Every path to financial security starts somewhere. Some of us had a leg up, in the form of debt-free college educations or trust funds. But lots of us didn’t. As you’ve probably read, fewer than half of Americans have enough money saved to cover a $1,000 emergency. If you don’t have an emergency fund or if you’re afraid to look at your credit card balance, you’re far from alone.
The good news is that, wherever you are today, that’s the perfect place to start down the path to financial security.
The path is a long one, and for most people, it’s not particularly exciting. Building financial security takes years of disciplined saving, investing, and asset accumulation. At Gen Y Planning, we describe this as “simple first, sexy later.”
But you’ll have a lot of milestones to celebrate along the way — and if you plan for it, plenty of money you can use to treat yourself.
Understand Your Spending And Make A Plan
Financial security looks different for everyone, so there’s no one-size-fits-all budget that any of us can or should follow. Creating a budget or a spending plan starts with understanding your life — your needs, your wants, and your bills.
Read through your bank and credit card statements and make a list of where your money goes each month. Note every expense, from rent or mortgage payments to your gym membership to your average monthly spending on your hobbies.
(Now’s a good time to remind yourself that this isn’t a test — what’s in your bank account doesn’t reflect your potential or your value as a person!)
Next, compare your average monthly spending to how much you earn from your job or jobs each month. If you consistently break even or spend more than you earn, take the Marie Kondo approach: Which of those expenses bring you the least amount of joy? Cut those first.
Once you’ve made some room in your budget, put that surplus cash to work.
Build An Emergency Fund
Aim to save between three and six months of expenses in an emergency savings account. That’s enough cash to cover all of your bills and necessities, including your rent or mortgage payment, utility and phone bills, insurance premiums, and regular expenses like food and transportation, for a set period of time.
The point of an emergency fund is that if an emergency comes up — if you lose your job, need to replace your car, or face a surprise expense — you’ll be able to navigate life for a couple of months without having to worry about how you’re going to be able to pay your phone bill.
If saving $5,000 or $10,000 feels like a huge, distant goal, start small. Set up automatic transfers that move $50 each week or $100 each month into your emergency savings account.
Soon you’ll build up to one month of expenses, then two, and then more.
To help yourself see your emergency fund as a truly separate financial reserve, don’t use the savings account linked to your checking account. Look for a high-interest savings account, like those at Ally Bank, that will pay more than 1% interest. You could earn hundreds of dollars in interest every year if you just leave that money there for when you need it — and you won’t see your emergency fund (or be tempted to dip into it) when you check your balance on payday.
Pay Off Your Credit Card Debt
Credit card debt is a vicious cycle. The longer it takes you to pay what you owe, the more debt you build up, and then the longer it takes you to pay what you owe, and so on. That’s why lots of financial advisors, including me, recommend tackling credit card debt as aggressively as you can.
Once you’ve set aside at least $1,000 in emergency savings (or whatever amount makes sense for you), allocate as much as you can toward your credit card payments each month. Start with the highest-interest debt, then work your way down to the next-highest, and so on.
If you give up some spending while you work toward each of these goals, make sure to reward yourself when you reach them!
If you’ve been burned by credit card debt, canceling all of your cards and starting fresh might be tempting. Closing credit cards can reduce your credit score, however, so it’s not a decision to make lightly. Keeping an old, no-fee credit card that you use only a few times a year can be a great credit-building exercise.
Start Saving For The Future
Retirement might feel far away, but the sooner you start saving, the better off you’ll be, even in periods of market volatility.
Start small: If your employer offers a 401(k) or a 403(b), contribute to it. If they match your contribution, make sure to contribute enough to get the full company match. This is free money, even though you won’t get to spend it for years to come.
Next (or first, if your company doesn’t offer a 401(k) or 403(b)) start a Roth IRA at a discount brokerage, like Vanguard or Betterment. Try to make the maximum contribution of $6,000 for as many years as you can before you hit the income limits of $124,000 per individual or $196,000 per household.
Once you max out your Roth IRA, go back to your 401(k) or 403(b) and work your way toward the maximum contribution of $19,500 per year. (These plans do not have income limits.) Set a reminder in your calendar to contribute 1% more from your paycheck every six months or so. In total, work toward saving 10-20% of your income for retirement.
Plan To Pay Off Your Other Debt
Car loans, student loans, and mortgages usually carry relatively low interest rates and come with established payment plans — a five-year car loan or a 15-year mortgage, for instance. It’s perfectly fine to stick to those plans if they work for you, especially if you have credit card debt or other, more urgent financial goals.
If you find yourself with more cash than you need after filling up your emergency fund, consider paying ahead on those loans (and make sure to apply the extra payments toward the principal). You’ll get out of debt faster and spend much less in interest over time.
If you want to free up a little more cash each month to work toward other financial goals, consider talking to a professional about refinancing your student loans or your mortgage. Refinancing at the right time could help you achieve financial goals in the short term as well as save you thousands of dollars in interest payments over the coming years. However, if you refinance federal student loans with a private lender, you may lose out on some protections associated with your federal loan, so don’t make this decision lightly.
In my day-to-day life, I practice “reverse budgeting.” That means I make automatic contributions into my savings, retirement, and investment accounts, set aside money to pay my bills, and then I’m free to spend whatever’s left. (Other people prefer to limit their spending, and that’s fine too. The right way is whichever way works for you!)
Regardless of how you choose to budget, try to automate your finances as much as possible. Set up automatic transfers from your checking account to your emergency savings, retirement savings, and any other savings or investment accounts. Set up automatic payments on your debt. Auto-pay whatever bills you can. The less you have to think about your finances, the fewer opportunities you’ll have to worry about them.
Review, Adjust, Repeat
After you make that initial spending plan, wherever you are in your financial life, try to stick to it for six months. Then look back and see how you feel. Celebrate your achievements — whether you’ve saved your first $500 or maxed out your Roth IRA or paid off your student loans, you’re further away from financial insecurity and the fear and uncertainty that comes with it.
Revisit your finances once or twice a year to account for changes in your income or expenses. Remember that once you’ve achieved a goal, like paying off your credit card debt, you don’t automatically have to pour all that money into retirement savings or student loan payments — you can put it into a fund for travel, a wedding, or a down payment instead, depending on your goals.
Financial security isn’t about being afraid to spend money. In fact, it should do the opposite! Once your debt is under control and you know you can handle a sudden life change, you’ll have so much more freedom to live the way you want to — within your means, but without fear.