Step one: Prepare a budget. Almost everyone can answer the question, “how much money do you make?” However, very few people can answer the question, “how much do you spend?” If you don’t know how much is coming in and how much is going out, you will not succeed financially. Just ask 50 Cent, Mike Tyson, Cyndi Lauper, and a host of professional athletes and entertainers who have filed for bankruptcy. So figure out how much you are spending and how much free cash you have every month.
While you are doing your budget, be sure to take a look at all of your debt. How much of your debt is good debt? I classify good debt as anything that is backed by an asset with a reasonable interest rate, and if that interest is tax deductible, that’s a bonus. I can also make the case that debt you took on to improve your earning potential is good debt. If you take out student loans to get a degree and it increases your lifetime earning potential by more than the amount of the debt; that is good debt. Bad debt would be any high interest rate debt, or debt that is unsecured by an asset. If you get in a bind, can you sell your credit card to pay the balance? No, and meanwhile you are probably paying 17% interest on that balance. Credit card debt is definitely bad debt.
While you are focusing on the cost side of your budget equation, make sure that you are getting the best rates possible on your debt. Your credit score is an important piece of this, so make sure that you have done all you can to improve or maintain that score.
Also check on what types of accounts you have and where they are held. Make sure you aren’t paying unnecessary fees on your bank accounts, or high commissions for trades on your stock accounts. Bank fees can eat up hundreds of dollars per year, and most of them can be avoided by switching banks. Competition among financial institutions for your dollars is fierce, so don’t pay unnecessary fees.
On the other side of the budget equation, are you maximizing your income? Do you have the time or the skill to get another job to increase what you earn? There are only two sides to the budget equation, what you make and what you spend. Try looking at the income side if you can’t make that budget balance.
Step Two: Figure out how to fund your emergency fund. There is a good reason that we spend so much time talking about this one. It is probably the most simple and powerful financial planning tool available. No one ever thinks they will lose their job, but it happens. If you do, how are you going to pay your bills? Will you be running up credit card debt and taking out a second mortgage, or will you be paying it from the cash you have saved in your emergency fund?
Step three: Review your insurance coverage. Tied with losing your job as the quickest way to go broke are a variety of things that can happen if you don’t have insurance. The biggest risks are medical, automobile, and liability related. A simple trip to the ER these days with insurance can cost you hundreds, if not thousands of dollars. This same trip without insurance could leave you with a medical bill that you might have to mortgage the house to pay. Don’t let these things happen to you, but also make sure that you don’t overpay for your coverage. Do an annual checkup on your insurance and make sure better rates aren’t available.
Step four: Retirement planning isn’t something that will help you get financially fit today, but there will come a time in your life when it is the only thing you think about. Do your future self a favor, and start saving now. Ideally, 10% of your income is a good place to start, but be sure to put away at least as much as your company will match in your 401K.
Step five: Plan out your estate. This one isn’t so much for you, but you can save your heirs a lot of time and money by some very simple estate planning. I promise you that it isn’t as painful as you might think, and it will give you piece of mind if you have young children who need to be cared for if something should happen to you.
And of course, please contact a Fee-Only CFP to help you out in this process!