Dear Beth & Eric,
I need help with my relationship to money. While I can pay my bills and do most of the things I want to, I don't know if this is the best use of my money. I'm not saving any money for my retirement, which is still many years away. In fact, I don't have much in the bank if things start to go wrong.
I'd like to simplify my life, so that I am spending less and creating a nest egg for the future. Where should I start? Are there important principles I should know about? Anything would help.
Seeking Dollars and Sense
You are not alone. Even people who aren't in crisis may have issues with personal finance. And with the current recession, many people are taking a new look at their relationship to money.
The basics of personal finance are not a mystery. There are many good resources offering sound advice. The challenge is tailoring the advice to your situation and having the discipline to follow through.
Generally the goal is to have money flow easily through your life and to use it wisely. While optimism and good intentions are important, most people need a step by step plan. This will require an initial investment of time and effort, but it is worth it for the long run.
Start by spending some time looking over websites and perusing books to get an idea of the range of issues. If you find yourself stalling, frustrated, or stuck, you probably need some personal help. In this case, consider talking with a knowledgeable friend or a professional. To be successful, you want to make sure you have the support you need along the way.
First, it is important to use your money to secure basic needs: food, shelter, utilities, and transportation. Once you have a roof over your head and food on the table, then your next priority is stability: paying your bills on time, being in control of your debt, and generally living within your means. This includes eliminating reliance on costly long-term consumer debt, like credit cards, as a way of regularly meeting expenses. Creating a budget and learning ways to control spending will help you achieve this kind of stability.
When you are living within your means, you can begin building a financial cushion. Many professionals recommend creating a reserve equal to six months to a year's worth of expenses. This can help you survive being laid off or other unexpected expenses. It can also give you the freedom to make a major life transition or spend money on other priorities from time to time.
By this stage you will have internalized your budget, and your spending habits will usually fit within your means. However, you will want to continue tracking expenses to stay mindful and to be on top of any spending issues as they arise.
After you have some cushion, you can focus even more on how you are spending money and investing in the future. While we recommend that you always try to spend money in alignment with your values, it becomes less of a challenge once you have reached this level of stability. Spending money becomes a form of investing as you direct resources to those things that are important to you: local businesses, organic food, U.S. made goods, etc.
Ideally we balance investing in our current well being with investing in our future well being. We are not experts in retirement investing, and it is hard to predict with much certainty what the situation will be ten or more years out. However, the standard maxim of diversifying your investments applies to creating flexible options for different future scenarios as well. Investing in the future can take many forms including savings and financial investments, education and skill building, community building, maintaining your health, and developing security around housing and food production.
Do you spend all that you earn, and sometimes a little bit more? Are you aware of your monthly and annual expenditures? Knowing your budget is a critical piece of the financial puzzle, giving you the information you need to live within your means.
If need be, you can reconstruct your budget from the past if you have records of most of your expenses: receipts, credit card statements, and records of checks. Alternatively, you can begin by tracking your current expenses. It may take you a couple of months to get a good sense of your budget. There are financial tracking software programs (e.g. Quicken) that can aid you in this process if you are so inclined. See the Experiment section below for more details.
As part of this process you will want to categorize your spending into areas such as housing, groceries, dining, and clothing. This will help you see where your money is going and allow you to decide if you are spending in accordance with the value something brings to your life. People are often surprised to see $600 going to lattes or some other small, but regular, spending habit. And how does the $600 a year on lattes compare with spending $600 a year on yoga classes?
Another benefit of knowing your budget is that you will be able to discern the difference between having cash to spend at the moment versus truly being able to afford something. You may also see patterns about which kinds of spending are hardest for you to control. Do you spend more when you use cash, credit cards, or debit cards? Are you tempted more by rewarding yourself, convenience, or impulse buying?
Clarifying your goals and creating systems for working towards them can help you curb unrewarding spending behavior. Savings plans and behaviors and mechanisms that automatically and regularly direct money towards savings are examples of this.
It is not uncommon that emotions come up when we come face to face with our budget. If you are resistant to dealing with money issues, find out why. Is it math phobia, overwhelm, or a lack of information and structure? Again, finding support is crucial. Consider asking a friend to be your Budget Buddy, or seek out a professional who works with these issues.
Money is one important resource flow in our lives, however, there are a variety of ways to meet our needs. These include trading and bartering, sharing, creating or doing something ourselves, and reducing how much we need.
Trading and bartering are as old as the hills, and we all do this in some parts of our lives. How could you expand this into other areas of your life? What do you have too much of, or what do you love to do, that would be useful and appreciated by someone else? The same goes for sharing. What can you share with neighbors, co-workers and colleagues, family and friends? In addition to Craigslist and Freecycle, there are a host of places for non-monetary exchanges popping up on the web and in communities.
Knowing how much your time is worth is an important part of the equation. For example, say you really work 50 hours/week (including preparation and commuting) and really earn $20/hour (after taxes and expenses). Dinner out costs you $30 or 1.5 hours of work time. Is that worth it to you? The answer could be "yes" or "no" depending on what it is worth to you and other costs and benefits. Do you find cooking fun and better for your diet, or do you find your lack of interest in cooking leads you to unhealthy snacking and eating alone?
Probably one of the easiest ways of saving money is to cut expenses. The best way is to find solutions that solve several problems at the same time as well as enhance your quality of life. For example, a friend created Recession Tuesdays whereby she and a few friends get together in the evening to cook meals for the week and to share tips on job hunting and saving money. Another friend is sharing her overwhelming and untended garden with neighbors in exchange for some of the vegetables. Necessity truly is the mother of invention. By making expense-cutting a creative challenge you may find yourself enriched in ways beyond money.
While there are many resources on personal finances, here are some to get you started. Be sure to ask your friends for their local recommendations.
Track your spending for a month—everything in and everything out. Get a receipt or make a note after every purchase and sit down daily or once a week to record them. You can use a piece of paper or a spreadsheet, the Quicken program or www.Mint.com. Create basic categories like groceries, dining, transportation, housing, utilities, health, entertainment and clothing, and add categories that are meaningful to you (e.g. savings, personal care, gifts, etc.). Keep in mind that some expenses are not necessarily monthly (insurance, taxes, large ticket items, and holiday shopping). The goal is to know what you normally spend in a year. You may need to track more than one month to figure this out.
At the end of the month(s), total up your categories. Compare this grand total to your real take-home income. If you are spending less than you earn, see if those extra dollars are making it into an invested or saved pool of money or going toward capacity building (e.g. education, networking, etc.). If you are spending more than you make, look for areas where you can cut back by doing without or by finding a less expensive alternative. See if you can find ways to live on 90% of your income.
Finally, keep the big goal in mind. You want the flow of money to be supportive of your real well being.
You can do it!
Eric and Beth
Official Qualifier: We are not financial advisers and none of the above is to be construed as individual financial advice. Everyone's situation is unique. Seek out the help of qualified professionals as needed.
This monthly slow essay is from Beth Meredith & Eric Storm of Create The Good Life.
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