Many people find themselves in a vicious cycle of overspending, especially using a credit card, without putting aside any savings for an emergency or special purchase. This not only creates a lot of stress but can also create a great deal of debt if one is not careful.
In order to break the cycle of living paycheck-to-paycheck and debt, it is important to understand how the right combination of spending and budgeting can help you get ahead.
We spend our money in many different ways, but there’s one thing we can be sure of – we’re going to spend it.
If you’re one of the lucky few who can afford to spend money on anything, anywhere, anytime and still have it all work out in the end, we're happy for you. But the rest of us need to make some tough decisions.
We need to decide when we’re going to spend money and when we’re going to save it. We need to decide what our priorities are and how much we’re going to spend on each of them. We need to decide how much money we can afford to save, and we need to make sure we do it.
Tracking your spending
The first step to living a financially healthy life is tracking your spending.
The good news is that there are a number of simple and free tools to help you do so.
Here are a few of our favorites:
- Mint – The original online budgeting tool, Mint helps you keep track of your spending, set budgets, and even get financial advice from their network of experts.
- Personal Capital – Personal Capital is a great tool that not only tracks your monthly spending and spending history, but also analyzes your spending and helps you create a plan for your financial future.
- YNAB – YNAB (You Need A Budget) is a great tool that helps you track your expenses and manage your money. They also offer a free trial.
There are many other personal finance tools. This list is simply to get you started.
Tracking your spending for a month is a great way to become aware of where your money is going. You may be surprised at how much those daily coffees add up to, or how much you’ve been spending on clothing you don’t often wear. Tracking your spending makes you more mindful of your purchasing habits, and provides a foundation for the rest of your financial plan.
Now that you know how your money is currently being spent, you can decide how you want it to be spent in the future.
Budgeting is the act of setting a limit on how much you spend on different things during a certain time period. A budget will help you know where your money is going and take charge of your finances.
Creating a Budget
A budget is a plan for your income and expenses. Your income is the money you earn from your job (your salary or your hourly wage) plus any extra money you might receive from gifts, investments, bonuses, or any other sources of income. Your expenses are the money you spend on necessities (like food, rent, transportation, clothing, personal care, utilities) as well as the luxuries you’d like to treat yourself to.
Don’t forget to add in yearly expenses. For example, if you pay your vehicle insurance once a year, divide that amount by 12 and add it into your monthly spend. Then add up all of your expenses and compare it to what you’re earning. Are you spending more than you make?
If you find that you are spending more than you make, you should ask yourself the following:
- Do I need to cut back on my spending?
- Do I need to cut back on my lifestyle?
- Do I need to renegotiate my debt?
- Do I need to renegotiate my mortgage?
- Do I need to renegotiate my rent?
- What other steps can I take to make more money?
The great thing about budgets is that they are flexible. You create your own budget based on your own individual needs and use it to find ways to save money and get ahead.
Your budget will help you set your priorities and stick to them. You may decide to reduce or eliminate some expenses so you can set money aside for things like buying a home, travel, retirement, emergencies, and other important things.
Paying off debt
Aside from using debt as a tool, in most cases the best way to live a financially healthy life is to get out of debt.
If you're in debt, you're probably spending a lot of time and mental energy worrying about your payments.
This is especially true when you have a lot of debt or your debt is at a high interest rate. Paying off debt allows you to eliminate the stress - and the cost! - of paying back money that you owe.
Here are some things to think about when paying off debt:
- How much debt do you have?
- What is your interest rate?
- How can you reduce the interest that you're paying?
- What is your monthly payment?
- What is your total monthly income?
- How much do you need to allocate to pay off debt
- How long will it take you to pay off your debt?
Start paying off your debt by making a payment that is larger than the minimum amount required. (Next time your credit card statement comes in, do the math. That minimum payment could take years to pay off the balance, and by then you might have added to the amount you owe.)
Check out our article on borrowing & debt for more information.
If you add up your expenses and find that they are less than what you’re earning, congratulations! That extra amount is the beginning of your savings account. If not, pay off your debt, then continue making those payments to your own savings account instead of to your credit card. Your new mindful spending habits will make this so much easier.
Raising your financial IQ
Learning about money, and how to wisely spend or save it, is not an overnight process. It will take time and dedication. But it is worth it. An investment of time right now and a bit of discipline over the next few months will help you make better decisions for years to come.
Next, take a look at our article on saving & investing.