Over the last few weeks, we’ve been assembling a basic personal finance and tools. We came up with a personal financial plan, then we organized our records to get ready for using a balance sheet to discover our net worth, creating a cash flow statement to see where our money actually goes, and putting together a budget to plan for the future. This week is about putting it all together to achieve your financial goals.
Step 1. Start Where You Are
If you’ve made a personal balance sheet then you know what you own and what you owe. Looking at the sheet may have inspired you to revise the financial goals you created, or it may only confirm what you knew before about your financial situation. No matter what you’re setting out to accomplish, you have to start right where you are now. However in order to make progress you may have to reorient yourself to head in a new direction instead of spinning your wheels. Your cash flow statement told you what your current spending/saving situation looks like. If your cash flow statement showed just how on-target you are for achieving your financial goals, then come back next week to talk about taxes. If not, move on to step 2.
Step 2. Choose Your Financial Focus(es)
You can’t do everything. The more money you have, the more you can do, but you’ll never have enough time or money to do everything you want. Pick the short and long-term goals that you value the most. Saving for retirement should be in there somewhere, but if you’re not able to put much toward it now because you’re working on a more important short-term goal (like a debt that’s actively costing you money), then start working on it a little now and plan to increase when you’ve achieved another goal.
Step 3. Figure Out How Much You Need for Your Goals
With debt repayment this is (kind of) easy. You can come up with a monthly number based on how much you have to pay and how much extra you can afford to snowflake/snowball on top of that. Of course, the faster you pay it off the less you should have to pay overall. For savings goals, the simplest calculation is to divide the goal by the number of months until you want to achieve the goal (years x 12). So if you want to save $20,000 in 5 years, divide it by 60 to get $333/month. (Just think, if your debt is costing you $333/month and you pay it off, you could have $20,000 in 5 years!) There are more complicated methods of calculating based on interest you’ll be earning. If you’re saving $333/month and earning as little as 1% APY on it, you’ll actually have more than $20,000 in 5 years. But given the low rates interest rates have been taking, lately, I’m not going to go into that here.
Step 4. Figure Out Where the Money Is Going to Come From
Maybe your cash flow statement revealed that you’ve got plenty of cash to spare and you’re not worried about it. However, if you’re already spending most or all of what you earn in an average month, then the next step in working on financial goals is figuring out where the money to achieve them is coming from. There are two ways to to have more money in a month—spend less or make more. I earn extra money by running a blog consulting service. Another blogger I know is delivering pizzas to get out of debt. It’s not easy when you’re already working a full-time job, but both of us have found work that doesn’t drain us too much to function at our other jobs. That’s ideal. Cutting back on your spending habits is the other classic way to find money fast. The only problem for some people is that they’re already stretched to the limit with very basic needs and financial obligations. Nevertheless, this method works for many who realize that they can live just as well without some extraneous expenses. When looking at what to cut, ask if it’s more or less important to you than the goals you want the money for.
Step 5. Figure Out Where to Put the Money
And if you’re saving up the money, figure out where to put it. For short-term goals, anything under 10 years, conventional wisdom says to stick with FDIC-insured accounts like most savings accounts and CDs. Your main goal is not to lose money and your secondary goal is to pick up a little interest along the way. If your goal is something very long-term like retirement, then you’re probably going to get the most return by investing it with greater risk. Stocks, bonds, index funds, etc, are places to put your retirement fund. Even earning 5-6% average annually over the long run will significantly increase your funds. Obviously, this is all basic stuff. My goal in running this series isn’t getting into higher-level personal finance but providing a more thorough overview of the basics that most people never learned in a unified way.