STARTING FROM SCRATCH
The American educational system is interesting to say the least. Most graduates come out of high school with a great library of what is often referred to as “book knowledge”. They would have no problem describing for you where to find the noble gasses on the periodic table, calculate the sides of a triangle, or tell you about the different transcendentalist authors of America. If they paid attention well, they may even be able to name all the bones of the body or recite the preamble to the constitution of the United States. \While there is certainly nothing wrong with book knowledge, in the school system It often comes at the expense of some other categories of learning. Those are referred to as “street smarts” or “life skills” and I think that most of us would have no problem admitting that our schools fall short in this area.
Those same students who excel at complex math, have no idea how to operate a budget. They can recite parts of the constitution, but they don’t know what a Roth IRA is. They can analyze works of literature, but don’t know how to evaluate an investment. You can probably tell that I am an advocate of teaching financial literacy in our schools. It is my belief that if we did, we would see r reduction in the amount of student loan debt, credit card debt, and auto loans. Increased in consumer savings accounts, participation in workplace retirement plans, and less victims of financial scams.
One of the most common questions I get asked is “Where do I start?”. I love getting that question, because it signals to me that one more person has decided it is time to get their act together and start taking charge of their money, instead of letting their money take charge of them. For many of those people, I point them directly to Dave Ramsey’s “Total Money Makeover”, it is a fantastic book with simple steps to get you on the path to success. If you don't want to read an entire book though, here is my roadmap to getting started.
1. Get Term Life Insurance
Right off the bat, let me say that this step DOES NOT apply to everyone. I have found that it does apply to most of the people who ask me this question though, so I wanted to include it. Ask yourself the question “Will anyone suffer financially if I get hit by a bus tomorrow?”. If the answer is yes, you need term life insurance. If the answer is no, go ahead and skip to the next step. If you don’t need life insurance, it’s the last thing you should be wasting your money on.
If you do need life insurance, you need to get it. You need to get it right now. Especially if you have children, or a spouse who depend on your income. The reason I list this before doing anything else, is because it has the potential to make the biggest difference in your life. If you are in relatively good health, you shouldn’t have any trouble getting a policy for less than $40 per month (though if you are young that could go as low as $7). Admittedly, in the best-case scenario that $40 is a complete waste of money. But here is why I want you to start here. If you decide that instead you want to put that $40 a month into a Roth IRA (a great option for saving) you would over the course of 30 years build up a savings of about $60,000. While that is nothing to laugh at, by the time you are retired, having or not having that $60,000 is not going to change your life. You won’t even feel it. BUT, if something happens to you tomorrow, having or not having life insurance in place, will have an astronomical impact on your loved ones. Don’t become a gofundme account. Get a quote here right now.
2. Organize Your Financial Statements
Most businesses (at least those who are likely to be around for a while) live and die by two documents. The balance sheet, and the cash flow statement.
The simple version of a balance sheet is a two-column list. In one column is listed everything that the company owns along with its value. This column is referred to as the company’s assets. In the other column, is listed everything that the company owes. Essentially it is a list of all debts, and the balances. This column is referred to as liabilities. At the bottom of each column will be listed the total assets, and the total liabilities. If you have ever heard the phrase net worth, and wondered how it is determined, the formula is sitting right here. Net worth is simply an estimation of the total value of what you own (assets) minus what you owe (liabilities).
The cash flow statement is a monthly or yearly ledger tracking all cash that was both received and spent by the business. It helps them track their sales growth, their cost of inventory, and many other metrics that help then know how they are doing. In the personal finance world, you could also call this a budget.
My first step for someone wanting to get their finances in order, is to work on compiling their own personal balance sheet and cash flow statement. It’s important to note here, that I don’t want you to make a cash flow statement and balance sheet of what you want your finances to look like. I want you to make those documents to reflect how you are actually spending money etc. The whole point of compiling the reports, is so you have an idea of exactly where you stand financially, and what areas you need to be improving upon.
To make it into a metaphor, the reason I have this as the first step, is that we are essentially trying to take a good look at the foundation of your financial house. We need to examine it, and probably make some repairs before you are ready to start building upon it.
3. Free Up Some Cash Flow
Once step two is completed many people find that either their monthly cash flow is negative, or very tight. Our objective now is to fix that. Often the first place to turn to fix cash flow problems is the balance sheet. Many people find that a large portion of their cash flow gets eaten up by credit card payments, car payments and student loans. Step three is a page straight from the Dave Ramsey playbook. Before you can start to invest and save for the future, you need to be in a place where the only liability listed on your balance sheet is a home mortgage.
That means it is time to pay off some debt. You've got two options here. Cut your spending or increase your income. Ideally, you will do some of both. I have good news for you here, in the modern economy, creating extra income has literally never been easier. Do a quick google search for side gigs, and choose one, or more to get started with.
I will also tell you from experience that this is the step that I lose most people, because this is where it gets hard. The people who succeed are the ones who do this and do it hard. They cut their spending, they start driving for uber, or waiting tables at night. They realize that this step SUCKS. But they also realize that the harder they push, the sooner they will be done with this step.
4. Choose a Financial Planner
Now that you have gotten your house in order so to speak, you are ready to start interviewing financial planners to find the right fit for you. The reason you want to find one now, is that they can, and should help you with all of the following steps. There are a lot of things to consider when choosing a planner. This post can help. To be brief, make sure you are working with an independent fee-only financial advisor. That is the only way you can be sure they will always be acting in your best interest, and will not be pushed by financial incentives, or corporate agendas.
5. Define Your Goals
Now that your money is in order, it is time to make it start working for you. If you are like most people, you will find that you have several different financial goals you are working toward. Your chosen financial advisor can help you define what those goals are and make a plan to work towards all of them. These goals can be things like saving for kids to go to college, saving for retirement, paying off your house, buying a dream car, etc.
Having that plan and putting the pieces in place to accomplish all of those goals is the only way it is going to get done.
6. Begin Saving For Retirement
No matter what your other financial goals may be, they need to be accomplished in conjunction with saving for retirement. Because the amount you need to save for retirement is so large, it needs to be gradually chipped away at, and you need to start as soon as possible.
My general recommendation is that you should start by putting away 15% of your income into various retirement savings accounts, and you should do so in the following order.
First, if your employer offers a 40k program, AND they match your contributions, that is where you need to start. If they will match 5% of your pay, make sure you put in as much as you need to get all of that match. It’s literally free money, and you should not leave it on the table. If your 401k offers a Roth option, that is where your contributions should be going.
Once you have gotten the match in your 401k, or if you don’t have one, the next place to put savings is into Roth IRA accounts. These are after tax savings accounts, where all of the growth will be tax free forever. Individuals are limited to $6,000 per year ($7,000) if over 50 years old. Both spouses can have their own account effectively doubling that limit.
If you have gotten your match, maxed out Roth IRAs and still need to save more to reach 15%, now is when you go back to your 401k and contribute more to that. Remember to use the Roth version if it is offered.
7. Save For College
If you have kids, this step is for you. You may have heard that college is expensive. One of the best ways to prepare for that inevitable cost, is to start saving early. The Government has allowed for the creation of savings account meant specifically for this purpose known as 529 accounts. They can be a great option. My general recommendation is to start an account early, and decide on a monthly contribution amount, and turn it on autopilot.
8. Pay Off Your House
While all of that, and possibly more is going on, I also recommend starting to pay extra amounts towards your mortgage. The tax deduction IS NOT worth keeping a mortgage around if you can afford to pay it off early. Getting that payment out of your life, will open up a huge amount of cashflow in your budget that can be used to save for other goals, and start enjoying.
If you are in a position to make extra payments on your mortgage, take care to make sure that your mortgage company is applying the extra amounts to the principal of your loan, not simply crediting them as advance payments of your mortgage.
9. Enjoy Your Money
At the end of the day there are only three things you can do with your money. Spend it, save it, and give it away. My belief is that you should be doing all three. Everything prior in this article has been directed at the savings category, but once those goals are taken care of you can have some fun deciding how much of your income you want to spend and enjoy, and how much of it you want to give away. When it comes to your charitable giving, you may even be able to grab some tax benefits by timing your donations right.
Obviously, this article is meant to be a brief summary of the things necessary to get your financial life on track. It’s also important to note that while all of these steps are incredibly simple, they are also incredibly difficult. Don’t get discouraged if you get off track, or steps take longer than you hoped. Taking charge of your financial life is not an easy thing to do. Give yourself credit for even trying, learn from your mistakes, and keep moving forward.