Disclaimer: I am speaking from the perspective of a recent graduate currently working full-time. I do not claim to be a financial expert, but I encourage you to follow me as I lay out my observations and logical reasoning in my own experiences with personal finance.
A competent understanding of personal finance is probably one of the best skills anyone can obtain. Like most good habits, the earlier the better. Unfortunately, more often than not, it happens later than it should have to, resulting in a plethora of adults with poor spending and saving habits. This has many implications for the quality of our lives. If we are not masters over our own financial situations, how can we ever hope to allocate more time to aspects of our lives that truly matter? Money is a means, not an end. But it can end us if we pretend not to care for it or if we care for it in excess.
Most of us will, at some point in our lives, be earning a stream of income. It doesn’t matter if we are making 40,000 per year or 400,000 per year because poor spending and saving habits will yield the same outcome for both salary earners: living a life with zero economic freedom. What does this mean? Imagine a common scenario in which you and your boss are in disagreement over a matter in which you are clearly right. Or your boss asks you to do a task that conflicts with your moral values. Do you stand your ground? If you have little savings to carry you over to the next job and are completely dependent on your paycheck to support your current lifestyle, the answer is a most definite no. You wouldn’t take the risk of standing up for yourself because you are in no position to. There is no financial wiggle room. Thus, no economic freedom.
I know I don’t speak only for myself when I say that I can’t imagine living my entire working life in continuous compromise. So what then do we do to achieve this state of economic freedom?
Like raising children, there is no formal process by which we are educated to learn about the handling of our finances. Instead, we often learn from our own experiences or from parental figures, who may or may not have the best sense of cents themselves. After all, nobody really taught them either and it would be foolish to believe that more life experience is perfectly correlated to a more qualified understanding of any concept. That is why we must take it on ourselves to learn which habits are proper and which are not. Personal finance classes can be great, but merely taking in information only does so little to change the old habits that die hard.
Therefore, we must feel the weight of our hard-earned money at stake before we can learn anything that will stick. We must be willing to discuss this traditionally sensitive topic more openly with our friends and family so we can better discern sensible advice from the irrational ones. And above all else, we must practice.
I believe that the ultimate goal is to turn financial sensibility into a more automatic and intuitive process. That way, we can divert the precious and finite resources of time and energy to more pertinent matters: finding love, experiencing life’s offerings, and shaping this world into a better place for our children.
Listed below are some suggestions to alleviating some of the most common problems and misconceptions that I have observed in my daily conversations with people regarding their finances. I do not have any legitimate authority to be handing out financial advice but, as mentioned before, much of it is logical reasoning:
Build an emergency fund. You never know what could happen - unexpected medical bill without insurance coverage, losing your job, etc. If one of these emergency situations arises and you did not prepare for such circumstances, you will be out of luck. Many of the nasty downward spirals begins here. Don’t take the risk. Save. The general rule of thumb is to have a reserve of 3-6 months of living expenses.
It’s never too early to start saving for retirement. I have seen many doctors fail to save a single penny towards their retirement only to realize their mistake when they turn 50. Even with their high level of income, they will, more often than not, have to retire later than people who were diligent about putting money away into their retirement plans during the course of their career. Ask about your retirement plan at work (typically 401k, 403(b), 457, SEP, SIMPLE, etc.) and understand its nuances and its benefits. Starting young is extremely advantageous because of the power of compound interest. Very few people want to work until the day they die. Unless you are one of those few, I suggest starting sooner than later.
List out expenses and separate fixed versus variable. More often than not, we can reduce variable costs or just eliminate them altogether if we have the resolve to do so.
Credit is NOT an extension of spending power. A credit card is, as it is so rightfully named, a means of building a credit history to show lenders that you are not a risky borrower. And other than the few instances of emergencies when you don’t have enough money to front a bill (for example, because you are paid monthly), that’s all it should be treated as. A 5000 credit limit does not mean you have 5000 more dollars to spend. Credit is money you do not have.
Live below your means. You might find this obvious, but its surprising how many people do not adhere to this principle. If you have debt and have a take-home income of 40,000 per year, you cannot live a 40,000 lifestyle. Simple as that. Even if you didn’t have debt, you still cannot live a 40,000 lifestyle without struggling to make ends meet. If there is not available money, there are only two options: earn more and spend less. If the former option is not available, then the only option is to temper the lifestyle we currently have.
Here is some reading material that I have found to be incredibly useful starting points on the road to financial literacy:
- http://www.reddit.com/r/personalfinance/wiki/faq - good FAQ that breaks down personal finance conceptually
- http://www.bogleheads.org/wiki/Getting_Started - one of the best resources put together by a sensible, not-for-profit community
- http://www.amazon.com/Bogleheads-Guide-Investing-Taylor-Larimore/dp/0470067365 - worth picking up after reading above link
- http://www.mrmoneymustache.com/2013/02/22/getting-rich-from-zero-to-hero-in-one-blog-post/ - steps to achieve financial independence
- http://mint.com - useful web/mobile tool to aid in budgeting expenses and saving goals
- http://lazytraders.com/insights/5-steps-to-prioritizing-roth-iras-vs-401ks-vs-debt/ - priority list for saving money