3 Steps to Start Taking Control of Your Money
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Managing your finances can sometimes feel like you're constantly trying to keep your head above water.
There are bills to pay, unexpected expenses that come up, debt to deal with, and at the same time, you're supposed to somehow be saving and investing for the future.
It can leave you asking a pretty simple question:
Where do I even start?
I believe there are eight important steps you can take to gain more control over your finances and build toward your financial future. In this three-part series, we're going to walk through all eight.
But before we worry about building significant wealth, we need to build a strong financial foundation.
Here are the first three steps I recommend.
Step 1: Save One Month of Expenses
The first goal is to build a starter emergency fund equal to one month of your expenses.
This isn't your fully funded emergency reserve. We'll get to that later. Right now, we're simply trying to create a buffer between you and the unexpected things life throws your way.
Cars break down. Water heaters go out. Medical bills show up. Tires need to be replaced.
Without money set aside, even a relatively small emergency can force you to reach for a credit card or pull money from somewhere it wasn't intended to come from.
Having one month of expenses in savings gives you some breathing room.
But there's another reason I like this goal: you can't save one month of expenses until you know what one month of your expenses actually is.
Find Out Where Your Money Is Going
Pull out your bank statements and credit card statements and look at what you've actually spent over the last few months.
You need to know two numbers:
How much money comes in each month?
And:
How much money goes out each month?
You may discover you're spending more than you thought. You might even discover you're regularly spending more than you make.
That's valuable information because one of the most important financial habits you can develop is also one of the simplest:
Spend less than you make.
Once there's a gap between those two numbers, you can start directing the difference toward your emergency fund.
Separate Your Needs From Your Wants
This may require making some temporary sacrifices.
Start looking at your expenses and separating your needs from your wants.
Your mortgage or rent, utilities, groceries, insurance, taxes, minimum debt payments, and transportation to work are needs.
Eating out, vacations, entertainment, frequent coffee runs, and other discretionary purchases generally fall into the wants category.
That doesn't mean you can never enjoy those things again.
The goal is to create a season where you're willing to cut back aggressively so you can build your financial foundation as quickly as possible.
Once you know what you spend, reduce the expenses you can live without and start putting the difference into savings until you've accumulated one month's worth of expenses.
For an emergency fund, I generally like a high-yield savings account. It keeps the money accessible while potentially earning more interest than a traditional savings account.
Once you've reached that one-month goal, you're ready for step two.
Step 2: Start Investing for Your Future
Now that you have a small emergency buffer, it's time to get some money working for your future.
If you have a workplace retirement plan such as a 401(k) or 403(b) and your employer offers a company match, that's generally where I want to start.
Why?
Because the company match is part of your compensation.
Imagine your boss offered you an extra $100 on every paycheck and you responded, "No thanks. You can keep it."
Most of us wouldn't do that.
But that's essentially what can happen when your employer offers a retirement-plan match and you don't contribute enough to receive it.
For example, suppose your employer matches your retirement contributions dollar-for-dollar up to 3% of your pay. If your contribution is $300, your employer may add another $300.
You've now put $600 toward your retirement even though only $300 came out of your pocket.
That's why I generally prioritize contributing enough to receive your full employer match.
What If You Don't Have a Workplace Retirement Plan?
If you don't have access to a workplace retirement plan, another option may be opening a Roth IRA.
At this stage, the important thing isn't necessarily starting with a huge contribution. It's developing the habit of consistently investing.
Even starting with something like $100 per month gets money working for your future and gives compound growth time to work.
The larger lesson is this:
Start investing.
You can increase the amount later as your financial situation improves. For now, we're building the habit and getting the machine started.
Step 3: Attack High-Interest Debt
Once you've established that initial savings buffer and started investing, the next step is attacking high-interest debt.
Why is this so important?
Because compound interest can either work for you or against you.
When you're investing, growth can compound over time and help build wealth.
When you're carrying high-interest debt, the same concept can work in the opposite direction.
I've seen people faithfully make payments on debt month after month only to be shocked by how slowly the balance declines. With sufficiently high interest rates, making only minimum payments can make it extremely difficult to gain ground.
That's why I want to start aggressively attacking this debt.
For purposes of this framework, I generally classify non-mortgage debt with an interest rate above 8% as high-interest debt.
That could include:
- Credit cards
- Personal loans
- Payday loans
- Some student loans
- Some vehicle loans
Once you've identified those debts, there are two common ways to attack them.
Option 1: The Debt Avalanche
With the avalanche method, organize your high-interest debts from the highest interest rate to the lowest.
Continue making the minimum payment on every debt, but direct all the extra money you can toward the debt with the highest interest rate.
Once that debt is gone, take everything you were paying toward it and apply it to the debt with the next-highest rate.
Continue until they're all paid off.
Mathematically, this approach generally results in paying less total interest because you're eliminating your most expensive debt first.
The downside?
Your highest-interest debt might also have a large balance, which means it can take a while before you experience your first win.
For someone who can stay motivated without seeing immediate progress, the avalanche method can work very well.
Option 2: The Debt Snowball
The snowball method approaches things a little differently.
Instead of organizing your debts by interest rate, organize them from the smallest balance to the largest balance.
Put all your extra money toward the smallest debt first while continuing to make minimum payments on everything else.
Once the smallest debt is gone, roll that entire payment into the next-smallest debt.
Then do it again.
And again.
The advantage is psychological.
Paying off a smaller debt quickly gives you a win. You see an account disappear, free up a monthly payment, and feel like you're making progress.
Technically, you may pay more interest using the snowball method than you would using the avalanche method. But personal finance isn't only about math.
The best strategy is one you'll actually stick with.
If seeing frequent wins helps keep you motivated, the snowball method may be a better fit.
What These Three Steps Accomplish
Think about where you are after completing these first three steps.
First, you've built a financial buffer. When an unexpected expense comes along, you have money available to deal with it instead of immediately reaching for a credit card or pulling from your investments.
Second, you've started putting money to work for your future.
Third, you're eliminating the high-interest debt that's working against you.
That's a very different financial position than constantly feeling like you're falling behind.
And now you've created the foundation that allows us to start focusing more heavily on building wealth.
These aren't the only things you'll need to do with your money. They're simply the first three steps in the eight-step framework.
In Part 2, we'll continue with the next three steps and start building on the foundation we've created here.
This material is provided for educational purposes only and is not intended as individualized investment, tax, or legal advice. Your financial situation is unique, and you should consult with the appropriate financial, tax, or legal professionals regarding your specific circumstances.