Something hard to get excited about but something we all need to know about
Learning to manage your money well sets the foundation for a fulfilled life because it gives you options.
Ok, so having money is no guarantee that you’ll be happy but not having enough is sure to make you sad.
Some of us were fortunate enough to receive a financial education from a family member when we were younger, and these kind instructors deserve a medal.
For the rest of us, there’s the day you realise that you have likely been neglecting your finances.
Welcome to your financial awakening!
This moment normally results in a mild panic, but try not to spend too much time thinking about what you could have done better. Instead, focus on what you can do now.
The good news is that you don’t need to be a maths genius to become financially savvy.
Most of what there is to learn is common sense. But just because it’s common sense doesn’t mean it’s common practice.
To get you started on your journey to money nirvana, here are ten personal finance tips presented in no particular order:
1. Live Below Your Means
People who live far below their means enjoy a freedom that people busy upgrading their lifestyles can’t fathom.
This is both the simplest and easiest form of financial advice to understand.
And yet it’s surprising how many people don’t follow it.
Living below your means involves making sure that your monthly expenses do not outweigh your monthly income.
This is for two reasons.
Firstly, it saves you from going into debt and secondly it allows you to set aside some money to invest.
Ultimately, it’s about adopting a frugal mindset.
This does not mean living the life of a monk; frugality is more about not wasting money than penny-pinching.
It means doing things like avoiding high-priced branded items and thinking more consciously about what you spend your money on.
It’s worth stating that this also applies to your partner if you’re in a relationship. Achieving financial independence is tough if one of you is a lavish spender.
Living below your means doesn’t mean living an unfulfilled life.
Quite the opposite, in fact.
It can help you focus on enjoying the many things in life that are free or low cost like hanging out with friends, going for long walks in the countryside, or learning a new skill.
Yes, it really is possible to spend less and enjoy life more!
2. Track Your Spending
Beware of little expenses; a small leak will sink a great ship.
— Benjamin Franklin
How often have you heard someone say “I just don’t know where my money goes”?
The truth is most people are delusional about their spending habits.
The first stage in your journey to better financial health is understanding exactly where your money goes each month.
Almost everyone is surprised once they’ve completed this exercise about how little things here and there add up over time.
You can track your spending using Excel, Google Spreadsheets, or other banking apps.
Complete this exercise for at least three months so you can start to observe your spending habits more objectively.
The idea is that by being mindful about your spending habits can have a dramatic impact.
3. Create And Manage A Monthly Budget
A budget is telling your money where to go instead of wondering where it went.
— Dave Ramsey
When the new Scottish parliament building was unveiled in late 2004, it caused quite a stir.
People felt the architecture was too modern, but they were also shocked at how much it was over budget.
The original projected cost was between £10 million and £40 million, but in the end, the final bill to taxpayers was £430 million or ten times as much!
The fact that the late actor Sean Connery was reputedly paid £600,000 for the use of his recorded voice to signal which floor you had arrived on when taking the lift offers one clue to how things became so out of control.
It’s an extreme example of budgeting gone mad, but it illustrates how important it is to manage one.
So, what exactly is a budget?
A budget is a spending plan.
No matter how little or how much money you earn, creating a monthly budget is one of the most critical aspects of managing your finances.
How do you go about creating one?
Start by determining what your budget categories are.
They don’t have to be overly detailed and complex but should include housing, food, transport, savings, personal and entertainment.
Next, apportion the right amounts to each category and commit to only spending the allotted amount.
It’s essential to recognise that a budget can, and most likely will change.
Your job is to keep it balanced and be aware of expenses that look out of line.
4. Pay Off Credit Card Debt
Every time you borrow money, you’re robbing your future self.
— Nathan W. Morris
It’s been said that the credit card is the cigarette of the financial world.
They are easy to get hooked on, and they end up doing you a lot of damage.
Credit cards are designed to encourage consumption by allowing you to buy things now and pay for them in the future.
Doesn’t sound too bad, does it?
The problem is you pay a high price for buying something now versus saving for it, and that comes in the form of interest.
Credit cards have high-interest rates which means you pay significant sums of money on top of what you’ve already borrowed if you don’t pay your balance in full each month.
For reference, less than a third of Americans pay off their credit card bill in full each month. In the UK, it’s approximately 50%.
Getting rid of debt is a prerequisite to building wealth because it consumes money you could otherwise have invested.
If you are in credit card debt, make it a priority to pay it off as soon as possible.
That way, you can start putting your money to better use.
5. Build An Emergency Fund
By failing to prepare, you are preparing to fail.
— Benjamin Franklin
Inherent in the meaning of the word emergency is the idea that it is something unexpected.
This means that’s a good idea to prepare for one in advance.
Emergencies can cover anything from broken appliances to car repairs or even the sudden loss of employment.
Consider for one moment the cost of replacing your water heater at home (assuming you own the property).
The very minimum you should aim for is £1,000.
However, most personal finance experts recommend setting aside enough for 3–6 months of living expenses. This is because it can sometimes take a while to find a new job.
You need to put this money in a place where it is easily accessible.
By the way, in case you hadn’t guessed it already, a credit card doesn’t count as an emergency fund!
6. Pay Yourself First
If you want to have enough to give to others, you will need to take care of yourself first. A tree that refuses water and sunlight for itself can’t bear fruit for others.
— Emily Maroutian
It’s strange to think that the first thing most of us do when we receive our salary each month is to start giving portions of it away to others.
We are programmed to pay the rent and bills before we’ve set aside anything for ourselves.
The better approach is to pay yourself first.
But what does ‘pay yourself first’ actually mean?
It’s the practice of setting aside money for savings and investments before you pay any of your bills.
Why do this?
If you don’t pay yourself first, you’ll have more money to potentially waste on unnecessary items.
Aim to save at least 10% and preferably 20% of your income; set it up as an automatic payment each month, so you don’t need to remember.
The sooner you make this a habit, the better.
You will quickly forget it’s an inconvenience because you don’t miss what you can’t see!
7. Set Yourself Financial Goals
If you set goals and go after them with all the determination you can muster, your gifts will take you places that will amaze you.
— Les Brown
Why is it worth setting financial goals?
Because goals help us to achieve what we want.
We use them to validate our progress towards the desired outcome and hold us accountable for achieving it.
So what counts as a financial goal?
There are three types:
- Short-term goals (less than three months to achieve)
- Intermediate goals (takes 3–12 months to achieve)
- Long-term goals (takes more than one year to achieve)
A short-term goal could be saving up for a basic emergency fund, an intermediate goal could be buying a car, and a long-term goal would be something like saving for retirement.
You want to make sure your goals are SMART (Specific, Measurable, Achievable, Relevant, and Time-bound). E.g. By December 31st, I want to have saved £8,000 to buy a second-hand car.
Remember, not everyone will have the same financial goals because individual circumstances are different — the shoe that fits one person pinches another.
If you are in a relationship, it’s a good idea to schedule time once a month to discuss your financial goals so you can prevent money from affecting your relationship.
8. Start Contributing To Your Pension Early
You can be young without money but you can’t be old without it.
— Tennessee Williams
Your retirement plan should not be based on winning the lottery.
This means you need to start thinking about setting aside money as early as possible to give it a chance to grow.
This is hard to do because we’re wired to prioritise the immediate over the future. This is known as hyperbolic discounting and explains why we find it challenging to save for retirement.
Take advantage of employee matched contributions and, if you can, go for the maximum yearly contribution towards your retirement fund.
And how much should you aim to have in your nest egg?
The answer is, it depends.
First, you need to determine the age you wish to retire, and then you need to work out how much money you will need annually to meet your post-retirement expenses.
A popular rule of thumb is the ’70 per cent rule’ which states that you will need 70 per cent of your working income to maintain the lifestyle you want in retirement.
For example, if you currently earn £50,000 a year, you will require £35,000 a year in retirement.
Assuming an average growth of 4 per cent on your pension pot, you will require a total of £875,000. In other words, if you retired at 65, this amount would cover you for 25 years.
Just don’t forget to account for inflation!
9. Make Sure You Have Insurance
All life is the management of risk, not its elimination.
— Walter Wriston
Insurance exists to prevent financial loss.
Another way to look at it is that whilst investing builds your assets; insurance protects them.
So how does it work?
An insurance company assumes the risk on your behalf in exchange for you paying them a premium (monthly or annual fee).
For example, if your roof at home starts leaking and needs replacing, you won’t be saddled with a huge bill that might otherwise be financially crippling.
Essentially, it’s a form of hedge against big expenses.
The 5 types of insurance you need are:
Life Insurance — If you die with life insurance, your family will be protected and have a reasonable amount of time to adjust to your absence. So how much is enough? Should cover 6x your annual salary
Health Insurance — Thankfully, we have the NHS in the UK. However, private health insurance gives you more treatment options and can help you avoid waiting a long time to be seen.
Income Protection Insurance — This covers you against loss of income due to unemployment, illness or accident.
Vehicle Insurance — Whilst this is mandatory in the UK, you still need to shop around for the best deal, so you’re not paying over the odds.
Home Insurance — There are three main policies in the UK: buildings insurance, contents insurance, and combined building and contents cover. The first covers the structure and fittings of the physical building, the second your belongings and the third covers both. The last option only makes sense if you own the freehold. If you rent or own a leasehold, the building insurance is covered by your landlord.
10. Track Your Net Worth
Your net worth to the world is usually determined by what remains after your bad habits are subtracted from your good ones.
— Benjamin Franklin
Isn’t this something only the mega-rich need to worry about?
The honest answer is everyone should have an idea of their net worth.
The simple reason is that it tells you your overall financial standing — it is the true measure of your wealth as opposed to your salary.
So how do you calculate it?
Your net worth is the difference between your assets and your liabilities.
Your assets include your house, savings, investments you might have, your pension, your car, etc.
Liabilities include your mortgage, credit card debt, car payments, student loans etc.
A positive and increasing net worth is a sign that you’re in good financial health.
To achieve the ultimate goal of financial freedom, you need to work hard to grow your net worth over time.
This is simple but not easy — you need to reduce your liabilities (I.e. pay off your debts) whilst growing your assets (like increasing your savings and investments).
You can track your net worth by using excel to create a personal balance sheet.
How often should you review this information?
Most personal finance experts recommend you review it every three months.
It will fluctuate over time, depending on your circumstances, but if you follow the other tips outlined above, it should grow steadily over time.