Money management is a skill that every adult needs to have. It’s not exclusively for financial advisors, Wall Street experts, or even math people. Personal finance is, well, exactly that… personal. It’s about your financial habits and behavior toward money.
If you’re thinking, “That sounds great and all, but I don’t even have a budget and I feel overwhelmed about my fiscal future,” then start with the five core pillars of financial literacy. Learning about these terms and concepts gives you tools and guidance so you can create a promising path forward.
1. Cash Flow: The Foundation of Everything
Before anything else, you have to know where your money is going. This is called Cash Flow. Most of your money probably goes to:
- Rent, a mortgage, and living expenses
- Utilities and bills
- Health and other insurances
- Groceries and dining out
- Transportation
- Entertainment
If these expenses exceed your income, then you’re likely draining your savings or racking up debt. By creating a budget (or a spending plan if that sounds better), you ensure that you’re not slowing digging yourself into a hole from which you may never escape.
Okay, that sounds dramatic, but debt, especially credit card debt, can take years to pay off due to high interest rates. Setting up a spending plan helps use your income deliberately and in ways that are important to you.
A budget doesn’t have to mean restrictive. It’s just a way of saying, “This is where my money is going.”
Choosing a Budget That Fits Your Lifestyle
You can use budgeting frameworks that suit your preferences. Here are a few:
- Budget Ratios. Depending on what is important to you, use one of these easy-to-follow formulas.
- 50/30/20 is the standard, and it assigns 50% of your earnings for needs (housing, food), 30% for wants (leisure), and 20% for savings and debt repayment
- 70/20/10 is for high cost of living. It puts 70% of your income toward needs, 20% to savings, and 10% to wants.
- 40/30/30 is for aggressive savings. This distributes 40% to needs, 30% to wants, and 30% to savings.
- Zero-Based Budgeting. This method involves assigning every single dollar a “job.” Say your income is $3,000 per month, your total expenses, savings, and debt payments should equal $3,000. This prevents small purchases from draining your account.
- No-Budget Budgeting is a perfect option if you aren’t detail-oriented. It involves automating your expenses and savings.
- Calculate your monthly net income and fixed costs (living costs, utilities, food, debt, etc.)
- Subtract fixed expenses and savings from your total income. The remaining is discretionary “fun” money.
- Create a “buffer” account. Use this for automatic payments of your fixed expenses. Keep a couple of hundred dollars extra here to prevent overdrafts.
- Open a savings account.
- Set up automatic transfers to your buffer and savings accounts on each payday so your bills and savings are handled first. Whatever is left over is for fun.
The “perfect” budget doesn’t exist. But the best plan is the one you can actually stick to. For most, the smartest first step is simply tracking your spending for 30 days. Once you know where you are, you can decide which way you want to go.
2. The Emergency Fund: Your Financial Shield
Life is unpredictable. Tires blow out, appliances break, and jobs can be lost. Without a safety net, these events can ruin your financial plan.
Generally, experts suggest two stages for an emergency fund:
- The Starter Fund: Typically, $1,000 to $2,000. This covers most minor “life happens” moments.
- The Fully Funded Account: This usually covers 3 to 6 months of essential living expenses. If your monthly needs cost $2,000, your goal would be between $6,000 and $12,000.
An emergency fund should be liquid, meaning you can get to it quickly. However, keeping it in a standard checking account makes it too easy to spend and doesn’t keep up with inflation.
By putting your emergency fund in a high-yield savings account (HYSA) that is FDIC-insured, your savings earn money while sitting there.
3. Using and Getting Out of Debt
Debt is a tool, but it is a sharp one. Used correctly, it can help buy an appreciating asset (like a home). Used poorly, it can act as a bad investment, where you pay more for an item over time than it was ever worth.
The cost of debt is the annual percentage rate (APR). If you have a $5,000 credit card balance at 20% APR, you aren’t just paying back $5,000; you are paying hundreds of dollars a year just for owing that money.
Comparison of payoff strategies:
- The Debt Snowball – Pay the smallest balance first, regardless of interest rate. This tactic gives you a psychological win, which keeps you motivated to pay off other debts.
- The Debt Avalanche – Pay the debt with the highest interest rate first. The primary benefit is mathematical; you pay the least amount of total interest.
- Debt Consolidation – Combine multiple debts into one lower-interest loan. The benefits include a simplified single payment and less interest.
4. Investing 101: Growing Your Wealth
The biggest enemy of savings is inflation. $100 saved today only has the buying power of about $86 in five years. So, unless your savings account gives you at least 3 to 4% interest, you’re actually losing money.
Investing, however, makes your money make money. Some common investments include:
- Stocks: You own a tiny slice of a company. If the company grows, your slice becomes more valuable. This carries a higher risk because stock prices can drop.
- Bonds: You act as the bank, loaning money to a government or corporation for a set period in exchange for interest. This is generally lower risk but offers lower returns.
- Index Funds & ETFs: Rather than buying one stock, these funds allow you to buy a “basket” of hundreds of stocks (like the S&P 500). This provides diversification, which lowers your risk.
The long-term average annual return on investments for U.S. stocks, index funds, and ETFs is around 10%, which is more than inflation (average 3%) and most savings’ interest rates. Bonds typically have rates between 2 and 5%, which compound year after year.
5. Retirement Accounts: Tax-Advantaged Growth
The government provides special accounts to encourage people to save for retirement. These accounts are not investments themselves, but they provide better tax incentives than standard brokerage (investment) accounts.
- 401(k)s and 403(b)s are employer-sponsored plans. They take money directly from your paycheck before you pay taxes on it (lowering your taxable income today). Many employers offer a match (e.g., if you put in 3%, they put in 3%).
- Individual Retirement Accounts (IRAs) are personal investment accounts.
o With a Traditional IRA, contributions are tax-deductible now, but you pay taxes when you withdraw the money in retirement.
o With a Roth IRA, you pay taxes on the money before it goes in, but the growth and withdrawals are tax-free in retirement.
When it comes to investments (brokerage and retirement accounts alike), you must keep market volatility in mind. The stock market does not increase in a straight line.
As an investor, your accounts risk losing value during certain periods. That risk isn’t the loss itself, but panic-selling during a drop and locking in those losses.
