Personal Finance In Plain English
A plain English introduction to personal finance. Build your financial house and reclaim your sanity.
No matter where you are in life, unless you're a hermit living in a cave, you have personal finances. You have an income, you have bills. You may have loans, a checking account, a savings account, maybe even a mortgage, rainy day fund, and a retirement account.
You have money coming in, but does is sometimes feel like it's not even yours? That you're just a distribution center for your income? Do you ever loose sleep at night worrying about money?
This introduction will decrease your stress, help you make sense of your finances, help you come up with a plan, and get a full nights sleep.
The first step is to understand the goal of personal finance: retirement. Retirement isn't an age, it's a net worth. Net worth is calculated by the value of your assets (cash, real estate, investments, etc.) minus your current liabilities (usually just your debts). So, for example, you currently have $1,000 in your savings account, $20,000 of equity in your home, and your debts are a $200,000 mortgage and $1,000 in credit card debts, your net worth would be -$180,000. DON'T FREAK OUT! You did read this correctly, your net worth in this example is negative, but that's the situation for most people. This guide will help you get to retirement.
The first thing you need to do is figure out what retirement means to you. Do you want a retirement of luxury, a retirement where you only have enough money to be jailed in your home, or something in between? The keys to figuring out what retirement means to you are:
- If you're completely debt free, how much in today's money would you want to live on per month? Is $2,500 sufficient? $3,500? $10,000?
- Take the number you came up with, e.g. $3,500, think of a timeframe in which you'd like to retire, e.g. 20 years, and adjust that number for inflation. So $3,500 in today's money means, assuming 4% inflation, you'll need $5,477.81 per month to live on.
- Are you being realistic about the number you came up with in #1 above?
How do you reach the debt free income of #1 above? Increase your net worth and reach your financial independence number. Your financial independence number is the about of money you need to live the rest of your life in future money. We'll show you how to reach this number, and hit other financial goals along the way.
Keep in mind that personal finance isn't the accumulation of money for the sake of money, it's money for the sake of freedom. Money itself isn't intrinsically good or evil. Good people tend to do good things with money. Think for a moment, something happens, you get some sort of financial windfall and surpass your financial independence number. Say you have enough money to live comfortably and travel 2 months a year for the rest of your life plus an additional $10 million on top. How much good could you do to others and to the world? Would you support your favorite charity? Would you purchase a starter home for kids? Set up a college fund for grand kids?
The absolute, most fundamental rule about personal finance is to be honest with yourself. Most of us cringe when we think about our debts, our lack of savings, and our modest income. If you're not honest with yourself in what you your current financial state looks like, what you want to achieve, and how realistic it is to achieve your goals, your chances of success are greatly diminished. It is absolutely okay to be terrified to look in the mirror and see how things look. Most of us feel the same way. But you need to ask yourself, do you want this terror to continue or do you want the cold sweats to vanish forever?
The second most important rule is to never forget inflation. Have you ever known anyone who “retired,” to a part time job or was working again after a few years? Many times this is the result of either not considering inflation or not adequately calculating inflation. Forty years ago the idea of your pension providing you $600 a month when you retire sounded fantastic, but how well are you able to live today on $600 a month?
A few thoughts and tips before we begin:
1. Finance is simple and you can understand it! A lot of people make a lot of money from convincing you that they're the expert and finance is too complicated for you to understand. This is an outright lie. Most agents of most financial institutions work on either a full or partial commission basis and they often have monthly quotas. This doesn't necessarily mean the financial products offered by a commissioned agent are inferior to a similar product sold by a salaried agent or, with mutual funds that a no-load fund is better than a load fund, but it does mean you need to educate yourself so you can make an informed purchase or accurately judge the products you already have.
2. If money is tight you usually have two options: spend less or increase income (or both), but how much control do you have over increasing your income?
3. If you're a U.S. Citizen, especially if you're early in you financial life, i.e. you're still early in your career, do you want to bet on Social Security's existence when you retire? It may be there, but you're going to end up more financially secure if you assume it will not exist or, at the very least, not be sufficient to meet your financial needs.
4. What will happen to you and your family if your income stops? This question is important regardless if you're single, married with both partners earning an income or one is a stay-at-home parent. Again, it's fundamentally important to be honest with yourself and loved ones.
5. This is a difficult, but important question. If your married, in a domestic partnership, or in another long term relationship, what would happen to your finances if you or your loved one has an accident and doesn't come home? Will you suffer financial trauma in addition to the grief of your loss?
6. Track your spending! Keep receipts & write down everything you spend more than a $1 on, and includes all your bills as well as groceries and gas. This is important regardless of your income, and especially important if money is tight. After the first month, look back at your expenses and identify areas where you may be able to get more wiggle room. Can you free up money by taking a lunch to work and going out to dinner fewer times each week? Do you really need all those cable channels? Do you need to see that many movies or can you wait for more of them to be available to rent? Do need to meet your friends at a bar or can you have them over for drinks? Do you need that $4 a day mocha, or can you start brewing coffee at home?
The idea isn't to give up all extras (unless you're really financially strapped), but to identify areas where you can give yourself some breathing room, but most importantly, where extra money can be found to either begin, or accelerate your path to financial freedom. Often small lifestyle adjustments can have a huge long term impact on your financial security. For example: If you're already investing in a 401(k), but have a car loan, the extra money from not purchasing a $4 per day mocha ($80 a month based on a 5 day workweek), can be used to accelerate debt reduction. If you're not investing, it can be used to begin a retirement plan. If you don't have life insurance, it could cover your premium.
7. If you don't have anything else in your life organized, it's very, very helpful to at least have your financial documents organized in a single location.
Overview - Your Financial House.
Think of personal finance as though you were building a house. You want to be sure you have a solid foundation to then build sturdy walls so you can then build a second story and so on. We're bombarded with financial products and we may often end up with a product here and another there, but it's important to know how a house should be built before you begin construction. You don't begin with the second floor and work down.
When looking at your financial house, don't worry if you've already begun with the second or higher floors, you can shore up your foundation and make the rest of your house stronger.
Let's look at a blueprint for the house:
Foundation - Life Insurance
- Income Protection. What is the financial impact of your or your loved
ones on you or your family's finances?
First Story - Eliminate Debt
- You cannot be financially free if you owe money. This section also includes a Mortgage & Loan Calculator.
Second Story - Emergency Funds
- You need to think beyond a rainy day.
Third Story - Retirement
- Retirement isn't an age, it's an amount of money.
Fourth Story - College Funds
- If you want to help your kids go to school.
Fifth Story - Goals and Dreams
- You shouldn't give them up, and you shouldn't go into debt to achieve them.
Attic - Long Term Care Insurance
- Protect your financial legacy and don't burden your family in your twilight years.
Attic Loft - Additional Investments
- Other investments that can increase your net worth, with their pros & cons.
Let's Begin. First, our foundation ›› Life Insurance
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