How to get ahead financially

November 6, 2013 at 8:57 pm Leave a comment

The formula to get ahead financially is simple, really.  Spend less money than you make.

That’s much easier said than done in today’s society, however.  Everywhere you turn, you have marketers trying to sell you this or that.  I’m sure if you explore your closet/attic/basement/garage, you’ll probably find some items you bought that remain unopened, in the original packaging.  You fell victim to marketing and needlessly spent money.  If you bought that on a credit card, you may still be paying interest for that item.

Some industries try really hard to hide their best deals from you.  Take the cable industry, for example.  Ever try to get a price list from a cable company?  Something that’s clear, without any room for confusion?  If you call them to get their lowest priced plan, people being paid on commission will try their best to push you into a more expensive package.    The cell phone industry is another offender, though I think they are even better than the cable companies.

How do I get started getting ahead?

With so many people trying to get into your wallet, you may need to change the way you think about money.

Many months ago, I went through this change myself.  Previously, I would buy whatever I thought I needed, or I might buy an item when I found it on sale, if I thought I would need it later.  I wasn’t really keeping track of my spending and didn’t really have any sort of emergency fund built up at all.  I was buying practically everything on credit, and paying the bill off when it came due (most months).  This sort of worked, but I wasn’t getting ahead and saving up for my goals.  Money seemed to flow through my hands like sand.  I couldn’t tell you where it all went!

Your First Step

Think of your finances like a boat.  A leaky boat.  If you are taking on water, you know you have a leak.  The first step to fixing that leak is finding it!

The same is true of your finances.  If you are just making ends meet (or getting further under water) each month, your financial boat has a leak.  With a real boat, locating the leak should be as simple as looking around for where the water comes in.  To find your financial leak, you need to do a little work.  You have to track your spending.  I’m not talking about sitting down on a Saturday afternoon and writing down all your monthly bills, then estimating how much you spend on various expenses.  I’m talking about really tracking each and every expense.  This takes effort on your part, as you’ll need to do this every day.  Either put your receipts in your wallet and put it in a spreadsheet at the end of the day, or write it down in a pocket-sized notebook you carry everywhere with you, or some other system that works for you.

If you do this, you will almost certainly find that you are spending a lot more on certain categories than you think you are.  Think you are spending $150 a month eating out?  You might find that it’s more like $400!  Spending $4.50 on that Starbucks coffee doesn’t seem too bad, but when you realize that you do that four days a week, that adds up to almost $80 a month on coffee!

What, you say?  I can’t have Starbucks anymore?  No, I’m not saying that.  You can, but you just have to realize the true cost of things.

One more thing before moving to the next section – You can use a budgeting tool to track your spending as well.  I use one on my iPhone, but there are Android versions too.

I Know Where the Leak is, Now What?

Once you’ve figured out what you are spending, you can take steps to change things.  You probably won’t find that all your problems will be solved by going to Starbucks a time or two less per month.  Most likely, where you thought you had several small items you bought each month that didn’t amount to much, you’ll probably find that you are spending far more than you thought in several categories.

For the next step, I recommend you set up a Zero Based Budget.

For most people, budgeting is a bad word.  People feel that budgets are very restrictive and that you can’t have any fun.  If you approach it in the right way, you’ll realize like I now do, that budgets are freeing.  Do you enjoy worrying about your billing coming in?  Worrying about where you’ll get the money to fix the roof?  How you’ll possibly be able to afford to send your kids to private school?  Budgets are your friend.  Or do you enjoy being out of control?

Continuing to do the same thing over and over expecting a different outcome is a popular definition of insanity.  Take the step of making a budget so you can take control of your money, instead of letting it control you.

What’s a Zero Based Budget?

Quite possibly the best method of budgeting known to man.

The point of a zero-based budget is to make your income minus your outflow equal zero.  Wait… What?  How can I get things under control if I plan to spend everything I make?  No, I don’t mean you must spend every cent you make every month!  But, you have to plan where every dollar goes.  If you don’t put each dollar into a spending category of some sort, you are leaving yourself with a pool of money that you’ll inevitably find something to waste it on.  If you put that money somewhere, such as into an Emergency Fund category, or in a Debt Payments category, you’ll be putting that money to work.  Remember Starbucks?  Give yourself a Fun Money category and spend it on whatever floats your boat, but realize that the money you put in that category isn’t going to lowering your debt, or saving up for that roof/appliance repair that you need.  That doesn’t mean you don’t get any Fun Money.  We all need to have a little fun every once in a while.  This category of spending is a little money you can spend on whatever you want, each month, without feeling any guilt.  In my case, it’s $35 a month.

I won’t go in depth about Zero Based Budgeting here.  There are many other resources on the Internet that deal with it in depth.

I will quickly put a plug in for the particular tool I use for this job.  It’s called YouNeedABudget (or YNAB for short).  I’ve been using YNAB since March 2013.  By using it, I’ve gone from just over $20K in consumer debt to about $7500 in about 7 months.  They don’t just sell you the software and leave you on your own, either.  They have multiple live classes every week, dealing with a variety of topics related to the YNAB flavor of Zero Based Budgeting.  In fact, even if you don’t use their software, their website is a great resource for budgeting.

Don’t run to buy YNAB now.  Try it free for 34 days, and if it works for you, then buy it.  If it’s working, you’ll know it and the price won’t seem unreasonable.  You can use this refer-a-friend link to save $6 off the regular price of YNAB.

Building a Budget

Set up your Rainy Day categories.  These include bills that are due on an annual or semi-annual basis, like Homeowners Insurance, Auto Insurance, and Property Tax.  For bills, such as Property Tax, look at last years cost.  Divide that number by the number of months you have until it is due.  That’s the amount you must save every month so that when the bill arrives, you’ll be ready for it.

Other important Rainy Day categories are things like Christmas, Birthday, Car Maintenance, and Emergency Fund.  For things like Christmas, decide how much you want to spend on all gifts you plan to give.  Start putting some money aside each month so it’s there when you need it.  Same thing goes for BirthdayCar Maintenance is a little different, in that you’ll want to build up at least a few hundred and just let it sit.  When you do need it, you’ll be glad it’s sitting there waiting for you.  Finally, the Emergency Fund.  It’s the money you’ll want to have if something major happens.  If your A/C goes out, or a major appliance, or your roof springs a leak, it is there to catch you.  As for how much to put in the Emergency Fund, advice is all over the place.  I’ve seen some people suggesting 6 months of expenses, some more, some less.  Even having a single month as a goal is reasonable when you start out.

Why is a Budget so Important?

A budget is vitally important because it consists of concrete information that guides your spending decisions.  Whenever you make a spending decision, it should always be based on concrete information with all the facts available.  If you look at your checking account and say “I have $1200, so I can afford the new iWidget”, that may be concrete information, but it’s not complete information.  You may have outstanding checks that haven’t cleared yet, taxes or insurance due soon.  Even if you are uncommonly good with math, you can’t possibly be keeping all of the various spending categories and their independent balances in mind, especially with a new iWidget at stake.

Okay, I’ve got a Budget, Now What?

When you are about to make a spending decision, look at your budget categories to guide you.  Do NOT consult your bank balance to help you see if you can afford to spend money.

You’ll have money in “must spend” categories, like Rent/Mortgage, UtilitiesGas and you’ll have money in discretionary categories like Eating Out, Clothing, and Entertainment.  Realizing that you don’t have an unlimited supply of cash, you can move money around among the discretionary categories however you like.  The key is to prioritize what is really important.  If you want to spend the extra $25 for that new pair of sunglasses, you can move that money to Clothing from Entertainment, but it means that you’ll be going to see one or two less movies that month.

This may be where some people might stop reading.  You might be thinking that this is the restrictive part of budgeting that you don’t like.  Yes, you’ll have to make choices with a budget.  But here’s a secret:

Unless you are independently wealthy (in which case, why are you reading this?), you are already on a budget.  It’s a very vague budget, consisting of your Income, and a few “must spend” fixed cost categories floating in your brain, like Rent.  The rest sits in this big amorphous Miscellaneous category that includes just about everything else I’ve mentioned above, and more.  When you make decisions about spending, you are making budget decisions.  If you have concrete information when you make these decisions, they will be better decisions.  Without concrete information, you are much more likely to make bad decisions.

But I’ve got Debt!

Getting out of debt should be your top financial priority.  Some people suggest you build your Emergency Fund first.  Their reasoning is that if you have a problem, you’ll immediately run to credit cards to fix it.  I think the best approach is a hybrid approach, mostly targeting debt elimination.

I suggest this because your debt has a monthly maintenance cost.  By getting rid of that debt, you are lowering your monthly debt maintenance cost.  On a $6500 loan with the decent rate of 6.25%, this was costing me a reasonable $35 per month, a cost that has only gone down each month as I’ve paid more and more against it.

Back to your budget plan.  I suggest taking about 20% of the money you have available after funding your Must Haves along with some reasonable discretionary categories, and place that 20% in the Emergency Fund.  The other 80% should go to debt reduction, with the lower interest rate loans getting only the minimum payments and the highest rate getting the rest.  When you pay off that highest rate loan, in the following months, move all the debt reduction money to the 2nd highest rate loan.  Repeat until all your loans are extinguished.  This may take a year or two, but you might end up saving yourself $100 or so per month in interest charges alone, if you have very high interest rate cards!



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