Even though the world runs on money, and our lives revolve around its flow, there's an appalling lack of discussion and education about personal finance. The result is that finance remains a mysterious, often taboo subject among friends and around the dinner table. Here at MoneyWise, we strongly believe it's time for the wall to come down. It's time for everyone to understand how to grow their money with a basic understanding of personal finance.
Although it may seem intimidating at first, you don't need a degree in economics to understand or profit from personal finance. Anyone can learn to control the money flowing in and out of their bank accounts and how to start making investments that will grow their earnings over time. With the right approach, you can even become a millionaire just through dedicating your time to good personal finance!
Let's get started.
Discovering Your Goal
First ask yourself: what does money mean to you?
The answer to this question will determine your unique philosophy and approach to personal finance. For some people, money's a status symbol. For others, it ensures survival. But on its own, money doesn't have the power to make us happy.
The one thing that's always true is that money enables mobility. It allows us to satisfy our basic needs and enjoy some of life's luxuries. Money brings happiness because we enjoy these material luxuries, and also because it brings us peace of mind and a sense of security and stability.
They say "money doesn't grow on trees," but it makes sense to start thinking about money like a tree. As with planting a new sapling, when you're starting on your journey to personal finance, at first it's hard to make sure your income flow is steady and for a savings habit to take root. But with proper, regular care and management, you'll be able to solidify your income and savings to ensure you have enough money for when you need it. And with proper care and management, you'll be able to grow your money — just like a tree.
The second and equally important question is: what are your financial goals?
How do you see yourself living life five or ten years from now? Hopping from country to country? Enjoying summer in a Spanish villa? Owning a collection of cars? Not tied down to a 9 to 5 job and instead being your own boss?
The answer to this second question is crucial in mapping out your spending habits and patterns and your savings and investment plan. Consider these future goals as the light at the end of the tunnel. Your end goal keeps you going; it's the reason for you to stick to your route and your financial plan.
Visualizing where you want to end up is the same strategy used by professional athletes and Olympians. The final race and prize only comes after many years of often boring training on a daily basis. The vision of the prize, the end goal, is what keeps these athletes going back to their gruelling training and sticking to their diets, day after day.
Now, don't worry, personal finance doesn't come close to an Olympian training schedule's difficulty! What the two have in common is the vision and the daily dedication to reaching it.
This means that you can't begin your financial journey until you decide on a real vision and goal that will drive you and that you can tap into if the journey gets difficult. So, do that first — and be honest with yourself about what you want.
Personal Finance 101
Now that you have a vision and goal to focus on, there are two basic Personal Finance rules you need to know.
Spend less than what you earn. Saving money is impossible if there isn't any extra money to be tucked away. If you're spending a thousand dollars more than what you're bringing home on your paycheques every month, then it's easy to get into the habit of borrowing to make ends meet and to live a certain lifestyle. This can result in a vicious cycle of debt where any extra money you make goes to pay for these loans, leaving you strapped for cash. Spending less than what you earn means that you can put away any extra money for emergencies or future investments.
Make your money work for you. The purpose of saving money is to have a financial fall-back if you find yourself needing cash. But it's also used for investing, which earns you more money while you sleep.
To earn significant interest over time, money needs to be put in high-level investments and not a low-earning savings account. A thousand dollars can grow a lot in five years' time depending on where you invest it. In a savings account, the money might only earn an additional hundred dollars. But invested wisely, it might double in the same period of time. There's always some risk with investments, but with a trusted professional financial advisor at your side, you'll be able to reap these great rewards.
Getting Down to Business
Now, we'll dive deep into the nitty-gritty of managing your personal finances. But first, here's a disclaimer: There is no one-size-fits-all approach to financial management. There are basic rules, but it's up to you to fit these rules to your own situation and circumstance.
Those two rules earlier mentioned can be further broken down into four guidelines:
- Controlling spending
- Creating a savings plan
- Controlling debt
- Developing a long-term investment strategy
1. Controlling Spending
You can only control your spending when you know where you're spending your money. It's easy to spend money without thinking about it when we use credit cards, but this also creates a convenient data trail we can analyse to understand our spending.
Try this simple exercise: for the next month, list everything you spend your money on. Whether it's a couple hundred bills or a few pennies, keep track of every purchase you made, big or small. This includes every bill you had to pay (utilities, phone, etc.), every small luxury you treated yourself to (like a fancy coffee or drinks out with friends), and every emergency — major or minor — that you had to spend money on. If you use online banking, it's very easy to go back and look at your purchases, but make sure to track your cash spending too. In order to track everything properly, you need to regularly update your log.
You'll realize then that more than 90% of your monthly spending falls into two major categories: fixed and variable expenditures. Fixed or semi-fixed expenditures include rent, important utilities like water and electricity, staple groceries and food, and transport (whether it's fuel for the car or a monthly pass for public transportation). These are important expenditures that you need to allocate money for every month because they have to be paid. These are your necessities.
Variable expenses are things that you don't buy regularly. These include clothes bought on a whim, new books from the bookstore, or a movie night with friends. This is where you can save the most money, because you technically didn't have to spend this money and you won't have to do it in the future. You don't go clothes shopping everyday, for example.
In addition, you might have some fixed (regular) expenditures that aren't necessary or as important as food, transport, and rent. These bills include a monthly gym membership, data or mobile phone usage, or cable. This is another set of expenses where you can really cut down on unnecessary spending.
For example, if you choose to pay for Netflix instead of cable, you'll be able to save $50 – $75 a month. You can switch to a lower cost community gym or just decide to go running at the park and save the cost of a monthly gym membership.
The idea is that once you've tracked all your necessary, luxury, and entertainment spending for one full month, you can take a clear look at your spending and find places where you can cut back. Any and all money that you save can then be put towards paying off any debts and getting closer to achieving your greater goals.
Now you see why it's so important to have a goal that you're working towards. Every day and every month, you will be choosing to take the money you would've spent on daily luxuries you don't need and putting that money toward achieving your new goal instead. These actions form the basis of personal finance. Pretty simple, right?
2. Creating a Savings Plan
Once you have a clear vision, you can create a ballpark amount of money you'd like to save. This will become your new goal.
So, ask yourself how much money you want to have saved by the end of the year. Then how about after five years?
Let's say your one-year savings target is $1,000, and it's your plan to save that in the next 12 months. You divide $1,000 by 12 to get $83.33. This means that to reach a savings of $1,000 in one year, you'd have to put aside $83.33 every month. That's $41.60 from each paycheque if you get paid every other week. Not so bad, is it?
After you've started cutting down on unnecessary expenses, you should be able to put that much money aside. If you don't have about $40 to put aside from every paycheque, then either you need to cut back more on your spending — or you need to start making more money. Picking up more shifts at work or getting a side gig to make a little extra money every month should be able to help you start saving some money as soon as possible.
Here's a tip to maximize your savings: Double up your savings early on. If you can increase your savings every month as early as you can, then you'll have more money to begin investing. The sooner and earlier you can put your money into investments, the sooner they can start earning profit.
3. Controlling Debt
When you're saddled with high interest, persistent debt, you end up using your money to pay for penalties, charges, and interest. When you add these all up, this is already a considerable amount that you could already have put into your savings instead.
The most typical kind of debt is credit card debt. The average American household owes $16,000 in credit card debt. Because credit ratings are so important in North America, using a credit card is a necessary evil. But the important point is to be aware of how much money you actually have in your bank account, and to make a serious effort not to spend more than that on your credit card. If you don't have any money in your bank account, if possible, you should do all you can to avoid using your credit card, and especially for luxuries. No money in your account means you can't afford to use credit because you won't be able to pay your bill. Unpaid credit card bills begin to destroy your credit rating immediately.
This is a very important part of personal finance: reducing your debt as much as possible, as soon as possible. Putting money aside every month into savings is essential — and so is paying off your debts. So, these two goals, saving and paying off debt, should be the primary ways you spend your extra money.
4. Developing a Long-Term Investment Strategy
If you've managed to pay off the majority of your debt and have a good amount of savings in your account, it's time to consider investing your money!
Time is crucial when it comes to investing. The earlier you invest, the greater the growth potential for your money.
There are lots of ways to invest: by putting money into stocks, mutual funds, bonds, by starting your own business, by purchasing real estate... There are positive and negative aspects to each kind of investment, and knowing how they work is essential before you sign up. For example, you should know what a mutual fund invests in, who is managing the fund, what are the fees, and if there are any fees for accessing or taking out your money.
All this means that you need to get in touch with a trustworthy financial expert. Do your research before you hand over your money.
If you don't feel ready to get into this level of investment or don't have enough money to start, then you can begin with a simple retirement savings plan that you can fund with money deducted from your paycheque. Even better, some employers match your contributions (e.g. you put in $200 and they put in $200). That's literally free money!
No matter where you invest, the important thing to remember is that time is your friend. The earlier you start, the more money you'll make in interest. This is the number one reason to start investing as early as you can.
And that's it! You've read our basic summary on what you need to know to get started on your personal financial improvement journey. By spending less day-to-day, saving more, and investing your savings, you can generate enough money to reach any goal you want. So, think deeply and honestly about what you want out of life, then start saving to make it happen!