achieve your goal of debt elimination far quicker.
The Fifth Basic Rule – Spend Money to Make Money
Saving for retirement can be one of the biggest hurdles in your financial life, but the sooner you’re capable of doing so, the better. While saving for retirement can be difficult as you’re only beginning to establish yourself in the modern world, getting money into an investment account, like a mutual fund, can be a great way to start accruing that wealth.
The goal for savings should be 20% of your income, but we all fall short sometimes. So any amount is better than nothing. If you have access to an employer-sponsored 401k, that should be one of your first choices, especially in the case that they match your investments, as that doubles your starting capital. However you end up getting there, you’ll be glad you asked, “What are the five basics of money management?”.
