“The way to wealth is as plain as the way to market. It depends chiefly on two words, industry and frugality: that is, waste neither time nor money, but make the best use of both. Without industry and frugality nothing will do, and with them everything.”Benjamin Franklin
Table of Contents
The Financial Literacy Problem in America
Despite the prosperous economy of the United States, the income gap is increasing and American families of every income bracket are having trouble managing their money. Experts suggest that this problem is largely due to declining rates of financial literacy, which some studies report as low as 10%.
According to the 2018 NFCC Financial Literacy Survey, there are some alarming trends arising in the money management skills of Americans:
- Only 55% of Americans are willing to grade their personal finance knowledge as an ‘A’ or ‘B’.
- 1 in 4 Americans admit that they do not pay their bills on time.
- Only 29% of Americans are saving more this year than they did last year.
- 61% of Americans held credit card debt this year and 38% carry credit card debt month-to-month.
- All of this contributes to the reality that despite participating in the world’s largest economy, American’s rank 14th in the world for financial literacy.
Why should you Care about Financial Literacy?
While you may feel totally secure in your personal financial situation or that of your household, data shows that a false sense of security is lulling Americans into financial trappings. A recent financial literacy survey from Financial Engines reports that a whopping 47% of Americans feel better about their finances than they did a year ago (note: this data was collected before the Coronavirus pandemic).
What is most alarming about this data however, is that only 6% of surveyed Americans were able to pass a fairly basic questionnaire of financial literacy. Yet despite their lack of financial literacy, Marketwatch.com reports that Americans are spending more on non-essential expenses like entertainment and travel.
Moreover, Northwest Mutual Fund reports that as of 2018, Americans found money problems to be the most stressful problems in life, even more so than relationship problems.
This data foretells a foreboding story:
- Americans are feeling more confident about their finances because they do not understand their finances.
- They are feeling confident in savings because they do not understand how much they should be saving.
- They are unbothered by their spending behaviors because they do not realize what constitutes a ‘bad debt load.’
- And perhaps worst of all, Americans seem to be avoiding these things because money problems stress them out.
Put simply, financial literacy is the skill at assessing personal financial health and it is a skill severely lacking in America today. In order to assess personal financial health you need to have a firm grasp of modern financial terms and concepts as well as a strong understanding of the most impactful financial events in life such as buying a house, having children, or entering retirement.
What seems to be most lacking in American’s financial understanding is that of financial norms–that is, how much you should be saving for retirement, the average yearly expenses faced by American families, or the average cost life events listed above. Even if you suspect that you have a high level of financial literacy, you might be surprised to learn that you still have a lot to learn, but don’t worry. You are not alone, and remedying that lack of knowledge is the purpose of this guide.
See if you can Answer these 3 Financial Literacy Questions
In order to get a quick albeit incomplete picture of your financial literacy, try to answer the following three questions which reportedly gave surveyed Americans the most trouble:
- How much will the typical married couple retiring at age 65 spend on out-of-pocket costs for health care throughout retirement?
According to Financial Engine’s reports, around three-fourths of Americans about to enter retirement get this question wrong. Surveyed Americans ages 55 to 64 incorrectly believed the amount spent out-of-pocket would be between $50,000 and $200,000. In fact, due to rapid inflation of medical costs the current estimated expenditure is $266,000.
If you got this question wrong, don’t worry. Around 93% of Americans got this question wrong, which is the worrying element of this survey.
- A typical 65-year-old man can expect to live, on average, for how many more years?
- About 10 more years
- About 15 more years
- About 20 more years
- About 25 more years
Only about a third of Americans correctly guessed the average life expectancy of American males. According to the data from the Social Security Administration the average male can expect to live to around 84 and females can expect to live to around 87. Why is this important? Because despite popular belief, most Americans will not have someone to take care of them financially in advanced age and thus they need to prepare financially many decades in advance.
If you have only planned your financial budget to cover your life into your mid seventies. Adding another decade of expense can uproot all of your plans. This brutal reality is often realized far too late and has waylaid many geriatric Americans and their families.
- What is the average annual rate of inflation for college tuition around the country?
Just over one-fourth of Americans correctly guessed the annual rate of inflation at 8%, which means college tuition doubles roughly every 9 years. If you are one of the many Americans who will be financing college tuition for yourself or a loved one, this is crucial information. Because within a four year period you can expect a tuition jump of around 30% by the final year. Rising tuition costs are just one of many financial trends in America that is vital in order to grasp the reality of personal finance in America.
Even if you correctly answered these questions, they serve as only a very basic snapshot of financial literacy. The goal of this guide is to ensure that you not only know the bare minimum, but that you know enough for you and your financial projects to thrive.
How Will this Guide Build Financial Literacy and Money Management Skills?
In this guide we will cover:
- The basic terminology, concepts, and approaches central to building financial literacy.
- We will then look at some step-by-step guides for managing your money more efficiently and effectively as well as some helpful tools to assist in the process.
- And in the last third of this guide, we will take you through the best methods for making your money work for you: how to handle investments, how to evaluate banking options, how to choose a financial advisor, and how to launch a small business as a method of money management.
What is Money Management and How do you do it well?
“Without frugality none can be rich, and with it very few would be poor.”Samuel Johnson
The term money management refers to all of the decisions and strategies involved in handling financial assets. If a decision has any financial consequence whatsoever then it lies within the domain of money management. Thus the field of money management is not just limited to what you spend money on but also how you spend that money–that is, do you spread out your purchases over months, or are you a splurge shopper? Do you spend roughly the same amount each year, or have you been known to break the bank some years while being frugal other years?
All of these questions are crucial to the world of money management. In fact, some of the most financially successful take this philosophy to the extreme and believe that every aspect of human life has a component of money management–such that everything from relationships to how you spend free time should be evaluated by its financial merit. In this guide we will take a more tempered and practical approach, and while we believe ‘time is money’ and therefore each passing moment of life has a financial component, we also believe that certain aspects of the human experience are more important than financial gain.
Here are some of the primary goals of proper money management
- Financial gain – When you manage your money well, the hope is that you can leverage your current finances to increase financial returns in the future, either through return on investment, better terms on credit cards or loans, etc.
- Financial mobility – The idea here is that when you manage your money well you will be able to make financial decisions more quickly and handle life events more effectively, such as paying for a medical emergency or being able to seize on an opportunity in the stock market.
- Financial Preparedness – A prerequisite to financial mobility is the financial preparedness that allows one to leverage financial resources to make things happen. Financial preparedness primarily comes from financial planning and budgeting.
- Financial Security – When you are in control of your financial life there is a large amount of stress that can be removed from life, which would have otherwise been spent worrying about retirement or the potential for a medical emergency. When you are financially prepared for all of the “what ifs” of life then you do not have to stress about them.
What are the 4 Most Common Approaches to Money Management?
Money management encompasses a vast array of personal philosophies and financial etiquettes so that it can mean very different things to different people. In order to build a strong understanding of the different approaches to money management, let’s look at some of the most prominent schools of thought–both effective and ineffective:
- Money Management as Debt Alleviation
Unfortunately there are a large number of Americans who view money management as a response appropriate only for emergency situations. This philosophy equates to “there are no problems while you have money.”
Practitioners of this philosophy believe that one should only consider managing money when there is some financial problem that needs to be overcome, such as an empty bank account, increasingly high loans payments, or staggering debt payments.
This approach to money management is popular among young people who have not yet come across a financial challenge that cannot be remedied by hipfire problem solving. And sadly this approach is likely only abandoned after these individuals learn the hard way that money management is a slow and consistent process.
- Money Management as Savings Accumulation
A more prudent approach to money management is working to increase the amount of savings you have in your accounts. The reason why this is a more practical and effective approach is because it involves a number of responsibility-checks in order to succeed at this effort. To increase your savings you will not only want to look into ways to increase cash flow, but you will also want to decrease expenditures.
For this reason, budgeting and financial planning are both crucial endeavors in this type of money management. This is also one of the best focuses for those new to money management, because it is readily rewarding. Sometimes all it takes to convince someone of the value of money management is to see savings account balances multiply before their eyes.
- Money Management as Crisis Aversion
This approach is a rational version of the ‘money management as debt alleviation’ philosophy. This approach to money management involves disproportionate application of money management principles in response to the demands of the present. Most Americans probably fall within this category.
These individuals will budget themselves furiously if they are in-between paychecks, but will splurge their accounts dry if they find their accounts in excess. Holidays and vacations are saved for religiously but they result in savings accounts being emptied in order to enjoy them to their fullest.
In other words, these individuals exercise just enough money management so as to not run themselves into financial problems, however their approach causes much stress because they are rarely ahead financially, and thus will constantly have to adapt their budgets to given needs of their current situation, which will vary radically over time.
- Money Management as a Way of Life
The approach to money management advocated for in this guide is to incorporate it into your daily life and thought process. This philosophy operates as a more levelheaded approach than the money-obsessed approach where every decision should be evaluated for financial gain. Instead of making every decision based on its financial outcomes, we suggest that you only maintain awareness of the financial component of each event in your daily life, only letting it sway your decision making process if it aligns with your personal goals and morals.
If you want to make a financially challenging decision to take a more expensive vacation in order to reward the hard work of you and your family, then do it–but just maintain awareness that you are briefly choosing to live outside your means. When you adopt money management as a way of life, it gifts you the freedom to make rare ventures into luxuries that you might not normally be able to afford–as long as the events remain rare.
Not only this, but by applying the principles of financial responsibility to your daily routines, you alleviate all the stress that comes from not being prepared for life’s changing circumstances, or in the worst case an emergency situation. Similarly, when you commit to a consistent effort in managing your money responsibility, you reduce the burden of having to take that on larger doses of responsibility in response to financial unpreparedness.
In other words, if you commit to this way of life not only does money management become easier but its effectiveness multiplies as well. You can view this approach to money management as the fulfillment of an ethical duty to one’s self and one’s family–to make the most out of each dollar and thereby choosing the path of greatest reward, most security, and least stress. In this approach frivolity is replaced with frugality almost entirely–the operative word here being ‘almost’ with such frivolity limited to a rare reward for continued diligence.
Important Terms and Concepts in Money Management
“Money, like emotions, is something you must control to keep your life on the right track.”Natasha Munson
Let’s go over some important terms and concepts. Here is a glossary of terms and some of the most prominent concepts in personal finance. You can print off this page and check mark the terms you want to better understand. You’ll find the definitions in the section below in alphabetical order.
Glossary of Finance Terms
- 529 College Savings Plan
- Adjustable Rate
- Annual Interest Rate
- Bear Market
- Bull Market
- Cash flow
- Checking Account
- Compound Interest
- Debit Card
- Debt Load
- Discretionary Expense
- Financial Advisor
- Fixed Expenditure
- Flexible Expenditure
- Garnished Wages
- Interest Rate
- Joint Account
- Money Market Account (MMA)
- Mutual Fund
- Net Worth
- Power of Attorney
- Savings Account
- Tax Return & Refund
- Trust Fund
Glossary of Definitions
401(k): This is a tax-advantaged retirement account where individuals may deposit a pre-authorized amount of money from each paycheck into the account, which will be matched either partially or in full by the employer. These funds are not taxed until withdrawal in a standard 401(k).
529 College Savings Plan: This is the most popular tax-advantaged college savings account, where individuals can purchase tuition credits at participating universities for the current price of tuition paid towards future enrollment. This is a great option for parents who want to avoid massive inflation rates of tuition or for adult students who are saving for future enrollment.
Adjustable Rate: This term refers to a mortgage or any other form of a loan with an interest rate that is subject to change in response to economic fluctuations and events. (Adjustable rates are not typically viewed as a good thing, as they can end up blindsiding consumers in times of economic trouble.)
Annual Interest Rate: This term refers to the interest rate set by a loan or credit contract in terms of annual percentage-based fees on account holdings.
Appreciation: This term refers to an increase in market value of an asset over time, and is commonly used in real estate or other markets subject to large fluctuations.
Assets: An asset is any thing, physical or immaterial, that carries financial value or significance such as a car, office supplies, or a website.
Bear Market: An economy during a period of recession when stock values are dropping, which makes it a risky time for stock market investment.
Bonds: A fixed income-instrument in the form of a loan made by an investor to a borrower.
Bull Market: An economy during a period of thriving and growth when stock values are rising, which typically makes it an ideal time for investments.
Cash flow: This term typically refers to the amount of money coming into your accounts after taxes and all other expenditures.
Checking Account: A checking account is the most common form of banking account used for daily activities. While it does not accrue much interest, it is also highly affordable to move and withdraw money.
Compound Interest: Refers to interest that takes into account interest accumulation, so that 10% compound annual interest on $100 would equate to $110 the first year, but $121 the next year.
CPA: Stands for someone who is a certified public accountant. These professionals help individuals manage money and oversee correct filings of important financial documents and procedures.
Debit Card: This is the most common expense card used by Americans, and functions as a direct withdrawal from your checking account and therefore usually carries minimal fees.
Debt: Any outstanding payments owed on a loan or expense.
Debt Load: The sum total of all debt that you owe.
Depreciation: The reduction in market value of an item usually due to wear and tear over time.
Discretionary Expense: This term refers to expenses in a budget that are not necessary or essential to the budget. Discretionary expenses are optional expenses that you choose to spend your savings on and constitute ‘wants’ more than ‘needs’.
Financial Advisor: These professionals advise individuals on how best to manage their money, and help formulate budgets, plans, and investment ideas.
Fixed Expenditure: Any expense that remains constant despite level of activity, such as a gym membership or in most cases house rent.
Flexible Expenditure: Any expense that fluctuates according to activity, such as electric bill, grocery bill, etc.
Garnished Wages: The wages taken from a paycheck that go toward debts or a lien.
Income: The rate of a salary earned in a given period through employment or an occupation.
Inflation: A rise in the costs of items in a market coupled with the falling purchasing power of the currency.
Interest Rate: The proportion of a loan, or its outstanding balance, that is charged proportionately as a percentage referred to as interest rate.
Traditional IRA: Individuals deposit tax return deductions into an account to grow without taxation until the funds are withdrawn in retirement, when they may be taxed in accordance with the current tax bracket of the retiree, which is often a lower tax bracket than when the money was originally deposited therefore saving money in the long run.
Joint Account: A bank account that is held by 2 or more persons, which allows both depositing and withdrawing of funds for any person on the joint account.
Levy: A creditor withdraws money from a checking or savings account in order to cover any credit card debt.
Liability: A liability is anything a person or business entity owes and can take the form of loans, accounts payable, deferred revenues, bonds, warranties, and any other outstanding balances.
Lien: A lien is a form of guarantee on a loan where the debtor offers ownership of a possession of financial worth until the loan is paid off.
Money Market Account (MMA): A money market account is an account with features of a savings account and a checking account and is designed for larger sums of money that needs to be accessed semi-regularly, as it these accounts usually come with checks and a debit card but only allow a few transactions a month and have high requirements for minimum deposits and minimum account balances which are balanced out by interest rates higher than the average savings account.
Mortgage: A mortgage is the type of loan secured to purchase a home and is commonly spaced out over 15 years or 30 years.
Mutual Fund: This is a type of financial vehicle which pools financial resources of investors into an account to be invested in stocks, bonds, or other money market options.
Net Worth: Net worth is the value of assets a person or business entity owns after deducting the value of any liabilities.
Overdraft: An overdraft of funds is when you charge an account in excess of the funds in the account, and thus the bank covers the charge in the ‘overdraft,’ which is usually accompanied by a hefty charge.
Power of Attorney: This refers to the classification of contractual agreements which extend legal autonomy to a lawyer, financial professional, or trusted loved one in order to allow them to make financial decisions or sign contracts for the individual for whom power of attorney was given.
Savings Account: A savings account is a bank account intended to be used to build savings over time, and thus has steep limits on number or deposits, withdrawals, and minimum balance. In exchange, savings accounts usually come with slightly better interest rates.
Securities: A security is any financially tradeable asset and is primarily categorized into debt securities (such as banknotes and bonds) or equity securities (such as stocks).
Stock: Also known as equity, a stock represents a security in the form of a fraction of ownership of a company or corporation and consequentially carries a fraction of that company or corporation’s financial value.
Tax Return & Refund: The yearly or quarterly filings of personal financial dealings to the IRS meant to cover any and all forms of financial gains or loss, which in some cases may result in a tax refund if an individual has overpaid in the process of withholding too much money from paychecks or in overpaying on the return itself.
Trust Fund: A trust fund is a legal entity that can hold a property on behalf of an individual or a group until certain variables are met, such as a beneficiary coming of age or meeting other obligations outlined in the terms of the trust.
Yield: This term refers to any funds generated by an investment within a given period of time.
How to Understand Personal and Small Business finance
The amount of money you have has got nothing to do with what you earn. People earning a million dollars a year can have no money. People earning $35,000 a year can be quite well off. It’s not what you earn, it’s what you spend.”Paul Clitheroe
Now that you’re equipped with a solid understanding of basic financial terms, let’s start building a more vivid picture of money management. To understand personal and small business finance in America let’s look at some top-down statistics and trends in America. Before diving in though, it is important to note that these trends only represent an overview of American behavior. As such these statistics should not discourage you, as you are always free to avoid the problems outlined below. (Sources include: U.S. Census Bureau’s American Community Survey, Federal Reserve Report on Economic Well-Being / Consumer Finances, and data from the Bureau of Labor Statics.)
Statistics on Net-Worth (median values)
Net worth refers to the sum value of assets held by an individual or family minus the sum of all outstanding debts. The median family net-worth is $97,300 while the average is $692,100, which is a figure skewed by the uber wealthy families of America. That is why we will proceed with statistics based on median values, which give a more accurate picture of finances for most Americans.
Net worth by age
- <35 years old – $11,100
- 35-44 years old – $59,800
- 45-54 years old – $124,200
- 55-64 years old – $187,300
- 65-74 years old – $224,100
- 75+ years old – $264,800
Home-ownership and Education Level
- Home owners’ net worth – $231,400
- Renters’ net worth – $5,200
- High School Education – $67,100
- College Graduate – $292,100
Statistics on Americans Income
According to the United States Census Bureau, the median household income for Americans is $60,336 as of 2018 which marks a 2.6% jump from the previous year. This represents the first increase in adjusted income to a point past the pre-recession high of 2007. That’s a slow recovery. Some parts of the country recover more quickly than others, such as the median household income dropping to $43,469 in West Virginia and soaring to $82,372 in District of Columbia though much of this gap is proportional to cost of living in each area.
Income by Age
- 16 – 24: $30,108
- 25 – 34: $42,380
- 35 – 44: $53,716
- 45 – 54: $52,884
- 55 – 64: $52,884
- 65 and above: $45,604
Statistics on American Spending and Budgeting Behavior
As mentioned in the introduction of this guide the strength of the American economy is not the subject of our concern, rather it is the money management skills of Americans that rouses worry. According to a BLS consumer spending report published in April 2019, Americans with a pre-tax income of $73,573 are spending $60,060 annually.
The operative word here is ‘pre-tax’ which means that after tax income is likely less than the figure of expenditure, meaning Americans are just spending more money on average than they have coming in year over year. This is a huge red flag, as it indicates a lack of preparedness for economic challenges such as those we have now been faced with in the coronavirus gauntlet. Let’s look at the various components of American spending.
Components of Spending
- The above figure represents a 4.8% increase in spending from the previous year
- 10% increase in spending on entertainment
- 12% increase in spending on education
- Spending figures left only 18% of income to pay taxes or contribute to savings
- Housing makes up 33% of all spending followed by transportation at 16%
- 70% of all spending on healthcare is directed towards health insurance
Perhaps most alarming though is how prevalent it is in American for one to spend beyond their means. According to a NFCS survey from FINRA, only 40% of respondents spend less than they earn and a whopping 38% openly admit living paycheck to paycheck. What’s worse is that 18% of respondents reported that they spent more money than they made. Out of all respondents only 39% said that they would be able to gather $2,000 in the case of a serious emergency.
All of these problems can be attributed at least in part to the following fact. Most Americans do not follow a budget at all. According to a 2016 study from the U.S. only 41% of Americans followed a budget of any kind. This leads to problems where Americans are unable to differentiate between types of expenditures. For instance 43% of all spending on food was spent on take-out or restaurants, which represents an extreme level of frivalty amidst such irresponsible spending habits.
Statistics on Savings and Retirement
“He who will not economize will have to agonize.”Confucius
One of the most important reasons to establish a budget is in order to build savings and save for retirement. The reality is that many Americans are foregoing this responsibility altogether. According to a 2018 study GoBankingRates, the numbers are staggering and In this case the statistics speak for themselves:
- 58% of Americans had less than $1,000 in a savings account
- There is a gender divide here: 62% of women had less than $1,000 in savings
- 53% of men had less than $1,000 in savings
- Millennials are doing better–with only 26% having nothing in savings
Perhaps the most damaging trend is that Americans are not prioritizing retirement accounts like they once did. In 2017 the Center for Retirement Research reported that the median retirement savings are well below recommended amounts. Shockingly only half of American households have any retirement savings in a 401(k) or IRA. That is not to say though that some Americans aren’t saving, so let’s look at median household retirement savings by age group:
- 35-44 years old: $40,000
- 45-54 years old: $97,000
- 55-64 years old: $135,000
According to Northwestern Mutual’s 2018 Planning and Progress study, many Americans believe they are ill-prepared for retirement with nearly half (43%) expecting to outlast their retirement savings completely. Similarly 55% of Americans believe that they will have to work beyond age 65, which is the typical age of retirement. Both of these groups are likely influenced by the growing number of individuals who simply are not saving for retirement at all. According to the study, about 21% of Americans have no retirement savings account at all.
How do you Make a Budget?
Many financially aware individuals will elevate their money management game by making a budget. So now that we have laid the foundation in understanding basic terms of finance, let’s look at one key to money management: budgeting. There are many schools of thought on how to best approach the budgeting process, but before diving into the most popular budgeting techniques, here are some basic steps you can follow to create a functional budget for your personal finances or small business.
- Establish net income
- Calculate monthly cash flow minus expenses.
- Catalogue expenditures
- Organize your expenses into categories and track the expenditures in each category such as utilities, groceries, marketing, discretionary expenses, etc.
- Set financial goals and performance benchmarks
- Determine what financial goals you want to hit and then break these goals down into reasonable short-term performance benchmarks.
- Create on a plan of action
- Use the information from your income and expenditures in order to understand past financial behavior and then predict this behavior for the coming year. Make a plan to adapt this behavior in order to meet financial goals and short-term benchmarks.
- Select the most important variables to actualize the plan
- Determine the most important components to meeting short-term benchmarks, which might mean reducing expenditures in certain categories or increasing expenditures in areas with high return.
- Schedule budget updates
- Annual budgets run into problems when they become disconnected from the evolutions of personal finance or small business, which is a problem totally avoided if you schedule regular budget updates and amendments–commonly addressed quarterly at the time of other financial filings.
Let’s look at some of the most industry-common approaches to making a budget and the strengths and weaknesses of each. While a professional in the financial sector could probably write a dissertation on each of these approaches, this will certainly bring you up to speed for the purposes of this guide.
- Incremental Budgeting
The definition of this budgeting approach is insinuated by its name, and represents a conservative approach to budgeting doled out incrementally. In this approach, the budget is calculated by comparing percentage growth or decline from one period to another and then increasing or decreasing budgets according to this percentage.
Pros of this budgeting strategy
This approach represents an exceedingly simple option for individuals or small businesses looking to create a quick and easy budget. And considering you really only need financial performance records to get started, the barrier to entry is very low.
Cons of this budgeting strategy
The drawbacks are that this type of budget cannot adapt to rapid changes in the market, or any larger trends in the economy, and relies instead on slow and steady changes. For this reason, many individuals and businesses who used this strategy were hit hard during the 2008 economic collapse.
- Performance-based Budgeting (PBB)
This approach involves setting result-oriented outcomes that focus organizational efforts towards reaching these outcomes accordingly. This is a more intensive and advanced budgeting approach because it involves setting challenging but achievable performance goals. While this style can work with smaller businesses and individuals with a singular occupation, it is designed to benefit most organizations or individuals with multiple operative branches or occupations.
If performance goals are met, those responsible for the success will earn some sort of reward outset in the budget If performance goals are not met, the budget may be adjusted to shift funds away from underperforming areas of the organization.
Pros of this budgeting strategy
The strengths of this approach are in its function as a strong driver of growth for individuals with many professional projects or organizations with many branches. In this way, setting a PBB budget can compensate for lack of leadership directives. So if you are in a period professionally or financially where you need some direction, this can be a great option.
Cons of this budgeting strategy
The downsides are fairly evident: this approach requires a deep knowledge and understanding of finance in order to set realistic and productive performance goals, and not only this, but it also requires diligence and effort to focus one’s efforts specifically toward meeting budgeting goals amidst meeting all the daily needs of normal business routines. In other words, this approach just won’t be everyone’s cup of tea, particularly if there is any disagreement about what constitutes the performance goals set.
- Activity-based Budgeting (ABB)
This approach involves calculating the costs of all predictable financial activities for a business or individual. To make these calculations, you will want to catalogue all the various expenditures that come on a regular basis in order to discern what benchmarks need to be hit. A simplified example of this would follow this process:
- Catalogue expenditures: such as monthly rent, groceries, and other costs–$3,000 monthly in this example which equates to $36,000 annually.
- Contextualize these expenditures in terms of benchmarks: If you are paid bi-weekly, you will want to save ($1,500) from each paycheck, or if you are paid more sporadically you will want to cover benchmark costs first before moving on to savings or discretionary expenditures.
Pros of this budgeting strategy
The strengths of this approach are in its simplicity and focus. Anyone can create this type of budget for their personal finances or business simply by cataloguing expenses past and present.
Cons of this budgeting strategy
The larger and more complicated the business the more demanding the workload of upkeeping this type of budget. For this reason an ABB budget can be expensive when outsourced or time-consuming if managed by an individual.
- Rolling Budgeting
In this approach to budgeting, quarterly budgets are refined and redirected as financial variables change. This is the most extensive approach to budgeting efforts as it requires a dedicated awareness of business developments and how to properly adapt to them. Rolling budgets are appropriate for individuals and businesses alike, but will be most fitting in situations where a business or individual is subject to frequent forces of change in the marketplace–as a rolling budget’s primary purpose is adaptability.
Pros of this budgeting strategy
The strength of a rolling budget is in its adaptability to changing circumstances, so this approach can drive financial growth when financial needs are not only recognized but resolved through meeting the demands of the market particular to each need.
Cons of this budgeting strategy
A rolling budget requires constant updates in order to reflect the evolving needs of a financial venture, which constitutes a time consuming process for even experienced financial managers and will likely constitute a steep challenge for individuals or business owners.
What is Debt / Debt Load?
“Too many people spend money they haven’t earned, to buy things they don’t want, to impress people that they don’t like.”Will Rogers
Debt is a term used to describe a person or business entity’s outstanding payments due on a loan or payment agreement. Understanding debt is a crucial part of understanding how to budget and manage money effectively. Unfortunately debt is not just a financial term to learn, the financial debt problem in America is concerning to many economists.
- American households hold over $13.6 trillion in debt.
- The most common kind of consumer debt is a mortgage (over 64%)
- As such only about 35% of Americans own 100% of their home’s equity
- Other prominent forms: student loans, credit card debt, and automobile debt.
- The sum total of all the money you owe across all debt types is known as debt load.
Debt is not always a bad thing however, many financially successful individuals engage debt cautiously in such a way as to gain financial leverage they would not have had in assets alone. In other words, debt is a crucial variable of the American economy that allows Americans to increase their buying power in a short period of time. How many Americans would be able to afford $300,000 homes if banks did not off home loans?
With debt being the necessary evil that follows the ability to loan, the most prudent advice will be not to how to avoid debt entirely, but how to manage it once you have it. Only the most financially blessed will be able to avoid debt while still maintaining the mobility needed to grow and succeed in the modern economy, or those who avoid it out of some strict ethical code.
So let us be clear. With the right money management skills and financial planning, debt can become an easily managed part of your budget that allows you to either grow financially through taking on loans for an investment, or to make life moves such as buying a house or going to college. With that being said let’s look at some of the national trends regarding average household debts:
- Average credit card debt per household is $6,741
- Average automobile debt per household is $27,630
- Average mortgage debt per household is $185,591
- Average student loan debt per household is $47,634
While debt has certainly become ubiquitous within American finance, experts argue that certain debt indicators function as red flags for the overall health of the economy. There are two major concerns in this regard.
- The total household debt of $13.67 trillion represents a 7.8% jump from the previous debt-peak, which occurred in 2008 during one America’s most vicious recessions.
- Mortgage debt totals at $9.2 trillion, which many economists worry constitutes another impending real estate crash.
Another potentially worrying component of rising debt is the burden placed on up and coming generations, who are entering the job market with tremendous amounts of debt. In many cases students find it challenging and sometimes unreasonably difficult to pay back these debts. Let’s look closer at some of the relevant figures from the Federal Reserve Report on Economic Well-being.
- The average of student loans is $32,741
- The median of student loans is $17,000
- This means there is a disproportionate spread of student debt, meaning a smaller group of students are taking on high dollar loans.
- Approximately 42 million students have student loans higher than $100,000
- Students often accrue thousands of dollars in debt to pay for other aspects of their education such as book fees, room and board, or groceries.
The problem of students having trouble paying back their loans is a pressing issue. Millions of students have an outstanding balance on their student loans with around 19% of students being significantly behind on them. 5.5 million students have found their student loans in a state of default, which constitutes an outstanding loan value of around $120 billion. This is a staggering amount of financial assets to have hanging in the balance, and many economists worry that this could cripple America’s economy if too many students fail to pay back their student loans.
6 Steps to Manage Debt Effectively
- Do not even consider taking out a loan, or accruing debt in general, until you have made a budget.
- Make sure that you have a solid understanding of your budget and can answer these questions: is my budget subject to large changes in the next 1 to 3 years? Do you expect a steady cash flow and predictable expenditures within that time?
- Your confidence in the results of step 2 will predict which types of loans are within your grasp. So that if a mortgage is out of the question you might consider loans on the other end of the spectrum such as credit card or automobile loan: even amidst turbulent budgets, it might still be prudent to take on a credit card so long as you have the savings and income to safely manage it. Even within these categories there is tremendous variation, so just decide on a comfortable amount.
- Once you have decided on a desired loan, calculate its interest payments into your budget and confirm that you have plenty of cushion for discretionary expenses and emergency situations. You can calculate your debt-income ratio to quickly assess the viability of a loan. (Interest payments on loans are due rain or shine, so you must confirm that you will be able to cover them even if life should go awry.)
- Once you have concluded you can comfortably afford the loan, do not forget to dive deep into the fine print of the loan’s terms.
- After securing your loan, set up your bank account to automatically pay your interest down on a certain day each month. This will allow you to better predict the ebb and flow of your account balances, as well as ensuring you will not miss a payment by forgetting.
Another good tip here is this: no matter who you secure your loan with it will be helpful to ensure that you have set up as many points as contact as possible–sign up for additional correspondence such as paper, email, and phone calls. You don’t want to miss a payment or an account notice because you happen to not be at home, happen to be changing phone numbers, or get locked out of your email account.
Another point that likely needs to be made is that holding multiple debts can often be highly stressful to some individuals. If you are one of these people, do not be afraid to pay down a loan ahead of schedule in order to lessen the mental burden of such stress.
Top Tools and Resources for Better Money Management
“The price of anything is the amount of life you exchange for it.”Henry David Thoreau
Now that we have covered the basics of money management through exploring the topics of budgeting and debt management let’s look at some of the best tools and resources for taking money management to the next level. The first point here is that money management as a strategy is virtually identical regardless of your income bracket–that is, the same rules apply whether you’re managing $1,000 or $100,000. The differences lie in the scale of these strategies and the cadence of their execution. So with that established, let’s look at some of the best tools that will elevate your money management game.
7 Great Money Management Apps and Software Tools
This all-one in financial management app offers a wide array of functionality designed to keep you on top of your financial responsibilities. Track payment schedules, set budgets, and schedule account check-ins. You can sign up for free to see if it is your cup of tea with zero financial investment.
This app’s purpose is all in its name. It is designed to help you save money either as an individual or as a business, and offers a twofold goal–to assist you in alleviating debt and to save more money. This app definitely works, too. App users report saving an average of $600 over the first two months and a total of $6000 in the first year. Even with a stellar record and concrete results you can download a free trial to ensure it’s what you need.
This app functions as a low-cost alternative to a traditional financial advisor. It generates personalized recommendations and helps you to organize your budget with actionable goals and obtainable performance benchmarks. This can be a great option for someone who wants to get started quickly but doesn’t want to hand over the reins completely to a financial advisor.
This software tool covers a vast array of money management needs–everything from debt management, to investment coaching, and budget design. While these services do come with a price tag, they do represent some of the industry’s most well-known and reputable software. If you know exactly what service you want taken care of then Quicken might be just what you need.
BankRate offers a host of traditional financial management services as well as some unique software tools and apps. There are a number of resources listed on the website itself as well, and acts as an excellent jumping off point for anyone looking to get a better grasp on specific skills involved in money management.
This free-to-start app is designed to help you create your first budget within 10 minutes of signing up. Every Dollar is all about organization of finances as a method of creating actionable budgets. Beginner and experienced budget-makers alike will find tremendous value in Every Dollar’s offerings.
Located on both the Google Play and Apple app stores, Plan Mode is one of the most comprehensive and easy to use financial planner apps we have found. You can create multiple profiles, financial variable tracking, and payment schedules. There’s much more you can do with this app, in fact, its creative interface enables you to track and/or organize pretty much any aspect of your budget or finances that you can imagine.
6 Great YouTube Channels and Podcasts
Sometimes the best resources are those that are free and easily accessible. YouTube influencer Marko offers a channel based entirely around offering balanced and actionable financial management advice. He covers specific topics in quick guides, delivers quick rankings, and even offers investment advice.
Ryan Scribner offers a YouTube channel that is designed specifically with the purpose of introducing newcomers to personal finance and investment. His material is user-friendly and delivered in both bite sized formats and more comprehensive presentations, and thus offers an excellent resource option for those of beginner and intermediate experience levels in financial management.
Bigger Pockets offers a multitude of tools, books, and other resources to cultivate financial knowledge and understanding. Most notable of these in the context of this guide is the Money Show podcast. These podcasts offer extremely valuable and highly focused advice through interviews with successful influencers–usually honing on one subject and covering it in depth. Thus this can be an excellent resource for anyone looking to dive into a specific area of money management.
This YouTube channel is owned and operated by CFA, Joseph Hogue. His approach is angled more towards American families and the unique financial challenges faced in managing debt and responsibilities. Household financial management is often quite a bit different from personal financial management strategy, so if you are looking to learn how to better budget your family’s lifestyle look no further.
The Financial Diet is a YouTube channel designed to facilitate and elevate financial management for beginners and intermediates alike. Content takes the form of bite-sized list videos, rankings, and quick style guides. This content is an excellent option for individuals looking to learn a lot quickly.
As mentioned earlier in this guide, women are reportedly more challenged in their efforts to increase savings. For that reason we are listing this great YouTube channel that is designed specifically to help females cultivate more frugal shopping habits.
Great Money Management Websites
Erin Lowry is a renowned personal finance expert who has gathered her knowledge into several books, but most importantly she offers a wealth of knowledge on her blog. She covers a range of topics that will be helpful to anyone looking to learn more about financial management. The information she presents is helpful to individuals at all experience levels–from beginners to experts alike.
Typically known as a collection of legal sites, Nolo also offers a collection of guides and materials based on money management. individuals looking for a free and easy start to money management should look no further. The legal background of its authors also provides a much needed legal perspective to the mix, which is helpful for anyone involved in small business to explore.
5 Tips for Better Money Management
“Don’t think money does everything, or you are going to end up doing everything for money.”Voltaire
Now that we have covered some of the best tools and resources for upping your money management game to the next level, let’s look at some tips for how to make the best use of them–or how to make the most out of your money management efforts. Unfortunately personal finance is much like psychology in that what works for some might not work for others. Personality plays a key factor just as much as the specifics of the individual’s actual finances. Despite this fact we have come up with some tips that should apply in just about any situation and the reasoning behind each tip.
- Consider setting one of these goals
- Establish an emergency fund
One of the most important functions of a budget is to ensure that you will have the money you need in the case of a true emergency. So with this in mind, use your money management tools and skills to create a plan to save up money in an account that is specifically for the purpose of emergencies.
- Save for a vacation
For beginners, one of the problems with strict money management is that there is no tangible reward early-on. Watching savings multiply is reward enough for many, but for others they need to be able to feel the results of their efforts. For this reason, starting a budget in order to save for a vacation is an excellent way to start budgeting, while still being able to directly enjoy the fruits of your labors.
Of course it will not always be feasible to save for a vacation amidst other budget goals, but as a first goal, this is a great starting place.
- Set benchmark rewards
Much like the previous suggestion, an excellent way to ingrain budgeting habits is to reward yourself for their successful execution. So factor in a reward into your budgeting. These might mean placing a higher percentage of your discretionary income into the budget, but it will also make hitting your budget benchmarks more meaningful because it will also entail a reward of some kind.
We suggest monthly rewards as a fancy dinner for you and your significant other, or a weekend getaway with friends.
- Understand your financial situation
- Set your priorities
Two individuals with the exact same financial profile might have vastly different approaches to money management depending on what phase of life they are in and their priorities. For this reason successfully executing on a budget plan requires a firm understanding of your priorities.
For instance, if you are not yet a homeowner but you want to buy a home in the next ten years then you need to start saving immediately. Buying a house is one of the most monumental financial responsibilities you will ever undertake and as such requires proportionate preparedness for the task.
In short, your financial behavior should mirror your real world priorities. If you set priorities but all of your savings poor into discretionary expenditures then you may need to reevaluate your priorities.
- Measure Progress
Similarly, if you set a savings account to save for a house but you find that you have only saved a few hundred dollars of the course of several years, then you need to reevaluate either your budget or your priorities, or both. Measuring your progress towards meeting budgeting goals will you better understand yourself and your true priorities, which might not be clear upon first examination.
- Invest in a financial advisor
- Time is money
In the above section we listed some of the top tools and resources to help you in managing your money. The truth is however, many individuals will not have the time or the motivation to carry this through to its most successful conclusions. But this is not a bad thing and in many cases it is better to pass off the responsibility to a financial advisor who would have better results anyway.
- Know yourself
Much like how you will have to know your finances in order to successfully manage your money, you will also need to know yourself. Specifically you need to know whether managing a budget and putting in the work to constantly improve yourself matches your personality.
It is not a bad thing if it doesn’t but it is crucial to know the difference. Running a budget halfheartedly can be almost as detrimental as running none at all. The money you will save by more successfully managing your money will pay for a financial advisor many times over. So do not worry about the expense if you know a budget will save you money.
- Pay off high interest debts
- Not all debts are created equal
As we explored in the debt section, there are many different kinds of debt. The worst types of debt come with a high interest rate, which equates to losing large amounts of money throughout the debt’s lifespan. For instance many predatory student loans end up multiplying original loans, so that students end up paying two to three times the amount of their initial loan.
Similarly certain credit card debts involve tremendously high interest rates and can easily cripple one’s finances if ignored. With this in mind, you can save yourself large sums of money by nipping high interest debt in the bud.
- Use tools of financial leverage
- Get a credit card
A credit card is a necessary evil in many ways. Though if you are ready for the responsibility they can be a great tool for opening doors in a financial context. Credit cards not only increase one’s financial mobility, but they also lay the foundation for future success.
We will dive deeper into this in the next section, but one of the best methods for establishing a good credit score is by successfully utilizing a credit card. And a good credit score is crucial for landing approval for the best loans, which will be highly rewarding when it becomes time to secure a mortgage.
- Secure a small business loan
Small businesses are often viewed as risky and time consuming, but in many cases they represent ideal investment opportunities. Not all small business operations have to be full-time endeavors, and in fact, it is usually these that represent the most risk, because placing all your eggs in one basket is inherently risky in our world of rapidly evolving markets and changing industries.
Anyone interested in making their money work for them should consider investing in a side hustle. You can invest with either your time or money, or both depending on your situation. Many times a side hustle becomes just enough income to boost your finances into a place of more comfort and less stress, so that you can actually start saving and stop living paycheck to paycheck.
How to Use Credit Cards Effectively
“There is no dignity quite so impressive, and no independence quite so important, as living within your means.”Calvin Coolidge
As discussed in the sections above credit cards are risky things in the wrong hands and can lead to tremendous debt with high interest rates. In the hands of a financially responsible individual however, a credit card becomes a crucial tool for financial mobility and success.
- Start Small
Credit card contracts come with terms of all sizes from the enormous interest rates and fee structures to smaller more affordable options. Credit cards are least risky when you are most confident in your ability to afford fee structures, so the best way to ensure this confidence is sto start with a smaller introductory type of credit card.
Even if you already have a more advanced card that you find challenging to keep up with it can be worthwhile to pursue a downgrade. Not all credit card companies offer upgrade and downgrade options, but if they do, it should be viewed as a major strength of the company.
- Do your research
Not all credit cards are created equal. Some credit cards have more punishing fee structures combined with lighter interest charges and vice versa, while other credit cards pursue a model that attempts to offer balance throughout its terms.
Similarly some credit card companies are designed more towards accommodating small businesses rather than individuals and others are not equipped to handle the demands of small business at all. In order to find out which group a credit card caters to, talk to credit company representatives but also read customer reviews.
- Establish your needs
Beyond catering towards small businesses some credit card companies offer perks and rewards designed to accommodate businesses with a larger organization. These companies offer perks like a company credit card, employee rewards, or cashback options.
All perks can look appealing when shopping around, but try to establish an understanding of your credit card needs. Are you simply looking to build credit? Are you purchasing a credit card specifically for one type of transaction such as flying or grocery shopping? Make sure the credit card you get is designed specifically for your needs. There are just too many options available to justify anything else.
- Pay off account balance regularly
Nearly any problem associated with a credit card can be avoided entirely by simply paying off your account balance monthly. While credit limits are in place to allow users some flexibility here, just about everything in the industry points to the value of paying off your balance as soon as possible.
Credit scores can tank if you max out your credit card for too long and some lenders might even have fee structures that penalize it as well. If you are confident in your ability to pay off balances monthly you will be able build credit faster and more safely than most Americans, giving you a quick leg up in your personal finance game.
- Build credit
Your credit score is the type of thing that you might just forget about or not care about at all until it is the most important thing in your life. Do not let this situation creep up on you. Credit scores are designed to be slow moving but highly reactive. In other words, they are very difficult to build and too easy to lose.
Building credit should always be a top priority for you when shopping for credit cards. Even if you have good credit it can be better, and the rewards of great credit are just too impressive to ignore.
Making your Money Work for You: A Quick Guide to Investing Well
“An investment in knowledge pays the best interest.”Benjamin Franklin
If you follow this guide and learn to effectively manage your money, the end-goal is that you will become financially comfortable enough to shift some of your funds away from savings and into investments–where ideally your money can grow for you overtime. The quote above describes, investment can take many forms and many of them won’t follow the traditional conception of stocks or business investments. Sometimes the best investment is yourself–deepening your education, building a skill that can elevate your career, or simply investing in your own business.
With that being said, the stock market is a resource that since its inception in 1792 has provided tens of millions of Americans with financial security and in many cases high financial reward. To get an idea of the stock market’s value to American, take a look at these stats:
- The global stock market is estimated to hold a value of a staggering $80 trillion and thus represents one of the single most valuable financial systems in existence.
- The current stock market has been on a 10 year record, a bull-run which has made many individuals rich (we are not yet sure how the coronavirus will affect this.)
- The United States holds about 40% of the total stock market worldwide.
- Despite this only about 10% of American households have international stock assets.
Despite the tremendous value of the stock market and the multitude of relatively low-risk opportunities, many American families (almost half) are just too intimidated by it. Just over 52% of Americans have money in the stock market. This indicates a lack of investment activity which many financial advisors will seek to remedy if you ever work with one. So let’s look at some quick tips on how to invest in stocks.
- Know yourself: Are you able to invest yourself or will you need help?
Before starting you need to understand whether you are taking the DIY approach to stocks or if you will need assistance. This is an important question to ask because many financial advisors offer some form of investment coaching or even full-on investment management.
So if you are also working on your money management capabilities, then you can kill two birds with one stone. Otherwise you will have the option of working with a stock broker of your choosing. Be sure to look into whether your investment coach is comfortable with the level of control and input that you want to have. And remember that are “robo-coaches’ as well–automated and fairly advanced bots which can collect data and calculate strategies for you (though these might be better for when you are more comfortable with the stock market.)
- Open an account for your investing projects
Before sending your money off to be invested you will need to open what is called a brokerage account. The initial money required to open these accounts is usually miniscule. The real expense is in hiring an investment manager, though if this expense is intimidating you can work with a robo advisor for a fraction of the cost.
If you would consider your initial investment aims and goals as very basic, then a robo advisor might be the best option. With a robo advisor though you will need to be more hands-on and thus will need to have a stronger foundation of investment knowledge and skill.
- Establish a budget early and commit to it
Do not fall into the trap of being seduced by investment and remember that if it sounds too good to be true it probably is fictitious, or at least exaggerated. If investment was easy and not risky more Americans would be doing it. Avoid these financial trappings by setting your investment budget early and not budging.
It should be noted here that responsible investment advisors will not push newcomers for higher or more risky investments. If you experience this the best option is probably to walk away and find a new advisor.
- Evaluate your options: stocks or mutual funds?
Mutual funds represent a grouping of companies where buying into the fund represents an exchange of an investment for small pieces of ownership of each of the companies in the fund. Mutual funds are often praised for their ability to mitigate the risks of investing in single companies by balancing the ebbs and flows of the market by spreading investment between companies that will respond to different market fluctuations, thereby lessening the chance of losing your investment.
Individual stocks represent an exchange of investment for a small portion of ownership in a particular company. These stocks are often the most risky and the most rewarding as you can invest heavily in a company that is demonstrating financial excellence. The risks however, are in placing all your eggs in one basket where they run the risk of all breaking at once.
- It’s the long-game over the short-game
Warren Buffet, arguably the most successful investor of all-time, and he advises all Americans to get involved in the stock market. However he urges all investors to keep their eye on the long-game and to only invest in companies that have demonstrated continuous long term success.
While these companies often come with higher buy-ins that reflect the security of the investment, even large companies can grow larger. Such explosive growth has been seen in countless tech giants like Google and Apple. So while it may be tempting to hunt down the next up-and-coming Google, sometimes it is best to just invest in the horse with the best record.