Every financial success story has a starting point. For some, it’s a minimum wage summer job in high school where work ethic was acquired and a savings mentality began. For others, it’s the first day in a new career as a fresh college graduate. Maybe for you—like a friend of mine—it’s a second chance after getting it wrong, taking on too much debt, and going bankrupt. Whatever your circumstances as you stand at the trailhead of your financial journey, there is a proven formula for success and you can take action today!
Here are the 4 things that you should do now to take control of your finances if you are just starting out or are finding it difficult to save for your future:
1 Assess your income
The first thing you should know is where your money is coming from and how much you can count on receiving in an average month.
Is your income salaried or variable? Variable income is more challenging to deal with, but that problem has been solved and can even be turned into an opportunity. I will save the details for a separate article, but the bottom line is that variable income earners need to store up reserves during the good times to smooth out the lean times—just as people stored food for the winter before modern agriculture and distribution.
1.1 Increase and diversify your income today
Never depend on a single income. Make an investment to create a second source. -Warren Buffet
Now that you know how much income you have and its frequency, you can make a plan to increase it today.
Do you have a single source of income or multiple? A single source from a corporate job can seem stable, but a job loss can be catastrophic if another job is not found immediately. This is one reason that dual income households and “side hustles” have become popular today. My family diversified our income through two corporate jobs and a side business where we owned a few rental homes. In college, I worked in a restaurant on weekends and taught a few drum students to help pay my way through. If you have the time and desire, think about the skills you have and where you might branch out. Whatever you do, calculate your equivalent hourly earnings to make sure you are properly valuing your time!
Even salaried employees usually have options to earn more through overtime, bonuses, awards, certifications, or taking on additional responsibilities. Find a way to make yourself more valuable, make sure your boss is aware of what you are doing, and the increased earnings will come.
I will cover spending next, but many people focus too much on the expenses side of the equation and not enough on earning more. You can only cut expenses to a point before there is nothing left to cut. But there is practically no limit to your income or to the ways in which you can earn.
2 Find out where your money is going
Look at your bank account and credit card statements to understand the biggest sources of spending. Most large banks will categorize it for you, but if your spending comes from several different accounts you might consider an app like Mint, YNAB, or Personal Capital that will aggregate this for you and provide a single report. Early in my financial life, I tracked spending using my own spreadsheet. This is another option for those who really want to get into the weeds and optimize.
Bank accounts and credit cards do not provide the whole picture of your expenses if you receive a paycheck from an employer. Take a look at your pay stub. Before you receive a penny, you are paying several forms of taxes and might see deductions for benefits such as medical insurance and retirement savings. You should not overlook taxes, particularly if you are a high income earner since most taxes are progressive. That is, the more you earn the higher percentage you typically pay.
What are your top 3-5 expenses? You might have a unique situation, but most people’s list will look something like this:
- Taxes – federal, state, social security, Medicare
- Housing – mortgage or rent, property taxes and insurance
- Medical – insurance, deductible, and co-pays
- Transportation – car payment, registration, insurance and gas
- Food – groceries and regular restaurant meals
2.1 Make a plan and commit to reducing one major expense
There will be plenty of room for reduction within the top categories unless you are already super frugal and like to spend your free time reading the tax code. Pick the low-hanging fruit for now. What could you do right now—this week—that would make a significant dent in one of these without any change to your current lifestyle? Eat out one less time each week and make a delicious meal at home instead? Make a call to negotiate a medical bill? Shop for lower priced car insurance or increase your deductible (assuming you could afford to pay it out of pocket)? Start with a quick win. You can decide later if any further reduction is needed to reach your financial goals.
At Pathway to FI, we are looking to create our best life possible through wise money management. You shouldn’t need to cut anything that feels like a big sacrifice unless you see a major disconnect between your current lifestyle and your income.
If you need a little perspective to motivate you, however, consider this. If you are reading this, you have electricity, the internet, and likely a smart phone. You are living better than the richest people in the world just a couple hundred years ago. They had only the most basic sanitation systems, no air conditioning, no car or airplane travel, and no modern medicine such as anesthesia or antibiotics. You are probably making more than $37,400 (€33,200) per year, which is the income threshold that puts you in the top 10% in the world according to the 2022 World Inequality Report1.
Have you ever thought of that? Does reducing your expenses (temporarily) seem like an unreasonable hardship?
Of course, if you are ready to make a much bigger impact on your finances, you can get a smaller home or apartment, get a roommate, trade in your leased car for an inexpensive used one, or go down to a one car household. These are some of the most substantial changes the average person can make to set themselves up for financial success over the next few years. If you are honest with yourself, you know where you are spending too much money by now, and that is exactly where you should look to cut back.
3 Evaluate your debt
There are three kinds of people: the haves, the have-nots, and the have-not-paid-for-what-they-haves. -Earl Wilson
Do you know how much debt you have and how much it is costing you each and every day?
Most Americans would be astounded by their own numbers. How do I know? By the end of 2021, the average American had $92,727 of consumer debt2 and $6,569 of that is on credit cards financed at an average of 16.17%3. The credit card debt alone costs almost $3/day, $90/month, and over $1,000/year in interest! If the remaining $86k of car and student loans is financed at just 3%, this is another $7/day, $210/month, and more than $2,500/year. How can anyone get ahead by giving $10/day, 7 days a week, to the banks? That’s $3,650 of hard-earned after tax money every year. This needs to stop.
Unfortunately, it doesn’t stop there. While consumer debt is the most damaging to your financial life, it doesn’t include the $229,242 of average mortgage debt that an American family had in 20212. You may see this as “good” debt, and the mortgage interest may come with a tax deduction, but if your mortgage balance is more than about 4 times your household take-home pay, you almost certainly saw Housing at the top of your expense list and it is crowding out your ability to save and invest.
Wouldn’t you rather be on the other side of this equation? Save some money, buy a basket of bank stocks, and own the profits from other people’s debt!
3.1 Start a debt “snowball” or “avalanche”
Your strategy for getting out of the mess of consumer debt is to become obsessed with paying it off as quickly as possible. There are two popular methods for this called the debt snowball and the debt avalanche. They both can work, so I will not push one over the other. I will only say that the debt snowball is geared toward psychological behavior, getting you quick wins and momentum that help you keep at it until it’s gone. The debt avalanche is for the more mathematically-minded who are motivated by the idea that they are paying as little interest as possible. The point is to get this done before the math makes much of a difference, however. The sooner your consumer debt is gone, the sooner you can become financially free!
- Debt snowball – The debt snowball sorts all of your debts from smallest balance to largest balance without regard for the interest rate. You then pay off the smallest balance first, then “snowball” the minimum payment and every extra dollar you can find to pay off the next smallest. You will see the fastest progress with this approach if you have a number of small accounts, and will more quickly simplify your life by having fewer accounts to manage.
- Debt avalanche – The debt avalanche sorts all of your debts from largest to smallest interest rate. You then pay off the account with the largest interest rate first. If you put the same number of dollars into the avalanche as you would have in the snowball method, you will end up paying less interest this way.
If you have consolidated into one or two accounts or your higher interest accounts tend to have smaller balances anyway, there will be little difference between the two methods.
If you need further motivation to tackle your debt, take Dave Ramsey’s Financial Peace University and read the Total Money Makeover. These resources have helped millions of people, and are a great place to start for anyone at the trailhead of their financial independence journey. Come back to Pathway to FI and read on when you are on the ascent and ready to learn more!
Financial Peace University was enough for me to avoid consumer debt altogether after my parents brought me and my girlfriend—now wife—there my freshman year in college. I racked up about $400k in mortgages, though, before I decided to do something about that as well.
4 Identify a savings vehicle
If you have acted on this article up to this point, you are improving your income, reducing your expenses, eliminating debt, and now have a surplus of money at the end of each month. What should you do with it?
A large part of this website deals with more advanced topics and strategies for using your money wisely, but when you are just getting started, there are two things you should do first.
4.1 Put some money in the bank
Before you worry about investing for the future, you need to build a safety net, also known as an emergency fund. This is a cash cushion that is immediately accessible to deal with whatever life throws your way—whether it’s a broken down car, layoff, or a trip to urgent care—without touching the long-term investments that you will are building up separately. Most advisors recommend 3-6 months of expenses. If you are still paying off credit card debt, though, this is too much and will slow down your debt payoff. Aim for no more than 1 month of expenses and pile the rest into your debt. If you don’t have enough in the bank when life throws you a curveball and haven’t closed your accounts yet, the bank will gladly give you your debt back. In the meantime, stop paying 16% interest!
If you are already past the consumer debt phase, go ahead and save up that 3 months of expenses. I found it psychologically helpful early in life. But an emergency fund became less necessary after I had several diversified income streams, a high savings rate, investments that I could sell and transfer to my bank account in a couple of business days, and a credit card that I could use instantly and pay off at the end of the month. Another great thing that financial independence does for you is it reduces the number of events in life that you can call a financial “emergency”.
4.2 Take advantage of an employer match
If your employer offers a match on your retirement plan and you are not saving the minimum to receive it, you are effectively lowering your income! Do not make this mistake. All of these plans allow you to take hardship withdrawals as a last resort, and you can pay yourself back when your circumstances improve.
This is one area that I would deviate from Dave Ramsey’s advice. His point is for you to get out of debt before worrying about anything else, though, and if you do it quickly enough the math will not be very different.
Summary
At the beginning of your financial journey, there are 4 actions that you should take immediately to put yourself on the right course:
- Assess your income and how you can increase and diversify it today
- Find out where your money is going and reduce at least one major expense
- Evaluate your debt and start a debt “snowball” or “avalanche”
- Identify a savings vehicle, put some money in the bank, and take advantage of an employer match
Are your finances heading in the right direction?
Is anything stopping you from taking these actions today?
Contact me with questions or if you need help taking the next step on the Pathway to FI.
And don’t forget to sign up for FREE at the bottom of the page to get much more value from PathwayToFI.
Join me on the Pathway to FI!
References
1 https://wir2022.wid.world/chapter-1/
3 https://www.lendingtree.com/credit-cards/credit-card-debt-statistics/
