If you’re like most people, you’re in debt. You’re spending more money than you’re earning, and you’re hoping that you’ll keep yourself afloat for long enough to find a solution to your problem. But the solution never comes, and your situation is getting worse and worse. What to do?
The real problem is not that you’re in debt, but that you don’t know how to manage your financial situation. You think that being a financial manager is for experts to follow as a career choice. However, you have an income and you need to manage how that income is used. In effect, you need to become your own financial manager.
Most people don’t know how to be their own financial manager, so I’m going to provide a few hints to help out. These hints are based on what I’ve learned, and what’s worked for me. I hope that you can make them work for you too.
1) Always spend less than you earn
This is often considered easier said than done, but seriously – spending more than you earn is what got you into your debt-stricken situation, and is what’s keeping you there.
Go through the expenses of your last month. (If you don’t know what your expenses were because of sloppy record-keeping, then start recording your expenses over the next month.) analyze what you find, and work out what you don’t need to spend any more.
For example, if you’re spending $5 a day on Starbucks coffee, you could probably stop it. (Drink water instead, or bring your own coffee to work.) That’s $25 a week, assuming you only do it on work days. $100 a month. $1,200 a year. How long have you been doing it? Five years maybe? You’ve just spent $6,000 on coffee. What do you have to show for it? What else could that money have been spent on that actually gives you something substantial, something that might improve your life?
Look at everything in your life and work out what you don’t need to spend any more. And simply stop spending it.
Remember – doing this is extremely important if you are currently spending more than what you earn. You need to cut back! The time for excuses is over.
2) Pay yourself first
Once you’ve worked out what you can stop spending your money on, you’ll find that you have more money to play with. However, instead of playing with it foolishly, you need to actually manage it responsibly.
Your first priority with your money is to look after yourself. Pay yourself first and build up a savings account. You need this for a happy and rewarding lifestyle. It brings good things to you.
A good rule of thumb is to take 10% of your after-tax income and put it aside for savings. If your expenses prevent you from putting aside 10% of what you earn, then you need to re-read #1 above.
Get serious about this! Get rid of those frivolous expenses that you don’t need.
If you can’t find 10% after cutting out everything that you don’t need to spend, then drop it to 5%. As long as you’re putting some money aside, you’re doing yourself a favour.
Set up an automatic transfer with your bank, so that every time you get paid, the savings amount automatically gets transferred to another account. Getting this out of the way before you touch your income is better than saying to yourself, “I’ll get around to transferring it later.” If you leave it up to yourself, you’ll always find something else to do with it instead. And you know that hasn’t helped you in the past, has it?
3) Use the snowball method to pay off your debts
The snowball method works like this…
- Itemise every single one of your debts and how much you pay each month for that debt. Do not include utility expenses or other general bills. This particular exercise is only for those debts you have which can be paid off and eliminated from your life.
- Order your itemised list by the smallest debt down to the largest.
- Now double the amount you’re paying on the smallest debt. If it’s $20 a month, then pay $40. Keep up this modified payment until that debt is paid off.
- Once it’s paid off, you’ve now got $40 available to add to the next debt. When that debt has been paid off, you take the total amount that you now have available each month and add it to the next debt.
- Keep doing this until all your debts are paid off. The more you pay off this way, the more money you’ll have to pay off the rest of the debts. You’ll discover that you’ll be debt-free in no time! Well, at least it’ll be much faster than if you were to just continue paying the minimum payments or defaulting on those payments…
Note: if you don’t have any extra money each month to add to the smallest debt, then take it out of your savings each month. When that debt has been paid off, stop taking what you needed out of your savings. If your debt was $20, then now that you’re no longer paying it off, you have that $20 to put towards the next debt, and the amount you’re putting into your savings is back to normal again.
4) Until you’re in a better situation, get rid of your credit card. Now.
Credit can be a trap. In return for a quick fix of money now, you end up paying for it in interest payments. The more credit you have, the more interest you’re paying. Get rid of all your credit debts before you even consider going down that path again.
Credit can be useful, if used wisely and responsibly. But if you’re in credit debt that’s costing you a fortune, you need to do something about it, and you need to do it now.
Cut up the credit cards. I mean it. You don’t want to have that temptation lying around in your drawer, or your wallet or purse! When you’ve paid off a credit debt according to the snowball method, cancel the account. Close it. Get it out of your life.
You can consider credit in the future, when you’re able to manage your financial situation more efficiently, but right now, you don’t need it. It’s what’s gotten you into this mess!
5) Create a net worth spreadsheet
This is an excellent method of understanding and managing your financial situation, which is important in helping you achieve your goals.
- Open up an Excel spreadsheet.
- Itemise your asset names, and how much they’re worth. For example, I have the following itemisation: home contents, car 1, car 2, savings. I have the value of home contents as being what it’s insured for. I depreciate the value of the cars by 10% per annum, or 0.83% per month. Savings is adjusted every month.
- Itemise your liability names, and how much they’re worth. For example, I have the following itemisation: lease finance, personal loan, hire purchase account. The loans appreciate each month by the value of the interest rates, but then reduce by the value of the payments I’m making.
- At the end of it all, you’ll have a value for your assets, and for your liabilities. Subtract the liability value from the asset value to see your net worth. Update this each month.
Ideally, you want the net worth value to always be in the positive. If your net worth is in the negative, it means you have more liabilities than assets. This needs to change, and by following the suggestions in this article, it will change.
A positive net worth puts you into a more secure position than a negative net worth. This is because it means you have assets that can be sold if you need to pay off debt quickly.
6) Educate yourself on the important things in your life
Managing money is a skill, and it’s one of the most important skills you can have in your life. You can’t do much without money, and if you don’t know what you’re doing with it then you’ll just be making mistake after mistake. With effective financial management comes increased opportunities for finding greater success in your life.
If you manage your money effectively, then you’re managing your life effectively.
With all skills, you usually have to learn how to do what’s required, and then practice doing it. So you need to start learning how to do what’s required to successfully manage your money, and then you need to practice it.
There are financial management courses available, but there’s also the internet. There are countless websites out there that will help you manage your money effectively.
You owe it to yourself to learn one of the most valuable skills in your life, so start educating yourself.
7) Spend your money on things that bring value
Instead of spending $100 a month on coffee, for example, you could be saving it towards a deposit on an investment property. Of course, while you’re in your stressful debt situation, thinking about spending money on something you can’t afford is simply not a priority right now.
However, once you get to that point by following the advice in this article, you’ll find that using your money to make more money is an effective and beneficial means of financial management.
An investment property costs money to maintain, of course, but tax benefits from negative gearing can make that cheaper for you. The property is likely to appreciate over time, allowing you to sell it a few years down the track and make a profit over what you’ve spent to get it to this point. This is using your money to make money. There are other options as well, like the stock market, or investing in businesses, etc.
All of them require education, of course, so refer back to #6 above. Managing your money is one skill, but managing your money to MAKE money is another skill, and depending on what you choose to invest in, will determine what you need to educate yourself in.
On a smaller scale, any time you spend more than a few hundred dollars on something, make sure it’s adding value to your life. Buying new furniture, for example, will increase your home contents, which increases your assets. Buying property. Even buying cars.
People think of cars as a liability, because of how they depreciate. But if you do it right, you can turn your car into an asset. For example, I recently bought a new car worth AU$52,000. However, my circumstances and the way I bought it meant that it only cost me $42,000. I got a ‘fully maintained lease’ which meant the leasing costs cover every cost associated with the car (the lease plus insurance, registration, servicing, maintenance, fuel costs, tyres, etc). I was able to have this cost deducted each month from my pre-tax income, thus significantly reducing my taxable income. This meant an effective yearly saving on lease costs equivalent to my tax rate (eg. 40%). Even as the car depreciates over the next few years, the cost of having it will always be significantly less than the value of the car (unless fuel costs climb into the stratosphere!), thus ensuring the car remains an asset that can be sold to cover costs if necessary, and even give me a profit.
When you can buy something at a price significantly less than its value, then you are spending your money on things that actually become assets rather than liabilities. This is important when adding the value and costs to your net worth spreadsheet. By having a value higher than the cost, your net worth will remain positive, and you will become even more financially secure.
Important rule when doing this is to never spend more than you can afford.
When spending cash, you want to spend less than the value of what you’re buying, so that when it’s put onto your net worth spreadsheet, your net worth is always in the positive, and always growing. Eg. if you spend $500 to buy something worth $600, then your net worth has increased by $100.
As you follow the above suggestions, you will begin to appreciate the strength of being your own financial manager. Instead of naively spending what money you have on what you think is important at the time, you will actually be managing your money efficiently and responsibly.
If you fail to plan, then you’re planning to fail.
You might be earning a million dollars a year, but if your expenses are in excess of a million dollars a year, you certainly aren’t managing your money efficiently and responsibly. You’re going backwards.
It’s time to bite the bullet and get yourself out of the cycle of ignorance and debt, and into the cycle of knowledge and success. Understanding and managing your financial situation will put you ahead of the pack. Where others are still struggling with their debts, you’ll be managing yourself into a stress-free and financially secure lifestyle.
People think that financial security comes from being debt-free, but while this is one example of it, the truth is that if you always spend less than your income, and your assets exceed your liabilities, and you manage your situation responsibly, then you can be in debt and still be financially secure.
Think about property ownership. You can’t pay cash for property (unless your savings are huge!). You usually have to – and it’s wise to – get finance for it. As long as the value always exceeds the cost of owning it, you will be financially secure. That can be done with negotiating a lower price or putting a significant cash deposit down.
That is the secret. Use that knowledge with everything in your life.
Build your savings, get rid of your debts, and start again with a fresh slate, managing your money wisely and bringing value to your life.
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