New Years is my favorite (because, champagne). But really, I love cleaning out the clutter in my closets and my inbox, and contemplating how I can be and do better in the coming year. This January, along with renewing your gym membership, join me in becoming more financially fit.
1. Create and follow a budget
Having a budget is foundational to financial success. It’s important to know how much you spend and on what, balanced against what you earn, in an average month. By knowing where you’re overspending you can begin to reallocate and regain control of your money, instead of letting it control you.
If you’re new to budgeting, aim for the 50/30/20 rule. This means spending 50 percent of your income on needs (housing, utilities, groceries and insurance) 30 percent on your wants (eating out, shopping, travel and entertainment), and saving 20 percent. If you have credit card or other consumer debt, flip-flop the numbers to put 30 percent of your income towards debt and spend only 20 percent on wants.
For more on how to build a budget, check out my Budget Basics series.
2. Pay-off debt
First, get caught-up on any past-due bills. Harassing calls from creditors and a ding on your credit score that will follow you for seven years, are just some of the consequences of being late on payments. If you need help getting your bills current, start a side hustle to earn extra cash.
Once you’re making the minimum monthly payments on all your bills, there are a few options for tackling your debt:
Snowball method – This philosophy recommends you list your debts in the order of the amount owed. Continue to make the minimum payments, except on the debt with the lowest balance, which is the one you will focus on paying off first. Once you’ve paid off that first debt, you move to the next debt with the lowest balance. This method assumes you’ll find it easier to stay motivated when you’re rewarded more quickly with the elimination of individual debts.
Avalanche method – Instead of listing debts by amount owed, this philosophy has you prioritizing your debts by interest rate, starting from highest to lowest. You will end up paying less interest and eliminating your debt-load more quickly by tackling your debts by interest rate, so long as you can remain committed without the psychological boost the snowball method offers.
Tax-advantaged loans last – Depending in your income, if you itemize on your tax return you may be able to deduct the interest paid on student loans, mortgages and other select debts. If you benefit from these deductions, consider paying off these loans last.
3. Plan for emergencies
Everyone should have an emergency fund, but what that means is different for every situation. Dual-income families, those who spend far less than they make, and renters may be comfortable with just a $1,000 buffer in their checking account. Homeowners, single-income families, and those with unstable or commission-based jobs, may want to have more set aside.
Make sure you have adequate renter’s or homeowner’s insurance and expensive items like jewelry, electronics and art are covered. Also make sure your health insurance fits your individual needs. Everyone needs at least a basic policy that will cover catastrophic injury or illness. Women planning to get pregnant, families with children, and individuals with a family-history of disease or chronic healthcare needs should consider a policy with better benefits. And if your employer offers them, take advantage of flex spending, health savings or health reimbursement accounts. My generous employer offers extra HRA dollars for documenting healthy activities, most of which I’m already doing!
If you have dependents who rely on your income, such as a spouse or children, it’s imperative you have term life insurance, ideally for an amount that equals ten times your annual income or more. If you have kids, consider how you plan to handle their higher education when choosing the term.
Be prepared for weather and safety emergencies. We keep $100 cash in our safe, along with important documents should we need to evacuate or take cover from a tornado. This year, I invested in a survival kit fromWise Company (along with peace of mind I also got 8% cash back by buying through MrRebates.com).
4. Start saving
If you’re in your 20s or 30s and your employer offers a retirement match, contribute the minimum required for the match, even if you’re still working on paying-off high interest credit card debt. With compounding interest, that investment has the potential to double every decade between now and retirement. Plus, free money.
After you’ve eliminated any high interest credit card debt, increase your retirement savings by opening a ROTH IRA. The benefit of a ROTH is since you’ve already paid taxes on the amount you’re contributing today, withdrawals at retirement will be tax free. Vanguard and Fidelity are popular low-fee brokerage companies, and accounts are easy to open from the comfort of your couch.
After you’ve started funding your future, you can begin saving for the short term. Avoid getting back into debt by saving for life events, whether your plan is buying a bungalow, starting a family or spending a week sunning in Santorini.
If buying a house or condo, you can avoid the extra expense of private mortgage insurance (PMI) by putting at least 20 percent down. Don’t push pause on your retirement savings to achieve your dream of home ownership. If you do the math, you may find you come out ahead in the long-run by putting that money in the market and paying a little PMI.
5. Commit to learning more about personal finance
Develop your knowledge about and interest in personal finance by reading books, blogs and listening to podcasts about money. While I disagree with many of his principles and recommendations, the Dave Ramsey podcast is a good source for inspiration and success stories. I also follow a blogroll that includes Power Over Life, Think Save Retire, and Frugal Woods.
Find a community you can learn from and that will help keep you accountable. If you’re not comfortable sharing with friends and family IRL, join a forum like those at Mr. Money Mustache or Bogleheads. Social media is also a great resource for connecting with personal finance bloggers and others with the same money goals as you.
Improving how you manage money in 2017 will change the rest of your life. Raise a glass and toast to a better financial future. Cheers!