Lots of people want to improve their financial habits, establishing a budget and setting themselves up for a brighter financial future, but they simply don’t know how—and they’re too intimidated to get started.
While budgeting and personal finance can be intimidating topics, the fundamentals behind smart budgeting are easy to understand.
The Most Important Concepts
Let’s dig into some of the most important concepts for better budgeting and personal finance:
1. Understand the power of compound interest. Compound interest can work for you or against you, depending on how you approach it. The basic idea is that interest affects both your initial principal and new interest, resulting in exponential growth rather than linear growth over time. With too much debt, compound interest can cost you thousands of dollars or more. But with sufficient savings and investments, compound interest can help you rapidly accumulate wealth.
2. Learn to feel every purchase. Thanks to the availability and ease of use of things like prepaid cards, debit cards, and credit cards, it’s easy to buy things and spend money without thinking. By contrast, paying for items with cash “feels” more like you’re spending money. You can correct your spending habits and improve your awareness of your financial situation by paying closer attention to how much you’re paying, and when.
3. Live below your means. One of the most common pieces of financial advice distributed also happens to be one of the best: live below your means. Basically, this means living a lifestyle less expensive than what you can truly afford. For example, if you make $40,000 a year, try to live as if you made $30,000. This will help you establish better financial discipline, and give you a buffer, which you can use to cover emergency costs and/or invest in your future.
4. Identify the difference between wants and needs. Too many people misinterpret their own wants and needs. They feel like they “need” to stop for coffee on the way into work every morning, or that they “need” a new car. It’s perfectly acceptable to spend money on “wants,” but you need to identify them as wants, and understand that these items can and should be cut if you’re having trouble meeting ends meet elsewhere.
5. Keep entertainment expenses in check. Speaking of wants, it’s important to keep your entertainment expenses in check, since these can spiral out of control quickly. This is most apparent in the form of monthly subscriptions, since they’re charged automatically, often without being seen. Feel free to spend money on entertainment, but don’t go overboard.
6. Prioritize an emergency fund. One of your biggest priorities should be establishing and maintaining an emergency fund. An emergency fund is a collection of a few months’ salary, meant to cover unanticipated expenses like car repairs or medical bills. It can keep you afloat during difficult times, and prevent you from accumulating debt.
7. Pay yourself first. “Pay yourself first” is the principle that you should invest in your own future before you invest in your present. For example, generally speaking, it’s better to set money aside for an emergency fund or an investment than it is to purchase an item on impulse just because you really want it right now. This doesn’t mean you should avoid all desired purchases, but does force you to be more disciplined.
8. Don’t discount the effects of lifestyle creep. Lifestyle creep is a phenomenon in which the quality (and expensiveness) of your lifestyle gradually increases over time; you buy better food, you go out more often, and you get used to a bigger, nicer home. This can be bad because it gives your mind a “new normal,” making it nearly impossible to make cuts and pushing your budget higher than it needs to be.
9. Diversify your portfolio. When you start setting money aside for investments, try to diversify your portfolio. This common advice cautions you to distribute your money into a wide variety of assets, including stocks, bonds, real estate, and various funds. This will guard you against unnecessary risks, and help you achieve steadier growth.
10. Keep learning. No matter how experienced or confident you become in your own budgeting or personal finance skills, there will always be more to learn. Commit to ongoing learning from peers, mentors, and online resources if you want to get in an even better position.
Making Iterative Improvements
Don’t feel like you need to transform into a financially savvy, ruthless budgeter overnight. It’s going to take time to set goals, learn new things, and build a foundation for yourself. Instead of trying to do everything at once, make gradual, iterative improvements. It’s going to make things far more manageable in the long run.