Personal finance is a term that covers managing your money as well as saving and investing. It encompasses budgeting, banking, insurance, mortgages, investments, retirement planning, and tax and estate planning. It often refers to the entire industry that provides financial services to individuals and households and advises them about financial and investment opportunities.
Personal Finance Explained
Personal finance is about meeting personal financial goals, whether it’s having enough for short-term financial needs, planning for retirement, or saving for your child’s college education. It all depends on your income, expenses, living requirements, and individual goals and desires and coming up with a plan to fulfill those needs within your financial constraints.
But to make the most of your income and savings it’s important to become financially literate, so you can distinguish between good and bad advice and make savvy decisions.
The 8 Simple Steps to Personal Finance
The steps below form the core of the Beginner’s Guide to Personal Finance. While these steps seem straightforward, they are extremely powerful. If you learn them and follow them, you will both improve your relationship with money and be able to improve the quality of your life. We know we have! We will summarize the 8 steps below and then dive into more detail for each one.
1. Learn To Live Within Your Means
Research shows that the hardest part about reaching any goal is getting started. Saving money is no different. Most of us talk about wanting to save and what we would do with the money. But then we kick the can down the road and put off getting started until we “make more money”.
Most of the people who talk about personal finance tell us that they don’t know where to start. They have a job but are living paycheck to paycheck. We’ve been there too. For years. But you have to start somewhere. Saving just $10 a week will help you save over $500 in your first year.
Reading the Beginner’s Guide to Personal Finance is a good start! However, the first real step is to create a budget. A budget is a plan for how much money you will spend over a given period of time. We recommend starting by breaking it down by month. If you make $2,000 a month, then your budget must account for how every single one of those dollars will be spent or saved.
The easiest and best way to save is going to be by spending less money every month.
Set a realistic goal and slowly prove to yourself that you can save. In order to cut your living expenses we recommend focusing on housing first. Living with roommates, or even better, at home with your parents for a few years is a GREAT move.
We realized that we were spending too much money eating out every week so we began to cook more meals at home. Other items that you might be paying too much money for are monthly cell phone bills, cable bills, and car payments.
If you think you are already spending the bare minimum, you probably aren’t. If you still can’t find anything to cut, then you need to find a way to make extra money (ie. drive Uber/Lyft on nights and weekends).
It is important to put your credit cards away and not use them until you get your finances in order. You’ll be paying a lot more money in interest by carrying a credit card balance.
Don’t move onto step 2 of the Beginner’s Guide to Personal Finance until you have saved up and put away $1,000 extra dollars. If your savings drop below $1,000 you need to return to step 1.
If you still don’t know where to start, just email us and we can walk you through it. Make sure to check out our post dedicated to saving and budgeting to learn more!
2. Contribute Enough To Earn The Full Employer Match
Whether it took you 1 month or 2 years to get here, you should be very proud of yourself! Step 1 is the hardest! The next step is to max out any employer sponsored matching program, like a 401(k) with a match. This is one of the few things in the Beginner’s Guide to Personal Finance that you should commit to memory!
Some companies offer an incredible perk to their employees in the form of employer sponsored retirement plans WITH matching contributions. What this means is that the company you work for will put money directly into your retirement account to match or partially match the amount you put in (up to a certain amount).
This is free money that you can ONLY get by also putting money into the retirement account.
Not maxing out this matching contribution doesn’t make sense. It is exactly the same as walking past a $10 bill on the ground and not stopping to pick it up. Don’t be a dummy. Pick up the money.
If your employer offers a sponsored retirement program like a 401(k) without a matching component, or if they don’t offer a retirement savings program at all, then you should skip this step. If they do offer it, fund only the dollar amount to get the full company match. Work with your company to calculate exactly how much you should contribute every month to max out their matching contribution.
Again, before a single penny goes anywhere else, you need to ask your company’s Human Resources (HR) department if your employer has a program like this. Do NOT assume that your company doesn’t have it or that you don’t qualify because you only work part-time.
To learn more about 401(k)s make sure to check out our awesome comprehensive guide to 401(k)s!
3. Pay Down Your High Interest Debt
Next, you need to pay down your high interest debt! Like credit card debt and payday loans this is your enemy. We think of high interest debt as anything with an interest rate higher than 8%.
It is critical to pay down your high interest debt because the balances will continue to grow as more interest is added. Most credit cards have interest rates from 15% to 25% per year! This means that the balance can grow dramatically even if you don’t spend another dollar! This debt will continue to grow until it is paid off, so you should put every single extra dollar you have on hand after maxing the 401(k) match into paying down high interest debt.
It is important to realize that your student loans will likely fall into the high interest category if they are not subsidized. Don’t include mortgages here since they are often large and can prevent you from saving for retirement for several years. Check with your loan providers or credit card companies to figure out your interest rates if you aren’t sure.
One last thing to remember is that you should continue to make the minimum payments on your moderate interest debt so that you don’t hurt your credit score. For many of you, it might take several years to climb out of the deep high interest debt hole, and that’s okay. Remember that financial freedom is a long-term journey.
4. Beef Up Your Emergency Savings
You did it! You just dug yourself out of high interest debt hell. And saved yourself tons of money in interest. Now comes the more fun part – building wealth!
Now that your credit cards and high interest debt is paid off, the next thing you need to save for is an emergency. This emergency fund will be set aside to protect you in case of a medical emergency, loss of a job, or another catastrophe. The goal of this emergency fund is to help you get back on your feet as quickly as possible.
For example, if your car gets a flat tire, it will be hard to drive to work. The fund also limits the financial damage that can occur if your bills cannot get paid on time. We recommend that you save enough money to cover 3 months of your basic living expenses.
This money can be saved in cash in a safe place at home, but we recommend keeping it in a free online no-fee checking or savings account so that it can’t get stolen, lost, or destroyed. We recommend that you read our detailed post about emergency funds to learn more!
5. Open a Roth IRA
Now that you have 3 months of savings for an emergency, you can breathe sigh of relief!
You’re also over half way done with the Beginner’s Guide to Personal Finance!
Now it’s time to start to save in a Roth IRA! An IRA (Individual Investment Arrangement) is a retirement account that has tax benefits. You can think of it as a bank account except that you decide what you want the money invested in. Why not just save more money into a savings account or open a normal brokerage investment account?
The answer is that these accounts can save you a lot money on taxes when you retire.
You’ll want to save 20% of your annual income here until you reach the annual contribution maximum of $5,500. You’ll want to save more if you are older than 30 years old or haven’t saved regularly for retirement.
In general we recommend most people start with a Roth IRA. The main difference between a Roth and a Traditional IRA is the timing of tax breaks. In reality, the most important thing is just to pick one and start putting money in it. Because of the tax advantages, the government has limits if you earn over a certain amount. You should look into them, but for most people they won’t be an issue.
To learn the ins and outs of IRAs, make sure you read our comprehensive guide to IRAs. You won’t want to miss it. And your future or current kids won’t want you to either.
But don’t forget that saving money in a Roth IRA isn’t enough. You also need to invest that money!!
6. Pay Down Your Moderate Interest Rate Debt
You’re a personal finance star compared to your neighbors, but you aren’t done yet! You still have moderate interest debt hanging over your head. We consider moderate interest debt to be anything between 4% and 8%.
You’ve already paid down your high interest debt so you should be very familiar with the drill. This moderate interest debt can include personal loans, subsidized student loans, and other moderate interest loans.
Don’t include mortgages here since they can prevent you from saving for retirement for several years. If you are averse to having any debt at all, this is the place where you’d prioritize paying off all of your debt (even low interest debt). Once everything else is paid off, move to the next step of the Beginner’s Guide to Personal Finance!
7. Top Out Your Retirement Savings
Congrats! Your high interest and moderate interest debt is paid off! Now you can make an even bigger monthly contribution to your retirement savings to help catapult you to financial freedom. We recommend a savings goal of 20% of your gross income for your retirement. Or more if you started late or are behind on retirement savings!
This 20% includes any annual contributions you made to your 401(k) or Roth IRA in earlier steps!
The first step here is to max your contributions to your employer sponsored retirement fund (beyond their match). We recommend using your employer plan since your employer will usually help cover the administrative fees. If your employer doesn’t have a retirement saving plan, you’ll need to use a normal taxable account.
You’re almost done reading the Beginner’s Guide to Personal Finance! The most fun part comes next!
8. Save For Your Wildest Dreams
If you made it this far, you should be extremely proud of yourself! Few of your peers will be able to feel the freedom that you can already begin to taste. You set an ambitious goal of getting your financial life on track, and made a plan and stuck to it!
Now you can begin to think about other dreams like saving for your kids’ college tuition. Or paying down your mortgage early. If you haven’t been able to take a vacation, you can begin to set money aside for that as well!
What are some of your dreams? Comment below to let us know!
Thanks for reading the Beginner’s Guide to Personal Finance! Please comment below with any strategies that you’ve found helpful or if you have any questions!