Money matters. How you manage it matters even more. According to a study from Princeton University’s Woodrow Wilson School, money buys happiness but only up to a point. Once you hit an annual household income of $75,000 the effect money has on happiness flattens out.
However, a sense of control over your finances does correlate with happiness — whether you are ultra-wealthy or of modest means – which is why personal finance skills are so important.
To get you started, here are 10 important things about personal finance you should remember.
Everybody needs a personal finance plan
The first and most important step in personal finance is to decide what goals you will pursue. A personal finance plan will force you to be specific about your financial goals. These will guide your financial decisions and help prioritize the use of your time and resources.
Include short-term goals, such as paying for rent or a mortgage; mid-term goals, like buying a car or saving for a vacation; and long-term goals, such as buying a house, building a retirement fund or saving for your children’s college education.
Figure out a budget
Take an honest look at how you spend your money. Take the next 30 days and track every cent you spend. Identify areas where you can reduce or eliminate spending. Now create a realistic budget and stick to it. Treat your personal finances as a CEO looks at a company: avoid waste and place your assets where they bring the best return on your investment.
Spend less than you make
This is closely related to having a realistic budget, but it’s so important it’s worth emphasizing: it doesn’t matter whether you are on minimum wage or you earn millions of dollars a year. The route to bankruptcy is the same: spending more than you make.
In 2009, Sports Illustrated ran a piece on “How (and Why) Athletes Go Broke” that illustrates this point beautifully. According to the article, 78% of former NFL players go bankrupt or suffer financial stress within two years of retiring. The average salary for an NFL player in 2009 was $1.896 million, and the median salary was $790,000. How do you go broke when you have an income of $790,000? Easy, by spending $790,001.
Build an emergency fund
Life has a habit of throwing you a curve ball every now and then. Whether it comes in the form of an unexpected pregnancy, the loss of a job, or a faulty car transmission, you need to be prepared for the unexpected.
On average, it takes more than four months to find a new job; so look at your budget and calculate how much money you need to cover your basic expenses for six months. A year is even better, particularly if your line of business is prone to layoffs.
Take care of your health
Unpaid medical bills, not credit-card debt or underwater mortgages, are the number one cause for bankruptcy. Every year nearly two million people file for bankruptcy because they cannot afford to pay for their medical builds. Not surprising, when you consider a broken leg can set you back $7,500 and the average cost of a three-day hospital stay is $30,000.
Although health insurance will not shield you completely from financial hardship, it will give you a fighting chance. Apply for health insurance today and take other practical steps to protect your health, such as not smoking, exercising regularly, and maintaining a healthy weight.
Pay off debt first
The average savings account in 2013 had an annual interest rate of 0.06%. The average annual percentage rate for credit cards was 15.38%. The math is compelling. Pay off your debts before you start saving, particularly if you have credit card debt.
If having a financial cushion in your bank account makes you feel more secure, consider the extra credit available to you when you reduce your credit card balance as your emergency fund until you’re debt-free and can start building a more substantial financial cushion.
Save for retirement
The average length of retirement is 18 years. That’s an awfully long time to be broke. Once you have taken care of your basic needs, saving for retirement should be at the top of your financial to-do list. Don’t rely on Social Security. If it’s still around by the time you retire, great, you just got yourself a bonus. However, it should not be your main source of retirement income.
A good rule of thumb is to save 15% of your household income in Roth IRA and pre-tax retirement funds. If you can keep saving at that rate for 35 years, you should—assuming an 8% return on your investment—be able to live your golden years on 80% of your pre-retirement income.
Protect your credit score
A good credit score is key to your financial health. You probably already know your credit score will determine whether your lease or loan application is approved and will influence what interest rate you’ll pay on your mortgage, credit cards, and auto loans. However, that’s only part of it.
According to a 2012 study by the Society for Human Resources Management, nearly half of U.S. employers perform credit checks on job candidates. Insurance companies use your credit score to calculate your auto and renter’s insurance premiums.
You can find and compare a ton of credit reporting companies in our Super Money Reviews section.
Get life insurance
If you have dependents who would be affected financially by your death, you should obtain enough life insurance coverage to take care of their needs. If you’re single and without dependents, consider disability insurance to replace your source of income during prolonged illness.
Keep your investing and insurance separate. Whole life policies combine life insurance with an investment component that pays out cash once the insurance term ends. True. Knowing you will get some cash back at the end of your insurance’s term may help with the feeling you are throwing money away in an insurance you may never use. But there are better places to invest your money and the high cost of whole life policies could mean you end up buying less life insurance coverage than you need.
Plan for taxes
Although we must all deal with it, tax planning is often the least understood component of personal finance. Granted, tax law can be complicated; and If you run a business or you’ve made important financial decisions this year, such as buying or selling a house, it may be a good idea to hire a professional to file your taxes. However, preparing your taxes doesn’t have to be that daunting.
Keep accurate records of both your income and deductible expenses. Reduce your chances of being audited by filling your return completely, correctly, and on time.
Don’t give the government an interest-free loan. If you get a big tax refund every year, you’re paying too much, reduce the amount of taxes you withhold from your paycheck. On the other hand, don’t wait until the end of the year to pay your taxes. By the end of the year, you should have paid 90% of your tax bill or you could face hefty underpayment penalties.
Personal finance isn’t rocket science
Learning about personal finance is not like learning about economics or business management. Sure, it helps to know the meaning of key financial terms and some basic math skills won’t hurt, but truly understanding personal finance goes much deeper than that. Understanding financial concepts is the easy part. Putting them in the practice is the real challenge. As Dave Ramsey, the financial author and nationally syndicated radio host, once said, “Personal finance is more personal than it is finance: it is more behavior than it is math.”
Andrew is the Content Director for SuperMoney, a Certified Financial Planner®, and a Certified Personal Finance Counselor. He loves to geek out on financial data and translate it into actionable insights everyone can understand. His work is often cited by major publications and institutions, such as Forbes, U.S. News, Fox Business, SFGate, Realtor, Deloitte, and Business Insider.