Guide to personal finance
Getting a handle on your finances can be intimidating. There are so many financial products to consider, budgets to create, and decisions to make, it’s no wonder so many people give up on money management. Just reading about all the services and products available to “simplify” your personal finances can be overwhelming. But don’t worry. This step-by-step guide will demystify the process and help you get your personal finances under control.
What is personal finance?
Personal finance includes any money management transaction you carry out for yourself or on behalf of your family.
To understand your personal finance, you must be able to build a budget, set smart goals, and meet them. You must balance your debts while also saving for the future. And you must educate yourself on how to best grow your savings, both for emergencies and for your eventual retirement.
Taking these steps requires you to take an honest look at your current financial situation, estimate your short- and long-term needs, and implement a plan to meet those needs.
SuperMoney’s Personal Finance Guide takes the guesswork out of money management by offering an easy to follow plan that works. Once you’re clear on the steps you need to take, our comparison shopping tools and consumer reviews will help you filter out the best products and services available.
Creating a budget
Budgeting may sound daunting, but this step-by-step guide will demystify the process for you. To develop a sound and stable budget, just do the following:
1. Total your expenses
Pull out the past year’s bank statements, receipts and bills, including intermittent charges like insurance, auto and home repair and gifts. Also include incidental expenses, many of which you may pay for with cash.
On their own, minor charges seem insignificant, but they add up quickly. Get a true total of your spending by keeping a financial journal for a month and recording what you spend on miscellaneous items like coffee, quick meals, and tips.
When you have all of the necessary data, add your expenses up and divide by 12, which will give you an average of your total monthly expenditures. Tack on a 10% cushion to cover the unexpected. For instance, if you determine that you spend an average of $2,500 per month, bump the total up to $2,750.
2. Determine your true income
In addition to your regular net salary, add any additional money you receive. This might include alimony, child support, rental income, interest and dividends, cash gifts, or tax refunds. If you have a regular side business or often sell items online, include a monthly average of that income.
3. Do the math
Discover if you have a monthly windfall or shortfall by subtracting your expenditures from your income. If the figure is negative, you have a budget deficit that is likely eating up your savings or causing you to reach for credit. If the answer is positive, you have a surplus that you may be spending on incidentals, rather than paying down debt or saving.
4. Balance your budget
After doing the math, if you find that you’re breaking even or in the negative, you must either slash expenses, bring in more income, or both.
To lower expenses, look to your incidental category first. If you’re $50 in the red every month and spending $50 a week on unnecessary items, cutting the incidental spending to $15 a week will eliminate your shortage and give you approximately $90 ($1080 per year) to pay down debt and save. If you can’t cut enough from this category, look to your bigger ticket discretionary spending and consider reducing certain expenses. For instance, if you pay for a premium cable package but don’t actually use it, lower your cable bill or get rid of it entirely.
After making all necessary cuts, if you still have a shortfall or an insufficient amount of excess money, find a way to bring in additional income.
Need help developing your budget? Consider these money management solutions.
Building an emergency fund
How much should be in your emergency fund?
You should save enough to cover your living expenses for three to six months. How much is that? It all depends on how big your family is, where you live and your standard of living.
In the United States, a family with two parents and two children require about $5,466 a month on average to maintain a basic standard of living, according to the Economic Policy Institute (source). So, a family of four that follows the recommendation will aim to have $15,000 to $30,000 in its emergency fund.
A single adult with no children will need about $2,370 a month, which means an emergency fund of $7,000 to $14,000.
A married couple with no children needs about $3,305 a month, so they should try to put aside $10,000 to $20,000.
How can you save enough for an emergency fund?
The two keys to building a healthy emergency fund are friction and automation.
Friction and automation
“Friction” refers to the practice of making it difficult or inconvenient for you to deplete your savings. Set up a separate savings account for your emergency fund to put some friction between that account and your main checking account. This way, your savings will be out of sight, and you won’t be tempted to tap into them for frivolous expenditures.
If you need even more friction, set up your emergency fund savings account with a provider that is not your primary bank.
“Automation” means that your monthly contributions to your emergency fund should require no effort from you. They should happen by default, automatically. Automate your savings by setting up automated transfers for every payroll period.
Ideally, you should set up the automated transfers as part of your employer direct deposit as this will make it a little more difficult to turn them off. Alternatively, you can set up recurring transfers that are timed to your payroll directly in your online banking system. When selecting an amount to save, try to save at least 20% of your after-tax income, but any amount is better than nothing – even if it’s $20 per pay period.
Download an automated savings app
Another way to save is to download an automated savings app such as Acorns. These apps connect to your bank account to monitor your transactions. They round up each transaction to the nearest dollar and micro-deposit the difference into your savings. The money is invested and grows over time behind the scenes. This can be an excellent way to supplement your savings plan.
Shopping for a savings account to house your emergency fund? Check out the following highly-ranked options:
Getting out of debt
Simplify your interest expenses
Consolidate your debt
Debt consolidation allows qualified consumers to take out a new loan that pays off most or all their outstanding debt. The purpose of debt consolidation is to combine all your existing debt from various sources into one loan.
This means that you only have to pay one loan payment a month instead of several smaller loan payments. Ideally, debt consolidation loans should have a lower interest rate than the rates you are currently paying to help you get out of debt.
If you’re looking to consolidate your debt, consider the following options:
- Get a personal loan large enough to cover all outstanding debts.
- Transfer all your other credit card balances to one card.
- Apply for a home equity loan or cash out mortgage refinance.
Pay off your debt
There are two primary strategies for paying off your debts early: the snowball method and the avalanche method.
Also called the “the highest rate first” method, the avalanche method involves paying off your debt with the highest interest rate first.
Identify the account with the highest APR. Make minimum payments on all the other accounts, and pay as much as can toward the account with the highest APR. This method helps you reduce your interest costs.
The snowball method asks you to pay off your smallest debt first.
In this method, you’ll pay as much as you can on your smallest debt, while making minimum payments on the other ones. Once it’s paid, go on to the next smallest debt until you are debt free.
This method costs you more in interest overall, but it has the advantage of providing quick, rewarding wins, and it also simplifies your debts. This might help you stick with the debt repayment plan.
It doesn’t really matter which plan you opt for, as long as you stick with it. If you like instant gratification, consider the snowball method. If you’d rather save more overall, opt for the avalanche method.
Ready to get started on consolidating your debt? Check out the following debt consolidation loans:
Improving your credit
What determines your credit score?
To rate your credit, credit bureaus consider the following:
Investing and saving for retirement
How will you invest?
Here are three different strategies to managing your investments:
Brokerages allow you as the investor to make your own investment decisions. That includes picking what assets to invest your money in, diversifying your portfolio to reduce your risk, and continually managing that portfolio over time.If you’re new to investing, this way of doing things might be daunting. But if you have the time and desire to learn, it’s a great way to learn from experience, allowing you to improve your investing acumen over time.
2. Financial advisors
There’s an entire industry of people who have trained and are licensed to manage other people’s money. Financial advisors spend their lives in the financial markets, which can help them make good and timely investment decisions. That said, not all financial advisors put their clients first, and many of them work on commissions rather than a flat fee. Even if you get a fee-only advisor, that fee eats into your investment returns. This option is good if someone doesn’t want to manage their own money and is fine with paying a little extra to — potentially — get a better return than they can do on their own.
Relatively new onto the scene, robo-advisors do many of the same things that you or a financial advisor can do — picking your investments, diversifying your portfolio, and managing the funds as things change over time — at a fraction of what financial advisors charge. The primary problem with robo-advisors is that you have very little control over where your money is invested. You can say you want 90% of your money in stocks and the other 10% in bonds, for example, but you can’t choose the actual funds. You also can’t talk to a person about how the investment management is going. But if you’re new and aren’t concerned with those issues, a robo-advisor could be an inexpensive way to achieve your investing goals.
What will you invest in?
Investing in stocks, bonds, and mutual funds is more traditional. But there are other investment options that can help you achieve your investing goals.
There are several different types of assets you can invest in through most brokerages. Here are just a few:
- Options: These derivatives allow you to have the option to buy or sell a stock as it goes up or down.
- Futures: These are agreements to buy or sell assets, especially commodities, at a fixed price but to be delivered and paid for later.
- Exchange-traded funds: These function similarly to mutual funds, which means that they invest your money in a diversified group of assets. But unlike mutual funds, you can buy and sell ETFs like a stock.
Marketplace investing sites
Instead of investing in an asset, these companies allow you to invest by lending money directly to borrowers. Marketplace platforms, also known as peer-to-peer lending, makes it easy to diversify your portfolio away from conventional financial assets that may be sensitive to market changes.
Investing in your retirement
If you are self-employed or want to invest in other ways, set up an automatic contribution. More importantly, make it part of your budget. You may be tempted to try to just invest what’s leftover at the end of the month. But if you do this, you’ll likely have a hard time investing enough for your future needs. After all, going out to eat now sounds a lot more fun than waiting for years to see an investment pan out.
Some of the more common retirement plans include:
- Individual Retirement Accounts (including traditional, Roth IRA, and SIMPLE IRA).
- Company Pension Plans.
- Employer-Sponsored Savings (such as 401(k), 403(b), and 457 Plan).
- Annuities offered by insurance companies.
Ready to get started? Check out these investment tools.
Getting your personal finance under control can feel daunting, but if you take it step-by-step, you’ll be on the right path in no time.
Need help getting started? Finding the right money management tool is a great first step.
Andrew is the managing editor for SuperMoney 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.