Last week I gave a presentation on 3 ways to improve your financial health. I love getting down to the nuts and bolts of personal finance! We (including financial planners) often make the topic more complicated than it needs to be. When you really gets down to it, you can address 80% of your financial management problems with three things: a budget, a savings plan, and a debt payoff plan.
In this article I’ll explain these 3 points, and for each I’ll give you a simple exercise you can implement this weekend--each one taking about 30 minutes.
1. Create a Simple Budget
I’ve written a lot about budgeting, so I don’t want to belabor this point. It’s important for every family and small business owner to understand the importance of maintaining a budget. Changing the way you look at budgeting can help.
For starters, don’t think about budgeting as a cost cutting exercise. No one (except weird financial types like me) enjoys finding ways to squeeze 50 extra dollars from their monthly spending. If any excitement comes from budgeting, it’s in figuring out what the bottom number is. I’m talking about what’s left over each month after you’ve received your income and subtracted your expenses. The “What’s left over” number is what you can direct towards your financial goals, like savings and paying off debt.
- Essential Expenses
- Non-Essential Expenses
= What’s Left Over (This is the only number that matters)
A 30-Minute Budgeting Exercise
This weekend you could take 30 minutes and build a solid budget. Awesome tools out there like Mint, YNAB, and Personal Capital (I’m a Mint guy) have this game figured out. Some are more nuanced than others. There are lots of things you can do in Mint that let you get into the weeds, but all you should care about is what’s left over. A couple months ago I wrote an article explaining how to do this. You can review it here for how to get your budget up and running.
2. Automate Your Savings and Start Today
Consider two savers: Rick and Peggy. Rick is 25 years old and saves $5,000 each year until he’s 35 and then stops. Peggy STARTS saving at 35, saves $5,000 each year until she’s 60 and then she stops. Each investor averages an 8% annual return on their investment. If Rick and Peggy each retire at age 60, who has more money?
Rick ends up with $615,580 and Peggy ends up with $431,754.There is one key factor to explain why. Time.
Rick invests for only 11 years, while Peggy, needing to play catch-up, invests for 26. Rick’s total investment is $55,000 while Peggy’s is $130,000--more than double. So how is Peggy behind if she invested for longer? The fact that Rick started earlier than Peggy made all the difference--cranking his savings habit into full gear.
Most people reading this article are probably over 25, but the principle of time still applies. If Rick was 35 and Peggy was 45, Rick would win out by the same margin. The same is true for you. Starting now is always better than starting later, regardless of age.
A 30-Minute Saving Exercise
The decision of how much to save should start with your budget (See point #1). If you have no money left over then you have no money to save, so you’ll need to solve that problem before saving can happen. Here and here are some pointers.
If you do have money left, you need to do something with it. For most of us, idle cash in our checking or savings account is as good as gone. Putting an automated solution in place to direct it elsewhere is crucial.
If your goal is to save for retirement, you can open an investment account with a company like Fidelity or Vanguard and set up automatic contributions in 15 minutes. Do you have a retirement plan through your work? Perfect. Your contributions will come directly from your paycheck before even hitting your checking account. Call your HR rep and get it set up.
If your goal is to save for something in the not-so-distant future, like a new car or home down payment, you can still automate your savings. Set up a new savings account tied to your goal (call it “My New Casa” or something) and tell your bank you want a set amount ($100, $500, whatever) to be transferred from your checking account into the My New Casa account each month. Consistent, automated savings. Boom.
3. Make a Debt Payoff Plan
I hate debt. Even my relatively low mortgage interest rate feels like a millstone around my neck sometimes. Whether you have loads of debt or not much at all, if you want it gone quickly you need to have a plan to pay it off.
Paying off debt quickly shouldn’t be underestimated. The savings can be tremendous. Here’s a simple illustration. Dave has several debts. If he pays the minimum each month, he’ll pay tens of thousands of dollars of interest.
But if Dave pays just $200 more each month across all loans, he could save over $11,000 in interest and be debt free 67 months sooner!
But that’s not the half of it. Tweaking the debt payoff strategy a bit can result in even bigger savings.
A 30-Minute Debt Payoff Exercise
There are generally two debt payoff approaches. Either of these approaches can be mapped out and planned in 30 minutes time. It’s just takes some effort to round up your statements and drop the info into a spreadsheet.
The first is the Debt Avalanche. The idea is to prioritize your debt payments by the highest interest rate first. This is probably your credit cards, personal loans, or student loans. When the highest interest rate debt is paid off, you move on to the next one, but you also take the money that was going to the first debt and direct it to the next debt. So if you were paying $200 to your credit card and your next loan is a $100 payment, that loan is now getting $300 per month towards the principal.
The second approach is the Debt Snowball. This approach prioritizes your debt payments by the highest balance first. How is this approach helpful? There’s some psychological reinforcement that comes with getting a debt paid off. It’s an amazing feeling! The Debt Snowball approach acknowledges this and uses it to your advantage. Once one debt is paid off you carry that momentum and enthusiasm to the next one, and the next, and the next. Like the Debt Avalanche, the Debt Snowball carries the former payments from old loans into your current ones, increasing the rate at which they are paid off.
The Debt Avalanche will save you more money over time, but the Debt Snowball may give you the motivation you need to keep at it. Ultimately it doesn’t matter which one you choose, as long as you are consistent. If possible, find ways to automate your debt payoff plan through your bank or credit card company.
As I mentioned previously, the added savings using one of these two methods can be tremendous--especially when paying the highest interest rate first. If Dave prioritized his payments by highest rate first, here’s the result:
I hope this article has been helpful. Financial wellness shouldn’t be over-complicated--nor should be the methods used. In my view, it comes down to creating a simple budget to know what’s left, and then deciding where to direct the extra savings: to saving more, paying off debt, or some combination of the two.
If you want some guidance on putting a simple financial wellness plan in place, get in touch with me.