It isn’t uncommon for people to graduate from high school or college without formal education on personal finance! Yet, managing our personal finances is one of the most critical aspects of adult life. Fortunately it is never too late to learn, and it is never too late to implement better practices over your own finances.
Without further ado, here are 10 Financial Basics You Want to Know.
- Track your net worth.
Your net worth is the big picture number of where you stand financially. Net worth is the difference between your assets and debts. It is calculated by subtracting your debts (liabilities) from the value of your assets (including cash, stocks and bonds, retirement accounts, real property, and other valuable items). Knowing your net worth allows you to see the progress you’re making toward your financial goals. Or, to see a lack of progress, giving you the opportunity to course-correct.
- Set a budget and stick to it.
The starting point for every financial goal in life is your budget! For some guidance, check out our article The Benefits of a Budget and Sticking To It.
- Interest rates matter. Know what they are.
Paying attention to interest rates will help you make wise decisions about your finances, including which debt to pay off first, which savings account to open, and which loan to take out. For example, if you are working toward paying off two credit cards, focus on paying off the one with the higher interest rate first.
When deciding where to hold your savings, find the most favorable interest rate. The difference between a 1% versus a 2% interest rate may not seem like much, but on $20,000 in savings it is the difference between $200 and $400 of free money annually.
Know that when it comes to large loans, like a home mortgage, a difference of even just .25% (1/4 of a point) on the interest rate makes a huge difference on how much you’ll pay in interest over the life of the loan.
- Understand what compounded interest is and how it affects your savings and your debt.
Compounded interest is interest calculated on the initial principal and also on the accumulated interest of previous periods. That may sound confusing, so let’s break it down this way:
Consider your savings account. When your money earns interest, that interest is added to the principle sum. So you then have more money in your savings account. Assuming you do not make any withdrawals from the account, then that increased principle sum earns interest. Compound interest is essentially earning interest on interest. Thanks to the powers of compound interest, the earlier you save money the more will accumulate.
Alternatively, compounded interest on debts is essentially paying interest on previously accrued interest charges. The power of compound interest also means carrying debt forward will cost you more.
- You need an emergency savings.
Emergencies are expensive and generally unavoidable. A major car repair, a trip to the emergency room, or last-minute travel expenses to attend a memorial service can cost hundreds, even thousands of dollars. Without an emergency savings to cushion for such expenses, you could rack up debt that takes you months or years to pay off.
It is a good financial practice to have at least 3 to 6-months of living expenses in emergency savings.
- Start saving ASAP.
If you’re not already, start saving now. Even if it is only 5% of your income, begin the habit of saving. This goes hand-in-hand with numbers 4 and 5 above. First, money you save now will have more time to grow through the power of compounded interest. Second, you need an emergency savings.
- Set specific financial goals.
Getting specific with any goal makes you significantly more likely to reach the goal. “My goal is to save more,” is not a good financial goal. “My goal is to increase my savings account by $12,000 be December 31st,” is a good financial goal. Get specific with your financial goals using numbers, dates, and what you want to accomplish with your money (i.e. paying off debt, bolstering retirement, taking a vacation).
- If you’re struggling with overspending, go all-cash.
Using cash to pay for expenses will break you of an overspending habit. We don’t mean using a debit card instead of a credit card — we mean using cash to pay for your expenses. Your fixed monthly expenses can be paid through the bank (mortgage/rent, car payment, insurance), but for all other payments use cold-hard-cash. Forking over a fist full of $20’s for a tank of gas is painful. All-cash living will give you a wake-up call on your overspending.
- Do not cash out your retirement account early.
Dipping into your retirement account early will trigger hefty early-withdrawal penalties, tax consequences, and prevents that money from being invested or earning interest. Do everything possible not to touch your retirement funds early.
Moreover, do not borrow against your retirement funds in an effort to avoid bankruptcy. For the many reasons not to do this, check out our article Do Not Borrow Against Your Retirement to Fund Debt Management.
- Research shows that spending your money on experiences is more rewarding that buying stuff.
Buy experiences, not things. Studies (here and here) have found that people who spend their money on experiences instead of material items are happier and felt the money was better spent. A shiny, new gadget is fun. That pricey pump would look great with your suit. But the studies tell us that rocking out with your friends at a concert or going on whatever fun-adventure you’ve always dreamed of going on will bring you more happiness for your buck.
We all know money cannot buy happiness, but it can pay for experiences that become epic good times, bring joy into our lives, and leave us with cherished memories.
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