Follow these seven steps and you will be well on your way to financial security. These seven rules/steps are simple to understand, but take time and effort to implement. There is no short cut that will allow your to skip the seven steps to financial security.
Remember the old line, “30 years ago I was young and broke. Now I’m not young anymore.” If you are perpetually broke, and you don’t want that to be you, this article will help you on your way to a better financial future.
Before you even start down this path, you need to understand why you even want to bother. This will not be magic cure, but a work in progress. You need a goal. A real, tangible, measurable goal. You can’t measure, “I want to be rich.” But you can certainly measure, “I want to save $2400 over the next 12 months.” Better still, you can then to make it even more measurable, “I want to save $200 a month for the next 12 months.” Now you can easily see each month if you have achieved your goal.
I believe that while it is prudent to plan for retirement, it can’t be at the expense of removing joy from my family until then. I tried to balance saving and spending to get the most life for myself, and my family. We lived each day well, while planning for the future. Now that I am retired, we have a really good life, and money considerations do not really restrict our lifestyle, but Covid-19 sure has.
Understand that it’s your money. You (includes your family) should be the one to decide how it is going to be spent. Make decisions based on what you want to happen, not just plugging along, accepting whatever happens. If you don’t want to plan your finances, then you are planning for financial failure.
- Pay Yourself First
Plan to use the 20-30-50 rule. Save 20% of your net income. Use 30% for things you want, and the remaining 50% for necessities you absolutely must have. Examples of must have are food, shelter, utilities, health care insurance and life insurance (if you have family responsibilities).
Don’t feel badly if your immediate goal is simply to work out a plan to confine your spending to the income you have. Don’t worry if you can’t manage the 20-30-50 rule right away.
During the first few years of marriage, we were forced to live by the 0-0-100 rule as we could barely cover the essentials from our income. Once we had the basics covered, we trimmed carefully and for the next number of years we lived by the 10-0-90 rule. This will work for a while, depending on your personality, but for us it was not sustainable in the long run. By about our fifth year of marriage, we had it down to a 10-20-70 rule.
It paid off in the long run. Just to be clear, at the time, my employer deducted about 6% of my gross wages for a pension plan. So in reality, I guess we lived by the 6-0-94 rule and moved up from there. During the pandemic, we are living by a 45-5-50 rule as we have little access to discretionary spending.
Just a little aside, I know a couple who decided that they would do whatever it took to be able to retire comfortably in 20 years. They lived an austere 60-0-40 existence. A little to harsh for me. But it worked for them. They were off and retired while I had another 20+ years of employment to put in before I could even consider retiring.
Creating a budget is a great way to help you decide where you want your money to go. For help with your budget, read my article at Planning a Budget that Sets You Free.
I have created a free template to help you with your budget.
Set up your chequing account to transfer your planned savings into another account every payday.
Pay your bills on payday, don’t wait until the due date. This will reduce the temptation to spend savings income or bill payment money elsewhere.
As one of my friends said, “If I don’t see it in my account, I don’t spend it.” A little help here, and a little plan there, and before you know it you are on your way to reaching your goals.
If you haven’t been this methodical in the past, it may take a while to get yourself on track. (It took me years!) Don’t despair. Just keep plugging away and you will reach your goal.
Just keep in mind, you must start the race to have any hope of finishing it.
- Use Debt Wisely
Some debt is better than others. The rule I try to use is quite simple. If I incur this debt, will it provide me with an asset, that is help make me better off now or in future years? If the answer is no, then I would be purchasing a liability, so I don’t incur the debt.
There are exceptions to this rule of course. If I had used up my emergency fund to replace my dead refrigerator, and suddenly my washer can’t be repaired, I may be forced to take on bad debt to replace it. On the other hand, if the contract is up on my phone, it would be totally bad debt to purchase the newest smartphone on payments.
Is it an Asset or a Liability?
If a purchase has the potential to make money for the purchaser, or can be sold at a profit, then it is probably an asset.
If a purchase earns nothing and cannot be sold at a profit, then it is a liability.
Debt is a liability. The item purchased with the debt may be either an asset or a liability.
Buying a house can be good or bad debt, depending on a number of factors. Does paying the mortgage, taxes, insurance, etc. on a McMansion leave you broke and unable to to do anything else? That’s bad debt.
On the other hand, a house that costs little more than the rent on your current apartment each month, may be good debt. Note that this doesn’t apply if you are renting an apartment that you really can’t afford. One source says that the total cost of a dwelling should not exceed 32% of household income. Rental income can help with this requirement. Never buy a house counting on future increases in income to cover the costs.
A car is another example of debt that may be good or bad. As soon as a car leaves the dealer’s lot, it loses a great deal of its value. If you need a car to get to your job, or to do your job, then debt to purchase an appropriate vehicle would be good debt. If you buy more car than you need just to keep up with your neighbour, that’s bad debt.
Buying a new TV, computer or large appliance because you have paid off the last ones is bad debt. On the other hand, if the computer or other item is used to bring you income, then it may be good debt.
If you buy a multi-unit residential property in an upcoming neighbourhood, and the income covers the mortgage and other expenses, then that may be good debt. But only if the building appreciates over time.
Assuming debt to purchase a viable business can be good debt if you can make a profit in the long-term. Before buying any business, make sure that you know exactly what you are getting into. A business may depend entirely upon traits exhibited solely by the previous owner. An example might be that everyone loved the previous owner and didn’t want to leave him for a cheaper or better alternative. Since the clients don’t know you and have no loyalty to you, your purchase could trigger the change to another supplier. Suddenly you are stuck with a potentially worthless liability.
Assuming debt to purchase something you had the money for and were already going to buy can be good debt. A few years back, I was in the market for a new vehicle. I had the cash to cover the cost. The dealer was offering 0% financing, so I took the deal. I invested my money for the four years of the term. By the way, I paid off the vehicle from current income and so had the price of the vehicle working for me all that time, a sort of forced savings.
Should you buy a new or used vehicle. When I was younger, I was able to fix most anything on a vehicle for the price of the required parts. This allowed me to purchase older vehicles cheaply without worrying about the expense of repairs. Cars have changed, and I am too old to crawl around under vehicle hoods, so this purchasing model no long works for me.
I have found that if I keep a new vehicle for at least ten years before replacing it, the annual cost will be about the same as purchasing a five year old vehicle and keeping it until it is ten years old. The cost of insurance could change this dramatically because of the new safety equipment coming on-line.
Another way to state this, if I have $30,000 that I am willing to spend on a new vehicle, I must own the vehicle and save $3,000 a year for the next ten years so that I can replace it. On the other hand, if I only have $15,000 to spend, then if I purchase a five year old vehicle, and drive it and save $3,000 a year for five years, I can replace it. Either way, the average cost of the vehicle is $3,000 a year. Replacing your vehicle earlier will increase the average yearly cost of the vehicle.
This has been my experience and may not reflect the choices or situations available to you.
- Spend Less Than You Earn
An old proverb states that if you have $100 in income and spend $99, this will produce happiness. If, on the other hand, you have $100 in income and spend $101, you will eventually bring misery upon yourself.
As I explained in the section above, debt can be bad or good depending on its purpose. Credit cards can be the bane of a person’s existence. It’s such an easy, almost painless way to get into debt, that many soon find themselves in an impossible position.
Increasing the limit on your credit card, line of credit or mortgage may bring temporary relief, but all of the debt will need to be repaid! If you are not paying your credit card off in full, every month, your debt is piling up.
At some point, even the credit card companies will deny you further credit and want a plan for you to repay their money. At this point, your choices will be very limited, and none of them will be pleasant. It is far better for you to control your spending, rather than letting your spending control you. Perhaps, consider a budget to help you manage your money.
- Saving Will Not Create Wealth
Many years ago I knew a very prudent man who saved his money religiously. A nice chunk from every pay cheque went into his savings account. When it came to retire, he found that all of his savings were for nought. He had perhaps enough saved to live comfortably for two years.
Why did this happen to such a prudent saver? The answer lies in the fact that taxes and Inflation eat most, if not all of the interest earned on savings deposits. Savings accounts are great vehicles for short term savings. Obviously, relying on bank interest for gains is not a good idea over the long haul.
If you would create wealth, you must invest your money wisely. When you are young, you can take advantage of some riskier venture like individual stocks or a start up businesses. The potential for large profits is there, but so is the potential for large losses. When you are young, you still have time to make up for these setbacks.
As you get older, you should consider less volatile investments. Although the chance for large profits may not be there, neither should the chance for large losses. I am somewhat of a risk taker for my age, and currently tend to invest in index funds. Bonds, treasury notes, and money market accounts would likely be safer and less volatile, but there would be little chance of matching or beating inflation.
- Create an Emergency Fund
Your savings/investments should include a readily accessible emergency fund. This fund will help to prevent a disruption to your plans if the car breaks down and needs expensive repairs, or the roof needs replacing, or you are out of work for a few months, you should be planning for this. Right now, some people are 18 months without work because of the pandemic.
The more you have in your emergency fund, the less likely the unforeseen events will be to create stress and upset your financial life. Most experts recommend between four and six months expenses as a reasonable emergency fund.
- Information Can Help Create Wealth
Many investments have the potential to earn excellent returns for you. That being said, you should never invest in something that you do not understand. A hot stock tip can be great, if you understand the industry and the background for the opportunity. Even if you understand the industry, do you know and understand the reason for this investment to be behaving in this way.
Even a seasoned real estate investor is unlikely to invest in a property unless all of the facts pertaining to that property are available. A property could be a great price, in a great neighbourhood with top rated tenants, but be a less than desirable purchase. Do you know if there is a contractor in the process of putting a lien against the property for work done and not paid? Is the municipality in the process of selling the property for tax arrears?
Knowledge is power. Make sure that you have the power before you enter into any investment.
My rule of thumb – If I don’t have a thorough understanding of an investment, I don’t invest no matter how great the profit potential.
- Develop Good Money Habits
Here are a few money habits that I like to follow.
- Don’t spend money on things that are not necessities and will not bring a return in money or joy.
- Invest in vehicles that allow you to lower your tax bill. Almost every country has some form of tax deferred investment.
- Invest regularly. Don’t wait until your have saved a big chunk of cash, keep every penny working for you.
- Everyone understands to, “look before you leap,” but it is just as prudent to think before you buy. Reflect on a purchase. Don’t buy on impulse, even if it is only a few dollars and a great buy. It’s amazing just how many great buys end up unused on a shelf somewhere.
In Canada, we have the Tax Free Savings Account (TFSA), the registered retirement savings plan (RRSP), the registered education savings plan (RESP) and the retirement income fund (RIF).
The TFSA requires after tax dollars, but all withdrawals are tax free or nearly so.
The RRSP funds are tax deductible, but all funds are taxed at your current rate upon withdrawal. The RIF is money rolled over tax free from your RRSP when you turn 71. Each year you must withdraw a minimum percentage of the fund. It is taxed at your current rate.
The RESP requires after tax dollars, but funds are taxed in the hands of the child who may have little to no income upon withdrawal. This works well for higher income families, but may not benefit lower income families, except that it is a somewhat forced savings plan.
Some folks I know go as far as to keep their credit card in a block of ice. The are forced to wait for the ice to melt before making any purchase, which gives them a chance to reflect on the value of the purchase.
Bonus Tip: Few people, if anyone plans to be out of work for an extended period. You can soften the crunch by offering to become and internet gig worker. Although most gigs don’t earn a great deal, it is possible for an individual to bring in $100 – $200 a week. Some people actually make more from gigs than they could from regular employment.
Check out my article at 15 Ways to Earn Money on the Side.
Have you got any info that you think I should add to “Seven Steps to Financial Security” please leave it in a comment below.
As always, I am not a qualified financial advisor. I just relate financial management to my own experience which may not resemble yours at all. Advice is frequently worth exactly what you paid for it. Most of mine came from expensive experiences.