If you are new to personal finance and feel overwhelmed at all the different steps out there that you could be taking towards managing your money, take a deep breath. You are not alone – everyone has to start somewhere, and you’ve come to the right place!
Managing your money is actually quite simple. To make things easier, most steps can be automated or simplified with financial tools. Here is a simple and organized step-by-step framework for approaching your finances:
STEP 1: FIGURE OUT YOUR NET WORTH
STEP 2: IDENTIFY YOUR OWN VALUES, GOALS, & SOURCES OF HAPPINESS
STEP 3: MAKE A FINANCIAL ROADMAP (AKA THE BUDGET)
STEP 4: SET UP YOUR FINANCIAL ACCOUNTS & AUTOMATION FLOW
STEP 5: CREATE AN EMERGENCY FUND
STEP 6: PAY OFF DEBT
STEP 7: BOOST YOUR SAVINGS RATE
STEP 8: INVEST TO GROW YOUR WEALTH
STEP 9: PROTECT YOUR WEALTH
STEP 10: FUTURE PROOF YOURSELF
Not too bad, right? Let’s jump right in to learn more about each step and see how it all ties together:
TAKING STOCK OF YOUR NET WORTH
In the first step of your Financial Success Framework, determine the current state of your finances. Your net worth number is important for two major reasons.
One: it is a measure of your financial health right now.
Two: it gives you a starting point from which you can measure your progress towards your ultimate financial goals.
Start by figuring out your net worth with the simple formula:
Net Worth = Total Assets – Total Liabilities
Compile and calculate both your total assets and total liabilities to reach your net worth number.
Assets can include the following:
Checking accounts
Savings accounts
Retirement accounts (401k, IRA)
After tax investment accounts
Equity in your primary residence
Value of your business
Rental properties
Jewelry
Art
Automobile
Examples of liabilities include:
Student loan
Credit card balance
Car loans
Personal debt
Mortgage
Total up both your assets and liabilities and subtract your liabilities from your assets. This is your net worth number and where you currently stand. Think of this as a stake into the ground that lets you know where you are right now. This allows for you to create a plan to get to your destination – after all, you need to know where you are in order to know how to get to where you want to be.
To learn more about your net worth number, check out the Guide to Your Net Worth.
IDENTIFYING YOUR VALUES, SOURCES OF JOY, UTILITY, & PURPOSE
Think about the life you want to live. How do you want your life to look in one year? Three years? Five years? What are your goals, both financial and non financial? What do you value in your life, what are sources of either joy, utility, or purpose in your life that you want to prioritize?
Values, goals, wants, and ideas of what constitute a dream life are extremely personal and vary from person to person, so be honest about what matters to you and not to your parents, friends, or the Joneses next door.
Some examples of values include:
Freedom
Security
Creativity
Passion
Family
Spirituality
Some examples of ways that values show up in your life:
Feeling financially secure
Being able to show up as the highest, truest version of myself
Being able to pursue a less paying job that I’m passionate about
Quitting my job so that I can focus on my family
Some examples of goals include:
Paying off student loans
Paying off debt
Buying a house
Creating a college fund
Being able to retire when I am X years old
Taking a vacation once a year
Not having to live paycheck to paycheck
Brainstorm and list out your priorities. Don’t feel that these have to be what matter to you all of your life – they can change as you get older or value different things at different stages of your life. Instead, view these as a rough guide: you now have a destination that you can work towards and make purpose driven decisions with your money.
Next, come up with a roadmap to chart your path and help guide you to your goals.
MAKE A BUDGET
Making a budget is creating a financial GPS for yourself. You’ve determined your current financial location (your current Net Worth, Assets, and Liabilities). You’ve chosen your desired destination (your financial goals). You’ve envisioned how you’d like your itinerary to look (the life you want to live).
Next, your budget will act as a financial roadmap that gets you from Point A (you are now) to Point B (where you want to be). Learn more about making a budget for yourself in this Beginner’s Guide to Creating a Budget and What is the Best Budget for You guides.
Set Up Your Financial Accounts & Automated Financial Process Flow
Recurring financial transactions – whether that is depositing your paycheck, paying your bills, transferring your money to your investment accounts, earmarking a certain amount in your checking account to save, and keeping track of your savings progress for various goals – can take up prime brainpower if you leave these tasks to be done manually.
You’ll have to remember each month to go into your various accounts and manually initiate a transfer, or keep a running tab about your running savings balance on the downpayment of your dream home. What a drag! What’s worse if there are more pressing things going on in other parts of your life where you don’t want to be spending the time and energy with daily financial minutia. Worse, you forget to keep your finances in order and let it fall in disarray, with missed bills and neglected contributions to your savings.
Setting up a well oiled automated financial system ensures that:
1. You don’t miss a bill payment
2. You make consistent contributions to your investments
3. You build your savings
4. You can segregate the money allocated to different goals from money set aside to pay for living expenses
5. You can take your mind off of minutia
6. You don’t overspend
See an example of the automated cash flow system that I have for my finances, from paycheck to the various checking, savings, and investment accounts.
CREATE AN EMERGENCY FUND
One of the first steps on your journey towards financial security and ultimately financial freedom is to create a rainy day savings account. This is important for several reasons.
Extinguish the fear from financial insecurity
Life can throw many unexpected curveballs at us. We can find ourselves laid off unexpectedly from our jobs, suffer from a medical emergency, or deal with costly repairs to our home or car. Knowing that you have several months of living expenses gives you a peace of mind that you have options on your side: you have the means and financial runway to be more selective in your job search, and you can cover a medical emergency or unexpected expenses without worrying about being unable to cover our essential living expenses.
The amount that you want to include in your emergency fund depends on several factors. How secure do you feel about your job? How easy would it be to find a new, similarly (or better) paying job? How much would make you sleep better at night? Here’s a basic methodology to get you started:
Essential expenses for 1 month x months you want to be able to cover
Calculate your essential expenses each month and multiply that by the number of months that you want to be able to cover.
Essential expenses include spending that covers basic needs, such as housing, essential food, utilities, phone, transportation, essential clothing, insurance, childcare so that you are able to go to work, essential medication, essential grooming and hygiene products.
The multiplier, the number of months to cover, varies from person to person. Conventional wisdom says 3-6 months as a starting point, but it depends on a variety of factors such as the stability of your current job, company, industry, how easy it would be to find another job, if you have dependents, are you the only breadwinner, are there external factors that make job hunting more difficult than usual (recession/pandemic, etc).
Learn more in this guide here:
All About Your Emergency Savings Fund
PAY OFF DEBT
If you have any debt, whether it’s a credit card balance, student loan, auto loans, or personal loans, create a plan to pay off your debt. Once you are free and clear of your debt, you will be able to fully direct your resources towards other areas of building wealth.
When you create a budget, include a category for debt payoff. Consider the pay yourself first method of budgeting.
Read more about the debt payoff methods here, include the Debt Snowball and Debt Avalanche method.
BOOST YOUR SAVINGS RATE
Do you want to supercharge your path towards reaching your financial goals?
Consider increasing your savings and overall savings rate. Increase in savings can be achieved in two ways – by either increasing your income and/or decreasing your expenses. This is known as Growing the Gap.
Your earnings can be increased in several ways. You can try to grow your active income at your job (ie, get promoted, ask for a raise, get a job at a different company) as well as building revenue generating assets, such as dividend stock, REITs, rental properties, and side businesses.
It is not always easy to increase your income right away, so most people look at their spending to see areas that they can cut. Your expenses can be decreased in several ways. You can
1.) Pay down your debt
2.) Minimize your taxes (legally)
3.) Cut unnecessary expenses
INVEST TO MAKE YOUR MONEY WORK FOR YOU
One way that the wealthy make money is not generating active income through their wages, but rather through investment income. There are many benefits to this, including (1) not having to trade your time for money, (2) the relative passive nature of making money vs. active income, and (3) the favorable capital gains tax.
Getting started with investing can seem daunting – before I knew anything about investing, I had images of stodgy old gents in their exclusive boys club sharing stock tips that no one else knew about.
In actuality, basic investing is very simple and if you want, can be almost completely automated. The good news is, it’s not a secret at all – there are many resources to learn more about investing, basic and effective investing philosophies that anyone can use, and tools to automate and simplify investing. To get started, check out The Ultimate Guide to Investing for Beginners.
Wealthfront, Robinhood, and M1 Finance are examples of robo investors that lower the barriers to investing and are options for those who want a more simple, hands off approach to investing. Read more about them and other investing tools here.
PROTECT YOUR FINANCIAL WEALTH
Make a habit of checking your credit score.
Diversify your income streams so that you are not dependent on one source of money and can weather the storm if one of them dries up. Be on the offensive against unreasonable bosses that can make your work life difficult, unexpected company layoffs, outsourcing, automation, and wage stagnation. Check out the Future Proofing Your Wealth with Seven Different Incomes guide.
Do you have your beneficiaries set up for all of your assets? Make sure your finances are taken care of and go to their intended recipients in case anything happens to you.
FUTURE PROOF YOURSELF – KEEP ON LEARNING & GROWING
Grow your skillset and never stop learning, whether that is in your 9-to-5 job, your own business, or your own personal interest and passions.
You are the best way to protect your future.