This week, our blog series turns to organizing your finances. The most fundamental step in getting your finances in order is to see where you stand today. That means developing a net worth statement and a budget. This task is very time-consuming, but it will be worth it.
You can find a form for outlining your net worth here: http://www.washingtonpost.com/wp-srv/business/pdf/networth.pdf. A form for your budget is here: http://media.washingtonpost.com/wp-srv/business/pdf/BudgetWorksheetPost.pdf. You may have to add some categories for specific expenses you have.
To fill out these forms, you’ll need the most recent statements for all of your deposit accounts — checking and savings, 401k, IRA, Roth IRA, mutual funds, college funds, bonds, etc. You’ll also need about a year’s worth of your bills. I suggest working from 12 months of documentation since some bills are annual or seasonal. You don’t want to get a nasty surprise from an unbudgeted large bill, like an insurance premium, that shows up only once a year or fail to account for a seasonal bill like yard work.
Once you’ve filled out these forms, you need to understand what the forms mean. Your net worth gives you a sense of your financial health. You want your net worth to be a positive number. If that number is negative, you need to take a serious look at ways to reduce expenses and debt. Above all else, stop adding to debt unless you are in an emergency situation. If the number is positive, you may want to divide it into assets that can easily become cash (stocks and bonds) and those that cannot (IRAs and real estate).
Your budget form tells you how you spend your money. Ideally, your budget should balance. If you have money left at the end of the month, it should be in savings or investments. Your budget should not be in deficit regularly. That’s the fast route to credit trouble and bankruptcy, spending more than you earn. (Of course, there will be some months you spend more, but those higher expenditure months should be offset by frugal months where you save more than usual.)
For most people, a close examination of your spending will indicate places you can cut in order to increase your savings. It is likely to be different for everyone, depending on where your money goes. In the short term, it’s generally difficult to save on the big things, like mortgage or rent or your electricity or gas bill. Yes, you could move to a smaller place or improve your insulation, but those are probably a little more drastic than you want to consider right now.
There are places where the cuts are a bit easier. Eating out is a big expense for many people. Cooking dinner at home and carrying your lunch to work can save more money than you think. Let’s look at an example: If you spend $8 a day on lunch, that’s $40 a week. You can buy a loaf of bread and a pound of meat for about $10. Toss in a bag of baby carrots and a jug of iced tea and you can still save $25 a week. That’s $100 a month — a pretty big increase with very little effort. You’d save even more if you made your lunches from dinner leftovers that might otherwise go to waste.
Entertainment is another place to cut. Streaming services, movies, concerts, evenings at the corner bar, and weekend jaunts could be reduced or even halted for a short time as a way to increase savings. The same goes for non-essential purchases of clothing, electronics, or the like.
You may also want to take a look at the little expenses that add up over time: the premium cable channels you watch only on occasion, the cup of designer coffee in the morning or the late afternoon diet soda, the weekly manicure, the magazine picked up at the grocery store checkout because you’re bored. You don’t need to deprive yourself completely. You could cut back or alternate what you give up. For example, instead of buying coffee every day, you could make it your Wednesday treat. Or you could make the manicure biweekly. Or you could give up buying coffee this month and going to movies next month.
If you are carrying credit card balances, reducing or eliminating them is a great way of saving money. There are very few legal investments that guarantee earning 18% a year — a pretty standard credit card interest rate. It makes more sense to pay off high-interest debt (especially when the interest isn’t deductible) than it does to sock cash away in a 1.5% savings account.
To start getting rid of your credit card balances, calculate how much extra you can save each month and put that amount each month toward the balance on your highest interest card while making your usual payments on any other cards. Once that balance is paid off, go to the next highest interest, until you are credit card debt-free. (You can also do it by paying off the smallest balance first, whichever you prefer.)
Of course, there’s one very difficult step left. While you are paying off these balances, you can’t be adding to them. That means no credit cards. If you can’t pay for it in cash, you can’t buy it. It’s hard, but you will get used to it. Having to pay cash will help you decide what you need to buy as opposed to what you want to buy. And that distinction may be the most important financial skill you ever learn.