Good financial habits and building wealth do not have to be daunting tasks. There are three major elements of good financial health: budgeting, saving, and investing.
Budgeting
The first step to being a good budgeter is to focus on the why or what your overarching goal is. For example, is your goal to pay off student loans? Buy a house? Start a business? Whatever it is, start small by setting short, achievable goals and working your way toward your larger financial plan. The key to goal achievement is motivation, and you are more likely to stick to your goals if you see progress.
After you define your goals, follow these simple budgeting steps:
- Add up your income: This includes your household's regular paychecks and any extra cash you make from part-time jobs, contract or freelance work, etc.
- Track your spending: List your monthly expenses, including utilities, rent or mortgage payments, transportation, insurance, and other monthly bills such as credit card payments and car payments. Then track money spent on dining out, shopping, TV streaming services, and so on.
- Budget for essentials first. Fixed expenses tend to be the most important, such as a place to live, insurance, water/electricity, and childcare expenses.
- Account for variable spending next. The cost of these expenses varies month to month but reviewing variable spending can help you recognize your spending trends, making it easier to decide how much money should be allotted for them. Common variable expenses include gas, groceries, and healthcare expenses.
- Know your baseline. Your baseline is the minimum amount you need to spend each month to live within your budget. Knowing that amount can help you decide how much of your budget you can afford to dedicate to discretionary variable expenses. This can be helpful if you lose your job or run into a large, unexpected expense.
The 50/30/20 Rule
There are a variety of different budget approaches, the 50/30/20 budget being one of the most common breakdowns. With this budget, you will aim to spend roughly 50% of your after-tax dollars on necessities, no more than 30% on wants, and at least 20% on savings and debt repayment.
Over the long term, someone who follows these guidelines should have manageable debt, room to indulge occasionally, and savings to pay irregular or unexpected expenses and retire comfortably.
Budgeting worksheets are great tools to see where your money is going and help you budget for the future.
Saving
When it comes to saving, you might have longer-term goals in mind, such as a house purchase, saving for education expenses, or building up a retirement fund. But saving is also important for shorter-term goals such as paying off a car, taking a vacation, or creating an emergency savings fund.
What is a good amount to save? For most people, financial experts generally recommend building up a cash fund equal to three to six months of expenses. If you are a one-income family, self-employed, or if you have recurring medical expenses, consider building a fund that will cover you for at least six months.
A good place to store your emergency fund is in a savings account that is separate from your checking account. These can include a high-interest account that is safe and accessible so that you can take the money out in case you need it. Interest-bearing accounts include:
- High-yield savings accounts
- Money-market accounts
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Certificates of deposit/time deposits (CDs)
- It is important to note that CDs usually charge a fee to access the funds if the CD has not yet matured. Keep this in mind when deciding on a CD term
These accounts maintain access to your funds while maximizing the interest they are accruing.
Mistakes to Avoid
Not automating savings
The easiest way to consistently save money each month is to automate a transfer, such as 20% of your paycheck per the 50/30/20 rule. You can set up automatic transfers with your banking representative, online or using banking apps such as FirstBank's Mobile Banking app.
Saving as an afterthought
If you only save what is left over after monthly spending, you may not reach your goals. When you consider saving as a mandatory monthly expense, you can count on your savings to grow consistently.
Keeping savings in one account
When saving for multiple goals, it can be strategic to put your savings into multiple accounts, too. Keeping everything together in one lump sum can make it difficult to track which funds are allocated to which goal. Of course, each case is unique, and you should consider the options that best align with your goals.
Investing
It is also important to consider ways to grow your money. Investing allows you to put your savings in avenues that have the potential to earn strong rates of return, creating more money faster than traditional savings accounts. From stocks, bonds, and mutual funds to real estate and businesses, investing in a variety of vehicles can help you reduce your taxable income and reach your financial goals. It is possible to lose money with investments, so it is best to seek professional advice before you invest.
Compound Interest
Compound interest occurs when your earned interest is added to your savings, and the total balance accumulates more interest or money paid into your account. It is essentially interest on top of interest, which over time can lead to exponential growth and can be a useful tool to help accelerate your savings.
For instance, if you deposit $10,000 in an account that pays 4 percent annual interest, you would earn $400. Thanks to compound interest, in year two, you would earn another 4 percent on $10,400 or $416, totaling $10,816. By year three, you would earn $432.64, totaling $11,248.64, and so on. This might not seem like a lot of money at first, but if you continue contributing to your account and letting it build over time, you could be looking at tens of thousands of dollars in earned interest at the end. Please note that the above interest rate is only used as an example and may not reflect current interest rates.
Examples of Compound Interest
Savings accounts, 401(k), and certificates of deposit (CDs).
When you make a deposit into an account at a bank that earns interest, such as a savings account, the interest will be deposited into your account and added to your balance, helping it grow over time.
401(k) accounts and investment accounts
Earnings in your 401(k) and investment accounts also compound over time. The percentage that stocks gain day to day is calculated based on their performance the day before. If you reinvest your dividends and make regular deposits, you can help your balance grow even faster.
As your financial goals evolve and change, budgeting, saving, and investing strategies will help you achieve them and make unexpected expenses easier to manage. Check out more financial tips and resources on our blog.
Resources
Learn more about Budgeting, Saving, and Investing, view or download the infographic, or visit our blog
Strategies to Better Save and Grow Your Money
Four Tips for Becoming Financially Secure
The Do's and Don'ts of Retirement Preparation
Easy Tips for Building an Emergency Savings Account