Personal finance refers to the way that you manage your money now, such as by budgeting, and how you plan for the future, such as through investing. How well you handle your personal finances is your financial health. To improve your financial health, you must take control of your current spending and make sure you have a realistic and profitable plan for the future.
Calculate Net Worth
Some people become overwhelmed by their finances and ignore them. Even if you don’t want to know exactly how much money you do or do not have, it’s important for your financial health that you always stay on top of some basic calculations.
First, take out your calculator and add up all of your assets (the things you own) and subtract your liabilities (the money you owe) from that total. This resulting figure is known as your net worth, a number that describes where you are financially at the current moment.
“Calculating your net worth one time can be helpful, but the real value comes from making this calculation on a regular basis (at least yearly),” according to Jean Folger from Forbes. “Tracking your net worth over time allows you to evaluate your progress, highlight your successes and identify areas requiring improvement.”
Create a Simple Budget
It’s impossible to analyze your current spending and accurately predict your future finances without a budget. Fortunately, budgeting doesn’t have to be complex or time consuming. With a free online tool, such as Mint.com, it’s easy to automatically track expenses and determine how much you spend in various categories per month or week. You can use this information to tighten up on areas where you’re overspending and to determine how much you need to cut back to meet financial goals, such as saving up for a vacation.
Watch out for Lifestyle Inflation
“Most people will spend more money if they have more money to spend,” according to Folger. “As people advance in their careers and earn higher salaries, there tends to be a corresponding increase in spending … a phenomenon known as lifestyle inflation.”
If you want to have a healthy financial future, it’s important to keep lifestyle inflation in check. If you let lifestyle inflation get out of control, it will be much more difficult to save for your financial goals and plan for retirement.
In order to manage lifestyle inflation, be sure to recognize which life upgrades are required and reasonable and which are just a matter of the proverbial keeping up with the Joneses. For example, if you are promoted, you may need to buy nicer clothes, but you certainly do not need a sports car to perform well in your new position.
“Especially if you suddenly got a big jump in your income, keep your former standard of living and funnel the rest into paying off debts or adding to your retirement nest egg,” states Martha C. White from Time. “Since you’re not lowering your existing budget or cutting expenses, you’ll be able to accomplish all this without feeling like you’ve had to cut back or make sacrifices.”
Start Saving for Retirement Now
Because of compounding interest, the earlier you start saving the better. Compounding means that interest your money earns is reinvested to earn interest once more. This repeats each time your account is compounded, so the longer your deposit has to grow, the better.
“Even small amounts can add up over time,” states White. “If you save and invest just $5,000 a year in a tax-deferred account starting when you’re 25 and earn a 6% rate of return, that will have grown to $773,809 by the time you’re 65.”
Set Aside an Emergency Fund
Even if you have a well thought out budget, sometimes expenses arise suddenly that can blow your budget out of the water. If you have a $500 monthly automotive budget and you suddenly need an extra $700 for a repair, you will need an emergency fund to tap into.
One-time emergency expenses are one reason for an emergency fund, but they are not all you need to plan for. Most experts recommend saving enough to cover a few months’ expenses, so that your family can stay afloat if you lose your job or need to take unpaid leave.
Creating a category in your budget for your emergency fund ensures that you will regularly add to it and not use all of your discretionary money before you remember your emergency fund.
“Keep in mind that building an emergency fund is an ongoing mission: Odds are, as soon as it is funded you will need it for something,” states Folger. “Instead of being dejected about this, be glad that you were financially prepared, and start the process of building the fund again.”