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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.
- 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, that is) 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 personal budgeting apps for smartphones 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 so that you are in control of every dollar you spend.
- Mint streamlines cash flow, budgets, credit cards, bills, and investment tracking all from one place. It automatically updates and categorizes your financial data as info comes in, so you always know where you stand financially. The app will even dish out custom tips and advice.
2. Create an emergency fund
It’s important to “pay yourself first” to ensure money is set aside for unexpected expenses, such as medical bills, a big car repair, day-to-day expenses if you get laid off, and more. Three to six months’ worth of living expenses is the ideal safety net. 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 house.
- Limit debt
It sounds simple enough: To keep debt from getting out of hand, don’t spend more than you earn. Of course, most people do 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 can sometimes be more economical than buying outright, whether you’re renting a property, leasing a car, or even getting a subscription to computer software.
- Use credit cards wisely
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 not only crucial to establishing your credit rating but also a great way to track spending, which can be a big budgeting aid.
Credit just needs to be managed correctly, which means that you should pay off your full balance every month, or at least keep your credit utilization ratio at a minimum (that is, keep your account balances below 30% of your total available credit). Given the extraordinary rewards incentives offered these days (such as cash back), it makes sense to charge as many purchases as possible if you can pay your bills in full. Most important: 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 (see tip five).
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.
- Monitor your credit score
Credit cards are the main 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.
Factors that determine your FICO score include:
- Payment history (35%)
- Amounts owed (30%)
- Length of credit history (15%)
- Credit mix (10%)
- New credit (10%)
FICO scores are calculated between 300 and 850. Here’s how your credit is rated:
- 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. By monitoring your credit report, you will be able to detect and address mistakes or fraudulent activity. Federal law allows you to obtain free credit reports once a year from the 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. You can also get a free credit score from sites such as Credit Karma, Credit Sesame, or WalletHub. 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 once a week through at least April 2022.
- Consider your family
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 need to look into insurance: auto, home, life, disability, and long-term care (LTC). And periodically review your policy to make sure it meets your family’s needs through life’s major milestones.
Other critical documents include a living will and 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.
And while your children are young, take the time to teach them about the value of money and how to save, invest, and spend wisely.
- Pay off student loans
There are myriad loan repayment plans and payment reduction strategies available to graduates. If you’re stuck with a high interest rate, then paying off the principal faster can make sense. 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 will get the maximum benefit from compound interest (see tip eight). Some private and federal loans are even eligible for a rate reduction if the borrower enrolls in auto pay. 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 20% of your income (based on your income and family size)
- Plan (and save) for retirement
Retirement may seem like a lifetime away, but it arrives much sooner than you’d expect. 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 like to 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; it can also 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). If your employer offers a 401(k) or 403(b) plan, start paying into it right away, 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.
- Maximize tax breaks
Due to an overly complex tax code, many individuals 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, your enjoyment of the present, and your plans for the future.
You need to start each year 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 that you are taxed on, whereas a tax credit actually 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.
- 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 that 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.