Understanding Your Money
Money can bring a great sense of freedom: freedom from debt, freedom to purchase what you want…freedom in the greatest sense of the word. Thomas Jefferson, the third President of the United States, once stated: “Never spend your money before you have it.” His statement is just as prevalent today as it was hundreds of years ago.
In this course, we will focus on the following four aspects of money management:
As you look to the future, what do you see? Do you have dreams that require financial stability? Most people do. With that said, getting what you want does not always come easily. In fact, you must work hard to achieve the results in life that you desire. Just like anything you dream about, getting out of debt and securing your financial future requires perseverance, consistency, dedication, and the ability to manage your money properly.
“People never plan to fail; they just fail to plan.”
Setting Realistic Goals
In order to achieve any financial success, you must create meaningful and realistic goals. Let’s consider the financial goals established for the following individuals:
Who do you think is going to achieve the financial goals established? More than that, who is going to be able to reach his/her dreams? You should have guessed that John’s goals are more likely to be achieved because they are written down and they are realistic and specific.
Write Down Your Goals
Sometimes when people write down their goals, they find that some are broad and some are more focused. Some will take more than five years, while others can be accomplished within six months.
There are three different types of goals to consider, each with a different timeframe to consider. Each type of goal is based on the date the task is needed, the total estimated costs needed to accomplish the goal, and the required savings needed to achieve results. Let’s take a look at the different types of goals you should consider.
- Short-Term Goals: Short-term goals generally take one year or less to achieve. Examples of short-term goals might be paying off a VISA card, buying a piece of furniture for your home, saving for a family vacation, or purchasing a new game system for your family.
- Intermediate-Term Goals: These goals generally take between one and five years to complete. Examples of intermediate-term goals would be paying off your student loans, getting an education or certification, or purchasing a new or used car.
- Long-Term Goals: Long-term goals are those that won’t happen overnight, no matter how hard you work to achieve them. They may take a long time to accomplish; in fact, usually more than five years. Long-term goals usually require longer commitments and a larger amount of money than other types of goals. Examples of long-term goals may be saving for a child’s education or purchasing a new home.
Review Your Goals
You may need to change the time frames on certain goals. Take the time each month to review your financial goals and see what you may need to adjust. In this way, you can make sure your goals are always realistic and not just “pie in the sky.”
The key, however, is to maintain the discipline needed to follow your plan. Sometimes you will have to wait to make a purchase, or you may have to make a choice based on two good items needed in your personal life. Whatever the case may be, it is important to recognize that if you write down your goals, studies show you will accomplish 85 percent of what you set out to do.
Start today and take the time to go over the worksheets provided in this module. Play with it a little to make sure you are setting appropriate and achievable goals for your financial future.
Strong money management begins with a budget. Unfortunately, many have a negative attitude toward living on a budget, but it does not have to be restricting; it is just part of the entire money management process. You have established your financial goals, now you have to develop a plan to achieve those goals…that is your budget.
Track What You Spend
The first step in creating a budget is to track what you spend. Using the following worksheet, write what you spend each day on the items listed; add any additional items in the spaces provided.
You will notice that the first thing we have listed in the worksheet is “pay yourself.” It is critical that you pay yourself before you do anything else so you can begin to establish savings needed to meet your goals and keep you financially stable in any type of emergency. The rule of thumb is to save 10 percent of your gross income each month. For example, if you make $1,000 per month, be sure to pay yourself at least $100.
Next, you need to focus on your monthly income. In the worksheet below, you will be asked to type in all of the income you receive in a typical month. Take a moment to fill in that information now.
It is important that you track what expenses you have on a monthly basis. Take a moment to fill out the worksheet below and print it for future use.
Now you are ready to see how you are doing with your financial management. In the following worksheet, your monthly expenses will be subtracted from your monthly income to calculate the money you have left over, or your discretionary income. That doesn’t mean you want to spend all of your remaining income, it just provides you with a look at what you have available to either spend or save. You can adjust your budget accordingly based on your financial goals.
Click on the Discretionary Income Worksheet below to find out what your discretionary income is at this time.
Realign Your Budget
If you have money left, be sure to realign your budget to find a place for each penny you have. If you do not have any money left, you will need to take a look at one of two things:
- Can you bring in more income?
- Can you reduce your expenses?
Needs vs. Wants
As you can imagine, it is usually easier to reduce your expenses than increase your income. Take a look at what you are spending on a regular basis and see where you can make significant changes. You want to base your decisions on “needs” vs. “wants.” Take a moment to go through the NEEDS VS. WANTS exercise to see how to determine the difference.
Now that you have established financial goals and a budget, you are ready to save what you need to achieve the results you desire. Saving money is essential to meeting your financial goals. Unfortunately, saving money can be a difficult thing for some people. It’s not really that saving money is hard, but that spending money is so easy.
In this portion of the tutorial, we will focus on how to effectively save money for your immediate goals as well as for your future dreams and wishes.
Start a Savings Portfolio
As you know, saving money is not usually an easy task. But, with your financial goals intact, you are ready to begin. Don’t be discouraged if you can only save a little each month…a little is better than nothing. In fact, even saving $2 per day can have a great impact on your financial well-being in the future. Let’s take a look at how much you will be able to save:
- $730 after one year
- $3,650 after five years
- $7,300 after 10 years
And, that is not counting the interest that you could earn!
Pay Yourself First
The key is to pay yourself first. It is truly the best way to save. Set up a savings account where you automatically put in a percentage of your earnings each paycheck – money that you will never touch. Your earnings will then grow each month and you will feel good about the money you save.
Experts suggest saving approximately 10 percent of your gross earnings; however, if you have set financial goals and have created a manageable budget, and you can only afford five percent, it is better to save that amount than nothing at all.
Tips for Saving Money
The following are additional tips for saving money:
- Think of saving money as another monthly expense. While paying your bills, make sure to put money in your savings account each month as well.
- Set up an automatic payroll deduction directly into your savings account.
- Save all unexpected income, such as bonuses, incentives, tax returns, etc.
- Collect your pocket change.
- Participate in any type of pre-tax payroll deductions in your employment, such as a 401(k)
- Try to find a low cost alternative for some of your needs so you can save money in the end.
- Make a game out of saving; for example, see how much you can save during the month and still pay all your bills on time.
Monitor Your Net Worth
You need to figure out what resources you can draw from for your future. In order to do that, you should calculate your net worth. Just what is your net worth? It is what you are worth when you subtract your liabilities from your assets. Your goal is to achieve a positive net worth. Let’s go through this process so you have a better understanding of what we are talking about.
Step 1: Add Up the Value of Your Assets
The following lists some of the assets you may have:
- Personal Possessions
- Checking Account
- Savings Account
- Cash Value of any Life Insurance Policy
- Current Value of Investments (e.g., retirement accounts, stocks, bonds, certificates of deposit, etc.)
What is the total amount of your assets? Write it down on a piece of paper to use at a later time.
Step 2: Add Up the Value of Your Liabilities
Add up the value of all your liabilities. The following lists some of the liabilities you may have:
- Remaining Mortgage Balance
- Credit Card Debt
- Auto Loans
- Student Loans
- Income Taxes Due
- Taxes Due on Profit of Investments
- Outstanding Bills
What is the total amount of your liabilities? Write it down on a piece of paper to use at a later time.
Step 3: Subtract the Liabilities from the Assets.
The final step in the process is to subtract the total value of your liabilities from the total value of your assets to determine your Net Worth.
Review Your Net Worth
Do you have more assets than liabilities? If so, you are on the right track. A strong financial net worth will carry you through any type of financial crisis. If not, you will need to make adjustments to bring your net worth into the positive zone.
You should review your net worth on an annual basis, because things can really change in one year. Be sure to adjust your financial goals accordingly when needed.
Save for Retirement Now
Now that you understand the basics of saving for your future and the value of having a positive net worth, you need to now focus on the time when you will not be earning a regular paycheck – your retirement. Studies show that in the next 10 to 20 years (and beyond) retirement funds will be severely depleted. What that means is you will not be able to rely on Social Security for your daily needs; you will need to have your own funds to fall back on.
Furthermore, the cost of your retirement continues to get more and more expensive for two main reasons:
- We are living longer after we retire and we are more active. Some people are now spending 15 to 30 years in retirement. In fact, the U.S. Department of Labor stated that a male retiring at age 55 today can expect to live approximately 24 years in retirement. On the other hand, a female retiring at the same age today can expect to live approximately 28 years in retirement.
- Fewer companies provide traditional retirement programs and are contributing less to those plans. For example, in a typical 401(k), the employee pays for the primary amount of the fund, not the employer.
With that said, you are the one that must take responsibility for the biggest expense you will have throughout your life…your retirement. And, it is much better to begin saving for retirement today.
An easy rule of thumb is that you will need to replace 70 to 90 percent of your pre-retirement income. So, if you are making $50,000 per year (before taxes), you might need $35,000 to $45,000 a year in retirement income to enjoy the same lifestyle you are currently living. Generally speaking, the lower your income, the higher the portion of it you will need to replace.
Of course, this rule of thumb is not fitting for everyone. There are other variables that you may need to consider in your retirement planning process, such as larger medical bills, lower taxes as you age, work-related costs that may disappear, etc.
Additionally, it will depend on what you want to do when you retire. Do you want to live quietly in a low-cost part of the country, or do you want to travel all over the world? Do you plan to be active and take expensive vacations, or spend more time with family?
Back to the guidelines we provided for saving…start saving for retirement by putting away 10 percent of your gross income into a retirement fund. Then, every two to three years, you should review your plan and adjust it based on your annual earnings growth and other retirement plans.
Saving and Compounding
The name of the game for retirement saving is compounding. You are probably familiar with compounding. Money you put into a savings account earns interest. Then, you earn interest on the interest as well as the original amount of money you put into the account. Let’s take a look at the value of $1,000 when compounded over time:
Now, imagine if you add to your retirement accounts on a regular basis. This money can then compound at an even more rapid pace, helping you to meet your financial goals that much quicker.
Other Retirement Savings Tips to Consider
Let’s take a look at some other tips you should take when considering retirement savings options:
- Leave your retirement account alone unless you are adding money to it.
- When you change jobs, only rollover what you can without paying penalties. Check with your tax advisor and financial planner to make sure this is the best option for you.
- Do not borrow from your retirement account. While some programs give you this option with an attractive interest rate, do not take it. It not only lowers your savings potential, but it can also cause you to pay tax penalties if you can’t make a payment on the loan.
Credit is the ability to borrow money with the agreement that you will pay the money back at a future date. It is a way of life in our society, but it can be a source of financial problems if not used appropriately. Student loans, credit cards, home loans and car loans are all examples of credit.
Having good credit will allow you to get a loan at the lowest rate possible, saving thousands of dollars in the long-run. For example, if you have excellent credit, you can obtain a mortgage loan for the best rate available, providing you with a lower overall loan amount over the life of the loan, plus lower monthly payments.
Credit History Determines Your Character
Additionally, having a strong credit history will allow you to have the things you need as well as a few things you may want throughout your lifetime. In many instances, employers will look at your credit history to determine your character and integrity. If you want to obtain insurance, most representatives will check your credit history as well to determine how you will do when making payments on your policy.
How Do You Build Your Credit?
But, many young people do not have credit coming out of high school or college, so where do you start? Let’s take a look at how to build credit if you do not have any at this time:
- Open a checking account and don’t bounce any checks.
- Open a savings account and make regular deposits.
- Buy something from a department store with a department store charge card and make regular payments on time.
- Pay all your bills (e.g., utilities, telephone, etc.) on time.
- Apply for a low rate credit card and make all payments on time.
Tips for Using Credit Responsibly
It is easy to build credit, but it is a little more difficult to maintain that credit once established. You just need to be smart and control the credit you obtain so you can make monthly payments ON TIME. Here are a few tips to help you use your credit responsibly:
- Keep any credit card balances low, or try to pay them off each month. Your loan payments should be no more than 10 percent of your monthly income.
- Keep track of your credit lines so you know how much you have used and how much is available at any given time.
- Use a budget to manage our expenses; do not overspend. Remember, you will have to pay a loan back.
- Keep track of where you spend your money. You may want to save your receipts so you can compare them with your monthly statement.
- Save up over time for larger purchases instead of using credit. Save your credit for things that would be difficult to pay for with cash, such as a home or vehicle.
Monitor Your Credit Report
Another really important step is to monitor your credit report. Every time you use your credit card or other loan in some way, your transactions become part of your credit record, or your credit report. Some consider the credit report your financial report card. It literally keeps track of how you handle credit; for example, it tracks if you pay on time, and how much money you are currently borrowing, among other things. Lenders rely on these reports to determine whether or not you will repay your debts.
Credit Report Sample
Click here to view the sample credit report provided by Experian.
You are given an overall credit score on your credit report, or what is referred to as a FICO (Fair Isaac Corporation) score. A median FICO score ranges from 690 to 740; this number is compiled of the following information, listed in the order of importance:
- Payment History
- Amounts Owed
- Length of Credit History
- New Credit
- Types of Credit Used
Using the FICO, along with other valuable information required by policy at a financial institution or other entity (e.g., income, employment history, amount in savings account, etc.), will help a lender determine whether or not you will be approved for a loan as well as how much you will receive. Generally, the information in your credit history will remain on your credit report for seven years; however, if you file for bankruptcy, that information will stay on your report for 10 years.
You should always be aware of what is on your credit report. It is easy to get a copy of your credit report. By federal mandate, you have the option to go to www.annualcreditreport.com to receive a free copy of your credit report each year.
Review Your Credit Report
Take advantage of being able to review your credit report annually and report any sort of discrepancy you may see. Protecting yourself from identity theft or other type of fraud will save you money and maintain your reputation in the future. Furthermore, the law requires the credit reporting agency to make corrections if an error is found.
Your credit record truly is your financial reputation. Be sure you only take advantage of loans that are necessary and will improve your financial security.