When you start managing your own finances, you’ll probably have boatloads of questions. You’ll Google things like “How long will it take to pay off my student loans?”, “How much should I contribute to my 401k?”, “What does my credit score mean?”, and “How do I figure out what to withhold for taxes?”. Adulting can be sooooo complicated sometimes. If you feel completely stumped on how to take care of all of these things, rest assured you’re not alone. Many folks come out of college very well educated, but have never been introduced to the day to day concepts of money management.
Financial literacy should start early, like elementary school early. A recent study showed that kids who learned about personal finance in school “have better average credit scores and lower debt delinquency rates as young adults.” Clearly, the more you know about the ins and outs of money, the better off you’ll be. But don’t worry if you think you’re behind on the learning curve. Take the time to understand these three financial concepts, and you’ll be well on your way to improving your personal financial situation.
Concept #1: Managing cash flows.
Cash flow is the movement of your money. Money comes in and money goes out. It’s a relatively simple concept, but the key is how to manage that flow of funds. It’s much more than just knowing what’s in your wallet. You need to know how to save, how taxes affect your paycheck, what your expenses are each month (rent, mortgage, car payment, credit card debt, etc.), and what discretionary expenses you have on an ongoing basis.
A simple budget is a great starting point. You have X amount of income each month, X amount goes to taxes, X to fixed monthly expenses, X to your savings, and X is for discretionary (FUN) spending. Your expenses probably vary throughout the year (for instance, if you go on vacation during the summer, spend more during the holiday season, or hunker down at home in the winter). You can also start a cash flows spreadsheet, and track what you expect to happen with your money, and what really happens. It will give you much more control over your financial situation if you break it down into smaller monthly chunks. Plus, numbers don’t lie, and seeing what you’re planning to spend vs. actually spending can be a reality check for many people. Use this reality check to stay on track throughout the year. That way, you’ll no longer have that “Hey! Where did all my money go?” feeling at year end.
Concept #2: Compounding interest.
We’re always urging folks to save, save, save. It’s so important to start a saving habit while you’re young. One of the biggest benefits to saving early is compounding interest. If you don’t understand what that even means, here’s the gist: If you put a certain amount of money into savings (a.k.a. your initial principal), it will grow (a.k.a. earn interest) over time. But the interest you earn will also earn interest as time passes, which means your initial investment will grow even more quickly. How great is that!? The key to taking full advantage of compounding interest is letting the money accumulate over a long period of time. That means you must be diligent about putting money into savings on the regular, and be disciplined about leaving that money in your savings for the long haul.
Concept #3: Thinking long term.
We totally get it. Sometimes it’s hard enough to think past this week, or this month, must less years down the road. That being said, setting long term goals will have a huge impact on how you handle your day to day finances. If you know that in five years, you want to buy a house, or finish paying off your student loans, or start a business, or take a few months off work and travel the world, you’ll be more likely to control your spending, and work on saving. The farther out into the future you plan, the more likely you’ll achieve what you’re striving for. But the key is to think long term, and keep those goals in mind as you do your thing.
The most effective way to set your financial goals and figure out what needs to be done to accomplish them is with a financial plan. It doesn’t have to be complicated. In fact, we’ve found the more complex the financial plan, the less likely people are to stick to it. Setting your goals and having someone help keep track of your progress will help keep you on the straight and narrow along the way.
It takes years and years to learn everything you need to know about managing your finances. Understanding these concepts is a great starting point. If you have any other questions about your financial situation, or you’re ready to start setting those long term goals, don’t hesitate to reach out!