These 10 simple steps will put you on the path to financial security. The first 3 steps are the foundation and essentially "get your house in order". The 7 following steps will show you how to reach the long-term goals you set.
1. Establish a Plan
An old Chinese proverb states, "The best time to plant a tree is 20 years ago, the second best time is now."
It is important to setup a long-term financial plan that addresses the categories of debt, investing, insurance, and eventual retirement goals. When you are finished with your plan you should be able to answer questions like these:
1. How much debt do I have and what are the interest rates on those debts?
2. How much life insurance do I need and how much will it cost?
3. What age do I plan to retire and how much money do I need to have saved for retirement by that age? How much do I need to save/invest each year to reach that goal?
The retirement plan is the one I have the most trouble with. You have to make assumptions about how long you will live, what kind of return you will get on your investments, and what the inflation rates will be over the next several decades. A good rule-of-thumb is that you will need between 10x and 15x your salary in retirement. So if you currently earn $50,000 per year, you will want to have saved up $500,000 - $750,000 by the time you retire. This may seem like a very difficult thing to accomplish, but it is really not that hard if you follow these steps.
It all starts with a plan, and your plan will change, but the first step is to start a plan and to have your current long term goals written down.
2. Create a Budget
This step is simply to make observations about how you live your life. Evaluate your personal spending. Keep track of all financial expenses, and look back and categorize what you have spent over the last 3 months. Then answer these questions:
1. Do you save? How much, and where does it go?
2. Do you have Emergency Savings?
3. How much do you spend each month, and what do you spend it on?
Often simply observing where your money is currently going will make you more aware and careful of how you spend your money. Create a detailed record of where your money is consistently going. This simple step will help you with step 3.
3. Identify Roadblocks
Now that you know from step 1 how much you need to save each month, and you know from step 2 where your money is going, identify what needs to change in your spending. Ask yourself these questions:
1. Is there anything you are currently doing that is getting in the way of reaching your financial goals?
2. What do you need to stop or start doing today to begin making progress towards your goals?
3. What sacrifices are you and your family willing to make today that would lead to you making progress to accomplishing your goals?
When you finish this step you should be equipped to tackle the rest of the steps here.
4. Eliminate High-Interest Debt
If you have any high-interest debt, like credit card debt, make it a high priority to eliminate. The average interest on a credit card is 17.30%. That is absurdly high! Never allow yourself to carry a credit card balance month to month. If you are in this habit, stop now. Credit cards can be useful for benefits, but if you carry credit card debt, you are losing money.
Consider this quote that demonstrates the disastrous effects of high-interest debt on your financial status and overall happiness.
Interest never sleeps nor sickens nor dies; it never goes to the hospital; it works on Sundays and holidays; it never takes a vacation; it never visits nor travels... it has no love, no sympathy; it is as hard and soulless as a granite cliff. Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands nor orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.
- J. Reuben Clark Jr
Simply put, do you want interest to be working for or against you?
5. Life Insurance
If you have dependents (people that depend on you for your income to provide food and shelter) then you should have life insurance. Get some inexpensive term life insurance in case something terrible happens to you that will provide for those dependents until they can make other arrangements (get jobs, etc). You might also consider disability insurance that will provide for your family's needs if you become disabled. Some employers also provide some life and/or disability insurance for free.
If you do not have any dependents then you don't really need life insurance unless you just want enough to cover funeral expenses so your family doesn't have to foot the bill.
6. Emergency Fund
Establish a 3 month emergency fund. This should cover your necessary expenses for 3 months. You know your monthly expenses from step 2 so you know exactly how much that requires.
This fund is very important as it protects you from a "rainy day." This might be a medical bill, repairs on the car, a natural disaster, or even a pandemic. You can’t predict the unexpected, but this will help you be more financially secure regardless of what happens.
7. Invest
I have another blog post that has some detailed investing advice, but here are some basics:
8. Investment Creep
Instead of "lifestyle creep" where your raises go into a better lifestyle (eating out, a boat, bigger vacations, etc.), implement "investment creep". This means that some of your raises go towards increasing your saving and investments. Continue to do this until you have reached your target savings rate that is necessary to reach your goals.
A couple extra years of "living like a student" and using the saved money to pay off debt, build an emergency fund, or invest, will pay great dividends in the future. Immediately transitioning from living like a student to trying to live the "good life" may generate bad spending habits or cause you to take much longer to reach your goals.
This doesn't really mean that you should eat mac-n-cheese for several years after graduation, but the goal is to prevent you from thinking, "Now I have lots of money - I can eat out and get a new car!"
9. Educate Yourself
Take time to become more financially savvy. This can be done by reading books like "The Millionaire Next Door", reading blogs like "The White Coat Investor", or anything else.
Investing rules change, laws change, and best practices change. You want to keep up-to-date on what is happening so that you can adjust your plan if you need to, or so you can switch to a new type of investment if something better becomes available.
10. Evaluate Progress
Every 6 months to 1 year you should evaluate your progress towards your goals. Has your spending gone up? How are you doing on your goals? Are there any adjustments that need to be made?
Don't worry about how your investments are performing necessarily. As long as you are invested in index funds then in the long term you should see growth, even if there are dips in the short term. The main thing to check is to see if you are investing your 15-20% or if you have a sufficient emergency fund in place still.
Source: This is based on advice given by The White Coat Investor. The original post is geared towards doctors. I simplified it and made it more generic.
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