Are your finances in the shape you’d like them to be? Or, are they a disaster that you’d like to clean up as soon as possible?
The following post is by MPFJ staff writer, Melissa Batai. Melissa is a freelance writer who covers topics ranging from personal finance to business to organics to food. She blogs at Mom’s Plans, where she shares her family’s journey to healthier living and paying down debt.
If they’re a disaster, first know that you’re not alone. Many, many people find themselves in a financial mess at some point in their lives. There are a number of steps that you can take to strengthen your financial life and make yourself and your family more secure. Here are the steps that I recommend you take in this order:
Put two to three months’ expenses in an emergency fund
If you’re a fan of Dave Ramsey, you know that he advocates a $1,000 emergency fund and then attacking debt. My husband and I used to follow this approach, but then we ended up with emergencies bigger than $1,000, and we’d have to go back into debt to pay them.
I’d recommend instead that you first save two to three months’ of expenses, and then start paying down your debt. That way, if you run into unexpected expenses, you can tackle them without going further into debt and erasing the progress you’ve made on paying down the debt. (Seriously, nothing is more depressing than working hard for months to pay down your debt just to watch all of your progress disappear with one car repair or home repair.)
Pay down all of your debt except your mortgage
Once you have the two to three-month emergency fund, it’s time to pay down your debt. I’d recommend paying off credit cards first, then car loans, then student loans.
While Dave Ramsey recommends using the debt snowball and paying off the lowest debt first, others have good luck paying down the highest interest debt first. Which option is better depends on what motivates you. Are you motivated by seeing the debts disappear one by one, or are you motivated by knowing that less money is being paid to interest each month? Ultimately, your motivation will be what helps you through the sometimes long, painful process of paying down debt, so pick the method that works best for you.
If you use your credit card, pay it off each month
Credit cards can be a great tool if you use them responsibly. If you have a cash back or airline points feature, you can even earn money for using your credit card. The key is to pay it off each month. If you can’t do so, it’s time to retrain yourself and start using cash or a debit card. Once you get better control of your spending, you can start using the credit card again and reaping the rewards.
Credit cards can be a great tool if you use them responsibly. If you have a cash back or airline points feature, you can even earn money for using your credit card. The key is to pay it off each month. If you can’t do so, it’s time to retrain yourself and start using cash or a debit card. Once you get better control of your spending, you can start using the credit card again and reaping the rewards.
Contribute 10% of your income to your retirement fund
When you’re in the midst of financial difficulties, it’s hard to plan for the future, but if you want to be secure in the future, you must take steps now. Ideally, you’ll want to save at least 10% of your income in a retirement fund with the eventual goal of getting that number up to 15%. However, don’t feel intimidated by that amount. Start slowly if you need to, and contribute just 1% of your income to your retirement fund for six months. Then, slowly bump it up to 2 or 3% for six months. Continue adding more every few months. It takes
When you’re in the midst of financial difficulties, it’s hard to plan for the future, but if you want to be secure in the future, you must take steps now. Ideally, you’ll want to save at least 10% of your income in a retirement fund with the eventual goal of getting that number up to 15%. However, don’t feel intimidated by that amount. Start slowly if you need to, and contribute just 1% of your income to your retirement fund for six months. Then, slowly bump it up to 2 or 3% for six months. Continue adding more every few months. It takes time to get used to making retirement savings a priority. As you develop the habit, you’ll be able to add more to your retirement savings until you get up to 10%.
Buy term life insurance
(Bump this step up if you have a family before you get to this point in your financial life.) I was talking to a mom of four young kids recently. She is a stay-at-home mom, and her husband is older than her; he’s in his fifties. She was excitedly telling me about their new financial plan. Each month, they set aside $100 in an emergency fund in case something happens to her husband. That was their only plan if something happened to the sole breadwinner of the family.
I wanted to cry. They have four young kids, she doesn’t work, and her husband is in his fifties, yet they have no life insurance! While the money they’re setting aside is great, if her husband unexpectedly passed away, that money would quickly be consumed.
The family I’m referring to isn’t alone. According to Fox Business, “Currently, 95 million Americans live without life insurance and only one-third of consumers are covered by individually-owned life policies.”
Term life insurance is relatively inexpensive, especially if you’re young and healthy. While experts recommend you take out a policy for 10x your income, you can use an online calculator and talk to an expert to help you determine how much you actually need based on your life circumstances.
If you have dependents who rely on your income, you must make buying term life insurance a priority. I would move this to the first step in this plan, even before creating a two to three-month emergency fund, if you have dependents. Life insurance and the financial security it can bring your loved ones is that important.
Build an eight-month emergency fund
For ultimate security, you’ll want to bulk up your emergency fund once your debt is paid off, you’re adding to your retirement regularly, and you have term life insurance. Some experts recommend an eight to twelve-month emergency fund, but start with an eight-month emergency fund first. This money will be essential if you unexpectedly lose your job or suffer an injury.
Remember, when you’re measuring a month’s worth of expenses, you want to consider the essentials. If you were suddenly laid off, you’d probably cut non-essentials like eating out and buying new clothes. Base a month’s worth of savings on how much money you’d need to pay the essentials. While your current monthly expenses may be $5,000 a month, you may find if you cut non-essential line items, your expenses drop down to $3,800 a month. The latter amount should be the amount that you consider a month’s worth of expenses.
Pay off your house
When all the steps above have been achieved, it’s time for the biggie—pay off your house. While some people prefer to pay off their house right on schedule thanks to low mortgage interest rates, why not pay it off if you’re otherwise financially secure? Think what you could do with that extra money in your budget each month if you didn’t have to pay your mortgage payment? You could invest it, give to charity, travel the world. Once the house is paid off and you’ve completed all of the steps above, you’re truly financially free.
The best way to become financially secure is to create a map for yourself with financial goals that you want to achieve. While the steps above may take as little as 10 years to complete (depending on your current financial situation), or as long as thirty years or more, the point is that you have a plan that you’re following. It’s imperative that you’re continually making financial progress throughout the years rather than squandering money and going through life without a plan to guide you on your journey.
What do you think? Do you agree with these financial steps, or would you rearrange them? If so, what order would you put them in?
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