Personal finance defines the way you handle your money and prepare for your future, which has a significant impact on your financial wellbeing. Understanding your personal finances and managing your money better is an essential part of financial health. Investopedia offers five tips that can help you reach your goals.
Calculate Your Net Worth And Budget
Subtract the amount that you own from what you owe, and you have your net worth. It helps to write down all of your assets and debts first.
But creating a budget is just as important as determining your net worth. You can develop a monthly, quarterly, or annual budget to help you:
- Prepare for expenses
- Lower or eliminate costs
- Save for the future
- Practice responsible spending
- Plan for emergencies
- Prioritize expenses and saving
There are many ways to create a budget for yourself. Still, each one requires that you estimate your income (bonuses, social security, alimony, etc.) and expenses (utilities, housing payment, credit card bills, etc.).
After you make a list detailing where your money comes in and where it goes out, deduct your costs from your income. The amount remaining is your expendable income, which you can save, spend, or invest. If you spend more than you make, you will need to modify your budget. You can do this by making more money or finding ways to lower your expenses.
Recognize And Control Lifestyle Inflation
If your expenses increase with your income, this is called “lifestyle inflation,” and it can be detrimental to your financial health, even if you aren’t behind on your bills. That’s because lifestyle inflation restricts your chances of building wealth and can affect your lifestyle in retirement.
It’s not uncommon for people to spend more money if they have more of it. Just remember that financial health is more than paying your bills in full and on time; it’s also important to plan for the future.
Differentiate Between Needs And Wants
Recognizing the difference between needs and wants is one way to avoid falling into the trap of lifestyle inflation. But more than that, it helps you become more mindful of your spending.
Sometimes, categorizing certain things as either a need or a want is difficult because it’s not always black and white. When a purchase falls into a gray area, it can tempt you into justifying unnecessary spending by classifying it as a need.
For example, if you need a new car because of your growing family, you may want a luxury SUV. While big enough to hold everyone, this type of vehicle may not be the best decision for your financial health. You might consider buying a used SUV instead.
Needs are the first thing you account for when you make a budget. Once these are fulfilled, you can focus on your wants — though you should still focus on saving a percentage of your discretionary income.
Save Early On
Many finance experts like to tout that it’s never too late to begin planning for the future. While this is definitely the case, saving for retirement at a younger age can make the process much less stressful. Additionally, it ensures you will live a more comfortable retirement life.
The reason why so many professionals advise people to save early is because of compound interest. The more time you let your savings compound, the more you will get back in the future. When a large sum of your retirement savings comes from compound interest, you don’t have to put away as much of your own money to reach your goal.
Build An Emergency Savings Fund
In addition to saving for retirement, it’s just as crucial that you build an emergency fund. This money isn’t just rainy day spending cash. It’s funding for an unexpected expense, such as a medical procedure that your budget doesn’t account for. It is also a valuable resource in the event that you lose your job or are unable to work for some reason. An emergency fund will prevent you from going into debt by using a credit card or taking out a personal loan to cover this expense.
The rule of thumb is to save enough to cover three to six months’ worth of living expenses. But with the pandemic ongoing, you should try to save for the higher end if you can. Building an emergency fund can take months, and it’s not necessarily fun, but it’s crucial in case something happens to you or a loved one. There is a chance that as soon as you reach your goal, something will happen, and you will exhaust it. While this may be hard to accept, the silver lining is that you can rest easy knowing you protected your financial health by not going into debt.
- Folger, Jean. “Five Rules to Improve Your Financial Health.” Investopedia, Investopedia, 28 Sept. 2020, www.investopedia.com/articles/personal-finance/111813/five-rules-improve-your-financial-health.asp.