By Rachael Everly
We all know the old adage: “Being poor means having too much month at the end of your money.” How is it that some people always have the money to meet their financial obligations (and some more!) While some of us always struggle to make it through the last two weeks of the month?
You might think it has to do with the size of your paycheck, but the truth is that good cash flow has a lot more to do with effective financial management and planning than big money. Not that earning in spades doesn’t help – of course. But almost each of us can overcome the instability of our personal finances if we know how to deal with it.
Whether you are in your mid twenties or early thirties, if you have not started planning your personal finances, you will find it difficult to manage your financial affairs in the years to come. Here are five things we should all be aware of about personal finance:
1. It is important to keep careful records
You might think that record keeping is for big and medium sized businesses. However, the first step to effective financial management for everyone is one documented presentation of income and expenses. Make sure you know how much you are making and what your expenses and debts are.
If you are completing or just graduating on a student loan, you likely have a grace period of 6 months before your repayment plan begins. This is where most students call their financial intermediary and ask how much they owe – don’t be that person! Whether you are restructuring your student loan or deciding how much to spend on that vacation next year, you should know what your major expenses and predictable debt will be over the next 1, 2, and 5 year periods. Document them, whether in a notebook or with software like Excel. You might be tempted to think you can remember all of these details, but that is much easier said than done. Read Investopedia’s recommendations for the best budgeting software for 2020.
Once you understand your personal financial situation, you will have a lot more clarity about what next steps to take.
2. Don’t underestimate the time value of money
Perhaps the most basic concept of the modern financial system, “time value,” is not just a concept for investment bankers and finance gurus. Time value essentially means that every $ 1 you have today is worth more than $ 1 you will have in the future.
Why this? Because any amount of money you have today can be invested to generate interest or profit. The longer that amount contributes to an investment, the more money it will make. Understanding the time value of money can help you maximize your income in the long run. If you save $ 100 today at 10% interest, you will have $ 259 over the next 10 years.
3. It is important to start saving early
Going from $ 100 to $ 259 in 10 years doesn’t seem like that much of a difference, and in fact, the time value of money isn’t all that impressive with small numbers and small periods of time. But the larger both the amount and the time period, the larger the amount you will earn without lifting a finger.
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This is especially important for people in their twenties and thirties – the sooner you start saving, the bigger your victim’s payout will be. Consider this: Assuming a fixed interest rate of 10%, the $ 1,000 invested today will be worth $ 6,727 in 20 years, $ 17,449 in 30 years, and $ 45,259 in 40 years. This is about a difference of $ 38,000 between the first and the last amount! Bottom line? Don’t think in the short term; In the long run the money is there.
4. Take advantage of a good retirement plan
Save early sounds like a great plan, but what options are available to you once you’re done with it? A great way is to check if your employer offers a tax-privileged retirement plan. Most employers offer a 401 (k), a tax-qualified plan based on the matching principle. Your employer adjusts the amount you save and enters one dollar for every dollar you save through the account.
Even if you don’t have access to a 401 (k), you can still use products like the Roth Individual Retirement Agreement (Roth IRA), a retirement plan that gives you a tax break for the money you withdraw.
5. Don’t be afraid of the stock market
A 2018 Gallup poll found that only 37% of adults under the age of 35 invest in the stock market. This means that more than 60% of adults between the ages of 18 and 35 miss out on the benefits of a long-term equity horizon – including interest income and the ability to weather economic downturns.
While stocks can go up and down like crazy in the short term, speculation and volatility tend to zero in on the long run. What does this mean for laypeople? If you start saving early, your average return on the stock market will be positive. In the long run, you will earn a lot more than you lose.
One question that confuses most potential savers is where do I start? Not everyone has enough will or time to learn what stocks to buy or to track the financial progress of the companies they have invested in.
One solution to this problem is to invest in an index fund. An index fund is a mutual fund that is constructed to match or track a market index such as Standard & Poor’s 500. In essence, an index fund buys all types of stocks in the market at fixed ratios, resulting in performance that reflects the market as a whole. Additional benefits? Since index funds are not actively managed, fees are also low, so you can keep more of your income than with an actively managed mutual fund.
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Rachael Everly is a finance student who enjoys writing on personal finance, money management, and lending topics. Follow @Rachael Everly for more updates.
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