Checking your savings account’s balance at the end of every month and finding very little left over can be frustrating. You would be at a financial standstill without the means to buy anything except for the bare minimum. Even worse, you won’t be able to contribute to growing your savings. Although this could be the consequence of poor financial management, it can also result from unexpected expenses.
Hospitalizations, emergency repairs, and job termination will affect your budget and savings and may even cause you to take on debts to meet your needs. These situations force you to spend your succeeding income paying them off, leading to a cycle of debts and expenses. Fortunately, financial planning is a proven way out of this cycle (or avoiding it altogether).
Understanding Financial Planning
As a kid, have you ever wanted something you were willing to spend a portion of your daily lunch money to buy? That’s financial planning in action, in its very basic sense.
Financial planning is examining your current situation and planning accordingly to reach your financial goals. Essentially, it’s the continuous state of being aware of your money and where it should be spent or kept to grow.
Although it may sound easy, many people fail to plan their finances. According to Schwab’s 2021 Modern Wealth Survey, only 33% of Americans have a written financial plan, and 22% attribute the lack thereof to the complicated planning it entails.
The reasoning that financial planning is complicated isn’t without reason. After all, it’s not a single process but rather a system of organization processes, which include:
- Budgeting: This entails compartmentalizing your income or available money and distributing them according to your needs and wants.
- Tax Planning: It allows you to legally minimize your tax liabilities by leveraging tax laws and planning where to place your money at the right time.
- Retirement Planning: Planning for your retirement fund allows you to live a comfortable life even during late adulthood.
How to Plan Your Finances
Listed above are only some of the processes that holistic financial planning involves. It may seem complicated initially, but note that financial planning is a skill; you can practice and hone it like any other skill. With that in mind, below are a few effective ways to plan your finances.
- Set goals
Any plan can, and most definitely will, go awry if it does not have paths to take and objectives to aim for. So, the first step is to set your goals.
You don’t even have to set long-term goals immediately. Start with something small; for instance, you could buy a new phone within the next couple of months to replace your current malfunctioning device. After, you can start working your way up and identify your long-term financial objectives.
There’s no right or wrong goal to aim for. What matters is that the goals you set are genuinely things you want to achieve to bring you closer to your dream life.
- Adjust your lifestyle
Your plans and goals are useless if you don’t change your lifestyle and spending habits. You need to minimize unnecessary spending if you want to build your finances.
As the famous maxim goes, “Live below your means.” The keyword here is below, not within. This means that even if you can afford to buy something, it doesn’t mean you should. For instance, if you’re used to purchasing coffee from cafes, consider getting a bag of coffee beans and brewing your own. You could also cook instead of eating out if the latter is what you’re used to.
Living below your means also entails ignoring trends. Even if the new iPhone is coming out, but yours is still functioning, realize that you’re not obligated to buy it.
You can save more money for things you need or want when you choose the more affordable option, ignore trends, or avoid spending entirely.
- Practice budgeting
A budget is one of the foundations of sound financial plans. Practicing it ensures you won’t spend more than what you have allocated from your income. Moreover, it allows you to prioritize your needs and wants by categorizing your spending.
Try developing systems to improve your budget. A popular budgeting system is the 50-30-20 budget plan. The 50-30-20 system is a system that helps you know how to distribute your after-tax income: 50% for needs and 30% for wants, with the remaining 20% for savings.
The system may not always be applicable, particularly if your income has significantly grown. However, it’s a great starting point for developing your own budgeting system.
- Start an Emergency Fund
Setting aside a part of your income to build a fund for emergency purposes is a great way to ensure financial protection. As a rule of thumb, your emergency fund should be able to support your necessary expenses for at least three months. Most financial advisors suggest six months— some even up to a year or two, given the world’s experience during the COVID-19 pandemic.
Also, consider where you would be holding your emergency fund. A savings account is ideal because your money does have to be liquid and accessible at a moment’s notice. Although it won’t grow your fund, savings accounts provide the convenience of ATM cards and machines to access your cash anytime.
- Manage debts
Debts have garnered a bad reputation. It can make you feel like your money isn’t yours since you’re obligated to spend it to pay off your debts.
However, debts can also be good and beneficial, especially in building your credit score. Your credit score determines your financial trustworthiness to banks, car dealers, and other lenders. Taking out a loan and paying it off on time adds to your score, letting lenders know you’re financially responsible.
A great example of good debt is bank credit cards, which are essentially loans. The bank lends you a certain amount of money (your credit limit), which you’ll have to pay at the end of the billing cycle. However, this isn’t always the case with cards.
Certified financial planner Faron medicine recommends using cards to only spend on what you know you can pay off and to avoid store-issued credit cards.
The bottom line is to use debts wisely—leverage good debts to access more opportunities to grow your money instead of turning them into liabilities.
Put Your Plans Into Action
Planning teaches you to prepare and think about your financial behaviors; once you recognize them, you’ll know how to adjust your actions accordingly. However, the essential part of financial planning is execution. There’s a difference between reading how to become a responsible borrower and borrowing responsibly.
It’s important to realize that growing your money is mostly a matter of developing sound financial strategies and habits. Once you start exercising them, you’ll be on your way to becoming a millionaire and achieving financial freedom.
