You have probably heard about compound interest, and might even feel you understand the notion of compound interest quite well, but since it is the key concept in some of the next steps and because the impact of compound interest over time might be far bigger than you realize, this entire step is dedicated to looking at how compound interest works.
In finance compound interest is one of the most powerful factors at work that by using time as it catalyst, can do one of two things:
keeping you poor by losing money on outstanding debts
making you richer by making more money with the money you already have
When you were making your first budget in step 17, you might have felt it was a bit of a stab in the dark. Maybe you would have appreciated a simple formula that indicated how to allocate your money in a way that would just make it faster and easier to budget. A formula that also ensured you’d work towards you goals. Or maybe you were happy to rely on your own methods but would now like to find out about a general indicator of how much to allocate to each area.
In this step we are going to have a closer look at a very common concept in budgeting, the so-called 50 / 20 / 30 rule. I’d like to think of it as a guideline more than a rule, as depending on your financial position and your goals, your expense patterns change and you might spend more or less in certain categories at certain moments in your life. It is therefore wise to not just adopt but to adapt this guideline and adjust it to your own specific needs and circumstances. Continue reading “Step 19: Budget with the 50/20/30 rule”→
Step 18 is all about starting a new and incredibly powerful habit, one that will allow you to focus on your mission, realign your spending and savings patterns to your goals and get closer each time until little by little one day you tick off your first goal, then your second one, your third, until you realize you are able to hit your goals one after the other.
This new super habit is starting a weekly finance review, during which you will go through your goals and some of the main steps we have covered up til now, and when you work your way through the next 82 steps that are still to come, you will add some of those steps to your weekly review too. In that way you consistently hold yourself accountable for your success as you review whether you are on track (or not) for the rest of the month, and what adjustments need to be made in order to make sure you will achieve your goals for the month, and with that ultimately those much desired long-term goals.
Today’s steps will be one of the key steps to becoming financially independent. Learning how to budget and sticking to your plan will be absolutely vital to make sure you achieve your financial goals. Although budgeting might have a negative connotation to some, from today onwards, set yourself the challenge of seeing it as the new sexy and your smart move to going where you want to get to.
Budgeting will be a continuous learning process, one you’ll have to develop, adjust and simply get on with it in order to learn this new skill. It isn’t something that you will be able to master in an hour or even a day: every month new things come up, and with time you’ll work out how good you are at predicting your expenses, how flexible your various expense categories are and how to make sure to plan ahead enough, for example for the holiday period. Continue reading “Step 17: Start a Budget”→
No matter how organized you are and how carefully you have planned and budgeted for the next month, there will always be surprises that come up and hit you financially at unexpected and often inconvenient moments: a car maintenance or fix that you hadn’t planned for, a plumbing issue that needs immediate attention, a sudden vet bill for one of your pets or your washing machine that suddenly breaks down. I am sure you can think of many occasions and examples that could suddenly happen and throw you off-track.
If you don’t expect an expense to come up, often times you won’t have the money available, and you will either be forced to borrow money, eat into your savings or cut out money elsewhere.
In this step you are going to set up and build an emergency fund, in which you have a certain amount of money put away that you can use in case of these unforseen but needed expenses that come up. In that way you don’t need to worry about scraping the money together, you can just pay the bill and get on with your life. A good amount to aim for is generally $1000 or the equivalent in your currency. Whenever you take money out of this account, you aim to get it back up to the $1000 as soon as possible afterwards. Continue reading “Step 16: Start an Emergency Fund”→
When looking at all of your expenses in the various categories, you have probably become aware of how many different payments you have and to how many companies. Bills don’t just come in for your utilities and groceries, but also for bank fees, taxes and insurance, and even if you only pay them once a year, there are a lot of bills that need attention.
Many people spend a good amount of time “paying bills” each month and whereas there is an excuse to say that this is a way to more or less know how much you are spending and what you are spending on, there are two major disadvantages:
Time investment: going through the various bills and writing checks or making payments online can be very time-consuming;
Extra costs: bills not paid on time often result in extra fees.
In the last few steps we’ve laid all the groundwork to set ourselves up for success to achieve our mission. You should by now have a great overview of all your expenses, how much comes in, how much goes out and very soon you will be setting yourself some more detailed, time bound goals to work towards to. But to get you truly started, create momentum and feed the desire – that hopefully you are feeling by now – to see some positive results, now is the moment to take a very first step towards change. Therefore from today onwards you will by limiting one expense consistently for a whole month.
Does that mean cutting it out all together? Maybe, maybe not. You need to decide what works for you (I know! as always…). It might be that looking at your expenses you have suddenly become aware of how much you spend on your smoking habit, and since you’ve always wanted to give up smoking, now might be the moment. So yes, that would mean eliminating that expense altogether. Or maybe you’re surprised at how much you spend on nights out in the pub on Friday nights with friends. If you don’t want to give up those nights of fun, maybe you can make a commitment to staying in once a month, or going home just that one drink earlier and reducing the expense without cutting them out completely. Continue reading “Step 14: Limit one Expense”→
Simply put, in personal finance your cash flow indicates how much money you have coming in on a monthly basis, how much is going out and how much the difference is.
As you might expect, having a positive cash flow, where you earn more money than that you spend, is what you want to pursue, as if the reverse is true, you are either building up debt or you are eating away your savings. Having a positive cash flow means you are living within or below your means, and not beyond.
This might sound easier than it is: there might be some months when you have more money coming in than going out, but other months the opposite might be the case, and if your income fluctuates a lot, this might concept might be especially difficult to control. Continue reading “Step 13: Calculate your Cash Flow”→
So one last one to go: your savings expenses. Saving expenses are any expenses that you have that are related to improving your financial situation now or in the future. They are payments that you make towards your financial goals and include debt payments that you are making to pay off a loan, savings plans that you are paying into, investments that you are making and any emergency or rainy day funds that you have.
When you were looking at your fixed expenses you might have been wondering what to do with these savings payments already, or you might have even included them, as many of these can look like fixed expenses that you have monthly. The reason why we want to take these out and identify them as a different category however is that they are generally very different in nature to a fixed, variable or discretionary expense, as they are focussed on achieving a financial goal, as opposed to the other categories. Continue reading “Step 12: Identify your Savings Expenses”→
Discretionary expenses are expenses for thing that you don’t absolutely need in order to survive or run your household. They are often optional (some would even argue unnecessary) expenses that mainly enhance your day-to-day life and make it more fun. Think about dinners at the restaurant, holidays and a trip to the cinema. To give a definition of a discretionary expense, it:
is an expense of a variable amount that you have more or less complete control over;
might or might not have a regular time interval;
is not needed for day-to-day living;
you can cut out all together relatively easily.
Discretionary expenses are usually the type of expenses that people cut back on first during tough financial times, and also the first ones that increase again when their economic situation improves. That coffee you get every day at Starbucks on your way to work? That’s a discretionary expense: you have complete control over it, you don’t need it for day-to-day living, and you can cut it out all together and make your own coffee when you get to work or bring one in from home in a thermos flask. Continue reading “Step 11: Identify your Discretionary Expenses”→