Financial planning is a broad umbrella that covers a number of topics, including:
- Retirement planning
- Credit and debt
- College planning
To lay the groundwork for a solid financial foundation, you need to understand how each of these topics works together and affect each other. Here's a quick crash course in the most important aspects of financial planning.
At the basic level of personal finance, budgeting is one of the most important tools you can have. A budget is a plan for how you spend the money you earn.
Creating a detailed written budget allows you to see exactly where your money is going and make better decisions about how you spend. When you consciously think about budgeting decisions, you gain a lot more control of how you spend your money.
One of the biggest challenges with not having a detailed budget is being faced with so many financial decisions and trying to keep track of everything. This lack of understanding can lead to overspending and debt, not to mention it makes financial planning for the future more difficult.
When you create a budget, you begin to see a clear picture of how much money you have. You know what you spend it on and how much—if any—is left over. Once you can see the inflows and outflows of your cash, you can optimize your spending to cut back on the things you don't truly need.
2. Tracking Expenses
Tracking your spending is a key part of budgeting. This tracking includes keeping close tabs on your non-essential expenses, such as clothing, dining out, travel, or entertainment.
If you're spending too much on non-essentials, you may not be leaving anything left over to save each month. And saving matters, especially when it comes to creating an emergency fund.
Your emergency fund is a go-to pool of cash you can rely on when an emergency or an unexpected expense comes your way. Having emergency savings on hand can keep you from going into debt. If you're not tracking your spending diligently, you may be letting money that you could save slip through the cracks.
3. Credit and Debt
Financial leverage, or using credit and taking on debt by itself, isn’t necessarily a bad thing. However, there are two kinds of debt: good debt and bad debt.
When you borrow money to purchase a home, you may be taking on a lot of debt, but lower interest rates and the purchase of an asset that can increase in value is considered an acceptable form of debt. The same goes for student loans since you're financing a degree that could increase your earning potential, often at a low-interest rate.
On the other hand, going on a shopping spree at the mall using a credit card that has a 24% annual interest rate without paying it off in full right away is bad debt. You're buying things that don't grow in value, and you're paying steep interest to buy them if you carry a balance on your card.
Getting out of debt doesn’t have to be difficult, but it's essential in reaching a state of financial independence. The first thing to do when you find yourself in debt is to pay more than the minimum monthly payment. If you only pay the minimum each month, it will often take decades to repay the debt and cost a small fortune in interest.
Once you are paying more than the minimum, try to lower your interest rate. You can do that by transferring your credit card debt to a card with a lower APR, or by refinancing student loans or other loans at a lower rate. High-interest rates will make getting out from under the debt more of a struggle in the long run.
4. Saving for Retirement
With fewer companies offering full pension plans and the uncertainty of Social Security, it's become more important than ever to save and plan for your retirement. Unfortunately, many people feel that they don’t have enough money left over each month to save.
Retirement savings needs to become a priority instead of an afterthought. The Internal Revenue Service has made saving for retirement even more attractive with special tax-advantaged accounts such as employer 401(k) plans, individual retirement accounts, and special retirement accounts for the self-employed. These allow for tax deductions, credits, and even tax-free earnings on retirement savings.
Whether you are just out of college and have 40 years until retirement or you plan on retiring next year, it is never too late to plan and to maximize your retirement savings. Ideally, you should be aiming to save 10% to 15% of your income each year for retirement. But, if you can't do that, shoot for saving at least enough in your employer's retirement plan to qualify for the matching contribution if there is one. Then, work on increasing your contribution rate each year.
You've created a budget, cut your expenses, eliminated your credit card debt, and now you're saving for retirement. You should be all set. Those are all smart money moves to make, but there's one more important aspect of your finances that you need to consider.
Insurance matters because you work hard to build a solid financial footing for you and your family, and it needs to be protected. Accidents and disasters can and do happen, and if you don't have the right insurance, it could lead to financial ruin.
Some insurance policies are required, and everyone should have these types of coverage. But there are many other types of insurance policies that are probably not needed, and you could be wasting precious dollars that could be put to work elsewhere. There is a fine line between having enough insurance and being over-insured.
Evaluate your financial situation and ask yourself where the insurance gaps are. Do you have life insurance, for example? If not, is it something you need? And if so, do you have enough coverage? Consider also your homeowner's insurance, car insurance, disability insurance, and health insurance coverage. Adjust your coverage wherever necessary to make sure you're protected against every possibility.