I want to get ahead, I really do. But I am realizing that I should not get ahead of myself. There is much to be learned and much to do to get yourself together financially. But, before you go out and try to invest money, a great way to eventually build wealth, you should be sure that you have started on the proper footing and done your homework. Thus, you need to take control over your money in a step-by-step basic way. Here are the steps you should follow so you can figure out if you have money to invest. And, if you are investing for retirement through a 401(k) or other retirement plan, but do not know enough about how to invest, that's fine. You can always go for a no-load, low-expense fund that might even track your particular retirement date. Don't avoid your retirement because you do not have knowledge. However, when it comes to investing, do not just watch Cramer and think you can trade like the pros. Be sure to have your financial house in order before you take some portion of your income and invest it hoping to make big bucks. That's not quite like playing the lottery, it's a bit more like poker. So, the best way to get your financial house in order and take control over your money is to complete the following steps:
1. Figure out your net worth: Well, why, you might ask. Because if it is a negative number, you do not have the money you think you have to invest. It is not hard to do once you pull all the information together. (See "Organizing Your Finances"). Ultimately, you are looking at your assets minus your liabilities. In our case, our assets include our home, car, savings (retirement mostly), furnishings, some art and jewelry (okay, one piece of art and my 10th year anniversary ring [which probably would never had been bought had we been in our debt elimination phase of life 12 years ago instead of our debt accumulation phase]), and, perhaps, electronics. (Now, I actually don't include any of the furnishings or home electronics as my net worth because I am not selling them). Our liabilities include mortgage, home equity line of credit, parent loans for college, car loans, a time share debt, credit cards, [store cards which are paid off now], and our soon to be paid off debt for upgrading our central air three years ago.
2. Figure out your cash flow: This can be a little difficult at first because you may not have a handle on your true expenses. But it can be accomplished by recording your expenses for a month (it is easy if you use a debit card as a credit card for "cash" purchases, and you keep all your bills for the whole month. Then look at all of your reciepts and statements and write down what you pay monthly for each bill and each category of expense. Your expenses in a typical month will give you a fairly accurate picture of your general expenses; however, if you have quarterly expenses for things such as insurance or yearly expenses, you can try to figure them out as well. It is a good idea to put such expenses into a monthly expense so you won't be "blindsided" by them when you actually have to pay them. Subtract your expenses from your usual monthly income and you've got your basic cash flow for a month. If there's anything left after you pay your bills, you've got some extra money that can be used to reach your goals. If you have a negative cash flow, you are living above your means and have to figure out what expenses you can lighten up on. If you continuously live above your means, you will have to pay back the excess eventually making it very hard to accomplish your goals.
3. Figure out your goals: Most financial advisors give the following advice: we should all protect ourselves against future financial emergencies by having 3-6 months of living expenses put away where the money can be easily accessed. We should all be putting aside some portion of our income for retirement. Finally, we should all make an effort to pay off our debt, especially our negative debt. All of that should be done before we try to save any other money. That's your call. First, with respect to an emergency nest egg, such a goal is important in case you lose your job: you need to be able to live; however, if you have a lot of equity in your home, you might be able to tap that should such an emergency occur. I'm not suggesting you do that; however, getting out of debt is probably the best route to take before saving for emergencies. In the event of an emergency, you might end up in debt; however, if such an emergency never comes, you may spend a lot of money paying off credit cards just to hold on to money in an account that you are not using. So, that's your call. You probably will want to have some cash nearby so that you can deal with an immediate need such as paying for car repairs or something else, but, beyond that, if you are currently in debt, you might want to get out of debt before you save for anything else.
Other than trying to get out from under, saving for an emergency and saving for retirement, everyone's financial goals are different. You might be saving to buy a house, car, pay for college, or just to enjoy life -- like to take a vacation. Just identify the difference between a need and a want or you can get into trouble. If you are in a lot of debt, saving for a fancy vacation is probably not a wise use of your money. However, if you look forward to getting away and might burn out if you don't, who knows, maybe the vacation is more important to you. I cannot really say. But, if you have goals, you will enjoy your money more because you can make choices: is this piece of clothing that I want something that I want more than I want to be debt free. Sometimes the answer is yes, sometimes no. If you have no goals, then, you are basically buying the clothing and deluding yourself into thinking that everything else just falls into place. It only does so if you have a large net worth and higher income than outflows.
4. Create a budget: Budgets conjure up all kinds of images in our minds; like, uptight and cheap people are the only ones who keep budgets. Or at least that's what I thought. But, a budget is simply a tool. (See, "Why You Need a Budget.") Often, a budget conjures up images of spreadsheets and all kinds of work, but, actually, it can be simple and just done on the basis of cash flow for a while until you have a more clear understanding of what a budget can do to keep you on target with your goals. It is not so hard to make a pen and paper budget at first and then, you can use more sophisticated tools as you get more comfortable. My budget is essentially a calendar based budget that goes from my biggest payment due date, my mortgage, to my next mortgage due date. I figure out all my absolute expenses between now and then and all my income. Next, I write down somewhat more discretionary expenses that I am likely to incur. Most of the time, even with somewhat low discretionary expenses, I have nothing left beyond that. We are always saving though through payroll deductions to 401(k) accounts. So, I don't count that as part of our income because we do not see that. Our non-discretionary expenses also include an additional amount of debt repayment because that is the chief goal. We have been working on a debt elimination plan since the summer; thus, I consider repaying that debt our number one priority. Much of the time, we have expenses that basically meet our income but, as I figure it, as long as we do not have expenses that exceed our income, we are moving toward our goals. We do not have a lot of extra money to spend on items like eating out or ordering take-out, but, by eliminating our debt, we will have such discretionary money again -- just not in the near future. We are not living badly, though, we are just more frugal with our spending. (The result of our frugality is a change in our bad debt of 4% for the quarter and a change of 1% in our overall debt. I explain our changes in Give Yourself Proof: Time for an Update. )
5. Work on your goals: First, keep up with all the bills. Follow the steps to pay off your debt and bills first and get whatever savings you are doing taken directly out of your paycheck if possible. Spend a few hours a week looking at where you stand and refiguring out how you can move toward your goals. There are small and large methods. Go on a non-spending spree, clip coupons and take a list to the grocery store, keep your "discretionary money" in cash and when it is gone for the week, you have nothing left to spend. If you feel particularly ambitious, get a software program to keep up with your progress. I am partial to Quicken. And every month, or every quarter, measure the results: how much further numerically are you to your goals than you were before you started this new way of acting with your money. It doesn't matter whether you use $10.00 per week to move toward your goals or $500.00 per week. Figure out what you can afford and pay it out first. If you can, start paying your credit card and other monthly debt payments weekly to cut the interest by a small amount every month (you can reduce your average minimum balance for the month by spreading out the payments throughout the month; doing so will save you a few dollars at least per debt per month. If that's $10.00, it is $10.00 less you need to worry about finding to pay off your debt. If you are very ambitious, you can even resturucture your home loan to save you about 8 years and lots of interest by paying it bi-weekly instead of once per month. That adds up to one extra payment a year or a few months of principle.
6. Work on one new thing a month: Maybe this month you can work on organizing your finances , next month, you can figure out which debt to eliminate in which order, next month you can look at your work benefits to make sure you are using them all, the following month you can look for less costly insurance, the next month using coupons when you shop, the next month properly allocating the money in your retirement accounts, etc., etc. A few hours a week should be all that it takes to maintain your finances. In the meantime, you can start looking at the stock market and learning about it if your are so inclined; if not, you can figure out how to invest by using some of the very good advice you can find in many parts of the web and through a broker (if you are so inclined to use one). And, like I said, if you just want to save and you do not want to worry about learning a lot, go with a no-load, low-expense mutual fund. Before you know it, your finances will be in pristine order and you will see progress in your financial health. And, you will sleep better at night eventually knowing you have a net worth and can pay all of your bills when due.
7. What if you just cannot manage your money? Then, you need help. I would try to avoid debt management programs as they sometimes charge a lot of money and appear as a negative mark on your credit rating. Lots of people recommend fee-based financial planners (rather than those that work on a commission). You can find them through the website for Certified Financial Planners. I am thinking of starting a fee-based service to help people with basic financial management. If you have an interest in using such services, you can contact me via my contact form. Whatever you do, though, if you believe you have a problem that you need to solve by getting your financial affairs in order, get started now: debts can mushroom out of control, and, avoidance is a good way to allow that to happen. Facing the facts about your financial situation is the first step toward moving in the direction of fixing that situation. And do not wait until after the holidays when you will have gorged on spending that you cannot afford. Do it now. Take control over your money. You will be glad that you did.