Whether you work part-time for minimum wage, or you’re at the peak of your career making big bucks, you want to get the most out of the money you have.
These 7 steps to better managing your money will help you achieve that goal.
Table of Contents
1. Know where your money goes
You wouldn’t bake a cake without a recipe or take a drive vacation without planning a route. Managing your money without knowing where it’s going is a formula for failure.
Without knowledge of where your money is going you can’t determine where to make changes. You’re stuck guessing where you should save. Those efforts can be useless and painful.
If you know where you’re spending you can compare your expenses to established averages. That will allow you to identify any category that’s above normal. Once identified you can make changes where they’re the most likely to solve your problem.
2. Always save a little
If you’re creative you can come up with a dozen reasons why you can’t save some money each month. Some may even have a little truth to them. But, if you allow them to convince you not to save, chances are you’ll never accumulate any wealth. It’s that simple.
Saving a little with every month or paycheck has other advantages.
You’ll develop the habit of saving. You’ll be accumulating savings in both good and bad markets (taking advantage of dollar cost averaging). You’ll have compound interest working on your behalf. You’ll have money saved to handle unexpected big expenses.
3. Understand how compound interest works
Compound interest may be the most important economic concept for you to learn. And it’s easy to understand and tremendously powerful. Especially if you learn it early in adulthood.
Compound interest is interest earning interest. For example if you invested $1000 and received 10% annual interest you’d have $1100 at the end of a year. The 2nd year you’d have both your original $1000 and the $100 interest earning money. So, you’d earn $110 that year. The extra $10 might not seem like much today, but if it compounds for 20, 30 or even 40 years it adds up.
Not quite ready for investing? You can still earn interest on your money with an interest bearing checking account, like the Radius Rewards Checking account. The interest rate is currently 1.00% on balances of $2,500 or more. Compared to the national average of 0.04%, this is a great rate!
But just as compound interest is the friend of the saver, it’s a terrible master for anyone in debt. Instead of earning interest, they’re paying it.
Think that your credit card is helpful when you can’t afford to pay for something? Consider this example. If you pay the minimum (say 4%) and your interest rate is 18.9% you’ll repay $1.62 for every $1 you charge. Ouch!
4. The rule of 72
This tool is used by financial planners everywhere. It’s a quick and easy way to get an idea of how long it will take for money to double. Just divide 72 by the interest rate to get a time estimate.
Often you can do it in your head. For instance, if your interest rate is 8%, it’ll take 9 years for money to double (72 / 8 = 9).
Why would you want to know this? Knowledge can be a great motivator.
Suppose you’re 30 years old and trying to decide whether to increase your 401k contribution. You know that long-term you can expect your contributions to grow at an 8% rate. So, the money should double every 9 years.
$1 now will be $2 when you’re 39, $4 when you’re 48, $8 when you’re 57 and $16 when you’re 66. A quick calculation now might be enough to help you make your retirement more secure.
5. Manage your credit
Some things follow you everywhere. Your credit score is one of them. It’s used by financial institutions to decide whether to lend you money and to determine what interest rate they’ll charge.
Some landlords will check your score before offering you a lease. And some potential employers are checking before making a job offer.
So how do you manage your credit? Begin by making sure that your score is accurate. Your credit card company may provide your score as part of their service. That’s good. But it’s not sufficient.
Nearly 1 in 4 scores contain an error big enough to negatively impact you. The only way to find out is to get your full report on a regular (at least twice a year) basis. And always check for accuracy before taking out a large loan (mortgage, auto loan, etc.).
Next, know what actions can help or hurt your score. Having some unused credit is good. Having too much is bad. Don’t apply for multiple credit cards at the same time. Paying your bills on time is critical.
How important is managing your credit? A 1% difference in a 30 year, $200k mortgage is $119 per month. Or a total of $42,840 over the life of the mortgage!
6. Use a budget
But, use your budget as a management tool, not a straightjacket!
Everyone hates the ‘B-word’. Understandably so. But if they knew how a budget really worked they’d come to love it. Because a simple budget can be a wealth of information about your day-to-day finances.
A budget is not necessarily a way to prevent you from spending past a certain limit. It can be used that way, but that’s not it’s best use.
A budget should be a spending plan. Defining how much, or what percent, of your after tax income you expect to spend on certain things.
For instance you might expect to spend 17% for auto and related expenses. Knowing that would be helpful if you were considering buying a car that would run that expense up to the 19% level. Or if your actual expenses were above the 17% level you’d have to decide whether to adjust your plan or try to cut down the expense in the future.
At it’s best a budget is an information tool to point you to areas of your finances that need attention.
7. Have both short and long-range goals…and plans
You may not think of it that way, but we all have financial goals. We just think of them as things that we want.
We want to be able to afford groceries and the next rent payment. Those are short term goals. We want to send our kids to college and to retire someday. Those are long term goals.
But there is a difference. A want is something that we hope will happen. A goal is something that should include a plan to achieve the result.
Short-range plans will need to be more precise. If your rent is $1300 due the first of the month you’ll need to know exactly where the money is coming from by mid-month.
Longer range plans don’t need to be so specific.
For instance if you wanted to have $1 million in retirement funds by the time you turned 65 you could use one of the calculators to determine how much you’d need to save each month to reach that goal. The monthly savings goal doesn’t need to be that specific.
You’ll make mid-course adjustments as you move towards retirement. The important thing is having a plan and getting started towards your goal.
So, should you manage your money? It comes down to a choice. Do you want to manage your money? Or do you want your money to manage your life?
This was a guest post from Gary Foreman. Gary is a former financial planner and purchasing manager who founded TheDollarStretcher.com website and newsletters in 1996. He’s been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.