Congratulations on deciding to get your money organized. Being open to learning new personal finance skills and taking action on them is a great achievement. Here are seven easy steps to take to take control of your finances, starting today.
Step 1: Determine Your Net Worth
The first step to take control of your finances is to determine your net worth. Your net worth is calculated by adding up the total value of your assets and subtracting all of your liabilities.
The math is easy. Write down everything that you own that’s considered an asset (i.e., cash in the bank, investment account balances, your home) and subtract everything that’s considered to be debt (i.e., student loans, credit card balances, your home mortgage).
For example, let’s assume you have no other assets or debts aside from your house. If you own a home that’s worth $400,000 and you owe $250,000 on your mortgage, your net worth would be $150,000 ($400,000 – $250,000). As you pay down your mortgage balance, your net worth increases by default.
Determining your net worth helps you to figure out your current financial starting point. It’s okay if you’re starting out with a negative net worth. Knowing this number is important, as it helps you to understand your financial situation and to set goals.
As you continue on your financial journey, focus on increasing your net worth by 5% to 10% each year as you pay down your debts and accumulate assets.
Step 2: Determine Your Monthly Income and Expenses to Create a Realistic Budget
After you’ve determined your net worth, it’s time to figure out how much you earn and spend each month in order to create a realistic budget.
To create a budget, make a list of your monthly fixed and variable expenses. Your fixed expenses typically don’t change, while your variable expenses might fluctuate from month to month. Fixed expenses include your housing costs, child support or alimony payments, car loans, insurance premiums, etc.
Variable expenses, on the other hand, consist of categories like groceries, dining out, transit, clothing, personal care, medical care, utilities, and educational expenses.
What you’re actually spending vs. what you want to spend is where your budget comes into play. Use your list of fixed and variable expenses to get an idea of how much you spend each month. Then compare that number to your monthly take-home pay to determine where your money needs to go. This is your budget.
Set clear, reasonable spending limits for each type of expense. For example, if you take home $5000 per month and your fixed expenses are $3000, you have $2000 remaining to pay all of your variable expenses and to meet your savings and investing goals.
Many people, myself included, like to use a zero-based budget. Don’t worry, this doesn’t mean that you spend every dollar you take home to get your bank account balance down to zero! Rather, it means that every dollar that comes into your home is accounted for somewhere in your budget’s spending and savings categories.
Some of those dollars are responsible for paying your rent. While other dollars get funneled directly into your retirement savings. By giving every dollar that comes into your home a job, you are better able to keep track of where your money is going.
In our current example, if you take home $5000 every month, all of that money is accounted for somewhere within your zero-based budget. This $5000 pays for all of your fixed expenses, variable expenses, and savings.
If you have a partner, make sure to include them in the budgeting process. If one partner is a spender who isn’t afraid of debt, while the other prefers to save for a rainy day, it’s important to work together towards common money goals. Both partners should agree on how much money is being spent and saved every month in each category, and work together to stay within the budgeted limits.
Remember to allocate extra money for high-spend times of year. You can do this by saving a little extra cash every month in order to have the money you need available for high-spend times of year, like Christmas or summer vacation.
Once you get used to spending a set amount of money in each category every month, it will become second-nature to stick to your budget. Remember to build some treats and indulgences into your budget every once in a while, to help you stick to your big money goals and avoid budget burn out.
Step 3: Calculate Your Debt-to-Income Ratio
Now it’s time to take a closer look at your debt-to-income ratio in order to take control of your finances. This number is calculated by taking the total amount you pay in debt repayments every month and dividing it by your monthly gross income.
For example, let’s assume that your monthly gross income (before taxes and other deductions) is $7,000 and that you have the following monthly expenses and debt repayments: Mortgage – $1,700, Vehicle – $400, Personal Loan – $150, Credit Card – $200.
Added together, your total debt repayments are $2,450 per month. Divide that total by your gross income of $7,000 and you have a debt-to-income ratio of 35% ($2,450 / $7,000 = 0.35).
As a general guideline, most financial experts recommend that you have a debt-to-income ratio of 30% or less to take control of your finances. Don’t worry if your debt-to-income ratio is higher than 30%, this is something that you can improve over time as you earn more and/or spend less. Make it a goal to work on reducing your expenses and increasing your income, as able, if your debt-to-income ratio is above 30%.
Step 4: Start Saving an Emergency Fund
An emergency fund is a stash of cash set aside for unexpected costs or other financial emergencies. Unexpected car repairs, home repairs, medical bills, or a loss of income are all common examples of financial emergencies. In general, you can use your emergency savings to pay for large or small bills that you didn’t plan for and that aren’t part of your budgeted fixed and variable expenses.
Setting up a dedicated savings account that you use as an emergency fund is an important way to protect yourself financially. By putting aside even a small amount of money for unexpected costs, you can get back on your feet faster and get back on track with your larger savings goals if the worst happens.
If you don’t have emergency savings, even a small financial expense could set you back for a significant period of time. Many financial experts suggest that you should have at least three months worth of expenses saved up in an emergency fund of cash that is readily available.
Why three months? Research shows that three months is enough time to manage many common emergencies. As you near retirement, or if you’re single or self-employed, consider saving at least six months worth of expenses.
Experts agree that people who have trouble getting back on their feet after a financial emergency have less money saved up to help them in case of another emergency. They may rely on credit cards or loans, which can lead to debt that is usually harder to pay off. They may also use other savings, like retirement funds, to pay for emergencies. This can be an expensive mistake.
The easiest way to start building an emergency fund is to make your savings automatic. This means that every time you get paid, you will have a lump sum transferred automatically from your checking account into a designated emergency savings account.
Keep an eye on your account balances so that you don’t get hit with overdraft fees if you don’t have enough money in your checking account when the automatic transaction happens. Set up automatic notifications or calendar reminders to check your balance to help you stay aware. The day after you get paid can be a great day for your automatic transfer, as you will know that the money has been safely deposited in your account and it won’t be sitting there for days on end, begging to be spent at Target or Amazon.
Over time and with consistent effort, building your emergency fund will not only give you peace of mind, but it will grow into a sizable sum that can help to protect you and your family.
Step 5: Evaluate and Update your Insurance Policies and Estate Plan
Once you have a budget and an emergency savings plan underway, be sure that the rest of your affairs are in order, too. Estate planning is necessary to take control of your finances, regardless of how small your estate is. While these can be difficult topics to think about and conversations to have, they are absolutely critical.
Get a Power-of-Attorney or Living Will to ensure that your wishes are followed if you become unable to act on your own behalf in the event of a medical or other emergency.
Revise or update your Will to make certain that your wishes are followed when you pass away. Some people assume that their assets and possessions will automatically pass onto their family. Unfortunately, without a legal Will, the State or Provincial government might step-in to allocate your property, or your Will could end up in the Probate courts for years to come.
Evaluate your car, home, rental, disability, and life insurance policies to make sure that you’re protected with the right coverage. Check to see whether your policies are updated and their deductibles are fair.
You might want to purchase term life insurance if you have dependents who rely on your income and need to be provided for when you pass away, especially if you have minor children or a partner who does not currently contribute financially to the household.
You may also think about buying long-term care insurance to aid you in paying for nursing care as you age. Make sure you talk with your partner and family about your preferences related to organ donation, as well as your wishes regarding your final arrangements for things like burial or cremation. You might want to purchase a plot or niche at your preferred cemetery, or prepay for funeral arrangements and other related costs. Decide who will take care of any minor children if both partners become incapacitated or pass away at the same time.
Step 6: Make a Plan to Pay Off Consumer Debt
It’s always smart to pay off consumer debt, credit cards, and loans if you have any. To save the most money in fees and interest, start by paying off the credit card with the highest interest rate first, followed by the ones with lower interest rates. This is called the “Debt Avalanche” payoff method. Some employers offer tuition assistance and student loan support, which could help you pay off your debt even sooner.
If you have debt, spend in cash as much as possible, or only make purchases on a credit card if you know that you have the money to pay off the balance well before the statement due date. Stop overspending on your credit card or line of credit so that you’ll have access to any available credit on those accounts if you truly need it. You don’t want to end up in a situation where your earnings stop and you can’t access your credit cards because they’re maxed out or even closed.
Despite what some financial experts say, credit scores do matter in today’s economy. Prioritize improving your credit score, or keeping it in good shape. Make sure that you pay all of your debts on time, even if you’re only able to make minimum payments. This is critical to having a good credit score, and will ensure that you avoid late fees and other unnecessary financial penalties.
Avoid the temptation to overspend on non-essentials while you’re getting your debts paid off. Evaluate your monthly budget and try to reduce your variable expenses where possible. By taking an honest look at your budget to find areas where you can cut back, even temporarily, you can pay off your debt that much sooner.
You could also start your own small business or side hustle to increase your debt repayments. Remember that most of the time, paying off your debt is a marathon and not a sprint. Don’t set unrealistic goals, and don’t give up. By staying focused, consistent, and motivated, you will succeed.
Step 7: Start Saving and Investing for Retirement
Saving for retirement is one of the most important things you can do to take control of your finances. Open and start funding registered retirement accounts as soon as possible. Contributing early and often to your retirement accounts is the best way to benefit from compound interest and to build real wealth over time.
Aim to save at least 15%-20% of your income for retirement. Increase your contributions as soon as your emergency fund is in place. If you can afford it, save for both emergencies and retirement at the same time.
In the US, common registered retirement savings vehicles include the IRA, Roth IRA, SEP IRA, 401(k), and 403(b) accounts. In Canada, common registered retirement savings accounts include the RRSP and TFSA.
Do your research to determine the best registered retirement account(s) for you. Remember that these accounts have annual contribution limits, so make sure that you don’t overcontribute to avoid paying penalties and fees. You can also open non-registered brokerage accounts if you max out your registered accounts.
If your employer offers to match a certain amount of money you invest into your registered retirement accounts, make sure you take them up on it! These employer retirement account matches are part of your overall compensation package.
Investing enough money to reach your maximum employer match (at the minimum) will help to ensure that you don’t leave ‘free money’ on the table.
For example, if your employer offers to match any RRSP contributions you make up to 3% of your annual salary, make sure that you invest at least 3% every year. After your employer’s 3% contribution is made, you will have a total of 6% of your annual salary invested “for the price of 3%”. This is an automatic 100% return on your investment.
It might go against your parental instincts, but consider investing for your own retirement before saving for your children’s college education. Or at least save for both at the same time. Don’t neglect your retirement savings in favor of helping your children pay for school.
Students can apply for low-interest student loans, get scholarships, work part-time, or attend a good community college or state university where education is more affordable. As you consider your children’s future, you also need to think of your golden years. To put it bluntly, your children have much more time to save for their future and earn an income than you do.
If you really struggle with this, consider that having insufficient retirement savings could actually cause stress for your adult children if they need to help support you financially during your retirement.
If you feel like you need help choosing investments and making a plan, be very careful about who you go to for financial and investment advice. Consider hiring a fee-for-service financial planner with a fiduciary responsibility to act in your best interests. Not the salesman at a big brokerage who earns commissions on your hard-earned money.
Work with this fiduciary to create an investment plan and stick with it. Quality, low-cost investments that spread out your risk over thousands of companies, like a total stock market index fund, are almost always a better idea than gambling on the stocks of a few companies. Be equally careful about investing (or over investing) in company stock.
When investing for the long term, avoid the temptation to “panic sell” if the entire stock market goes down due to a recession or other similar event. If you chose to invest in quality index funds that you believed in when the markets were up, then it stands to reason that one day, these same index funds will recover their value. Technically, you never “lose” money until the day you actually sell an investment at less than the price you paid for it. If you don’t sell the investment, then you haven’t ‘locked in’ a loss, regardless of what your brokerage account balance might tell you. Remember why you’re investing. Keeping your “why” in mind can help you stay motivated to achieve your goals.
Wrapping it Up
Give yourself a pat on the back for making the important decision to take control of your finances. While these 7 easy steps to take control of your finances aren’t complicated, following through with them does take hard work, dedication, and discipline.
Don’t be too hard on yourself if you make mistakes while you’re learning these new money skills. And don’t try to be perfect with your money, either. Do your best, but remember that you’re only human and everyone makes mistakes at times. No one is perfect! As long as you keep trying and don’t give up, you’ve accomplished half the battle.
The issue of personal finance can be a difficult and emotional subject for many people. As you continue on your lifelong financial journey, remember your “why” and all of the reasons it’s important to you to get your money in order.
Creating and sticking to a realistic budget, saving for emergencies, paying off debt, and investing for the future are all positive things that you can do for yourself and your family. Prioritizing your money today will help you to be financially secure and confident in the years to come.
For even more information, be sure to download our free, full-length Money Mastery Playbook. It includes tons of money tips and motivation, plus 7 free personal finance printable worksheets to help you get your money life organized, starting today.
