Let’s be honest: Many people dread the thought of putting together a budget or creating a debt repayment plan. However, staying on top of your finances doesn’t need to be a cumbersome task. Our collection of tools enables you to manage your finances seamlessly. You can simulate debt pay downs to minimize interest expenses, track up to two years of payments, and view impressive visualizations of your expenditures (and that’s only the beginning).
Whether you’re just starting a career or trying to get out of debt, it’s essential to understand to core elements of personal finance. As they say, “you can’t build a great building on a weak foundation.” Personal finance revolves around budgeting, increasing income, reducing expenses, and saving for the future.
Are you ready to dive in and become a personal finance know-it-all?
Personal Finance 101: Everything You Need to Know
Personal Finance 101: A Final Glance
Create a Fine-Tuned Budget
Putting together a budget isn’t exactly thrilling, but it’s essential to meeting your long and short-term financial goals. A budget is an itemized estimate of your total monthly income and expenses. Your budget sets the stage for what you expect to spend each month – and hopefully has some cushion built-in for savings.
The best budgets have income and expenses organized into the following categories:
Income:
- W2 salary
- 1099 contractor payments
- Bonuses
- Dividends
- Money from side gigs
Expenses:
- Housing
- Transportation
- Groceries and eating out
- Utilities
- Entertainment
- Health
- Debt repayments
- Charitable giving
- Miscellaneous expenses
While it’s relatively easy to identify a budget’s categories, determining how much to allocate to each category is a bit trickier. Fortunately, there are various rules suggested by financial advisors that simplify budgeting.
50/30/20 Rule
The 50/30/20 rule is a relatively straightforward approach. Those who use this strategy allocate their after-tax income into the following categories: 50% to needs, 30% to wants, and 20% to savings or debt repayment.
By splitting your budget into the 50/30/20 rule’s three categories, you have a baseline that enables you to compare your actual spending and income to the budgeted amounts. After using this strategy for a month or two, you can effortlessly identify areas you need to cut back.
80/20 Budget Plan
Another popular budgeting technique is the 80/20 budget plan – a simplified version of the 50/30/20 rule. As its name alludes, the 80/20 budget plan lumps needs and wants into a single category while maintaining the 20% savings rule.
Those who find it difficult to differentiate between “needs” and “wants” inarguably benefit from an 80/20 plan. The general rule of thumb is to multiply your take-home pay by 20% and put those funds in savings as soon as possible. You then use the remaining 80% of your net income for expenses defined in your budget.
Envelope System Budget
Although some might dub the envelope system budget old-fashioned, it’s an excellent strategy for those who want to keep a close eye on their finances. Using this technique, you physically label envelopes with your budget’s categories and place cash inside them. After receiving your paycheck, you would refill the envelopes.
Given that society is becoming increasingly “cashless,” many people have swapped out envelopes for spreadsheets or mobile applications. Each time they spend money, they deduct the expense from the respective category. Even without envelopes, this strategy provides a holistic view of your overall finances, making it easier to avoid overspending.
Pay-Yourself-First Budget
In a pay-your-self first budget, your savings take center stage, essentially making this a “reversed” budget. You can follow the 50/30/20 rule and save 20% of your net income or take a more aggressive approach. Nevertheless, you need a solid understanding of your monthly expenses to avoid spending more than you can afford.
Why might one use a pay-yourself-first budget? Perhaps the most obvious answer is that it doesn’t require stringent categorizing. As long as you meet your savings goal and don’t overdraft your bank account, you don’t need to record every expense.
Maximize Your Income
Increasing your income, especially as you progress in your career, will help you pad your savings and achieve long-term goals. However, there’s a fine line between boosting your income and obliterating your work-life balance. As they say, “work smarter, not harder.”
Here’s a list of proven ways to boost your income without hindering your personal life:
- Look for a higher-paying job.
- Ask for a raise at work.
- Sell personal belongings you no longer use.
- Start a side hustle.
- Find a part-time job that you enjoy.
- Create a personal investment account (careful; you can lose money, too).
- Rent spare bedrooms in your house.
- Enhance your skillset and seek a new career.
If you start making more money, be mindful of lifestyle inflation. Simply put, lifestyle inflation is when your spending increases as you grow your income. You might be able to afford more luxuries, but your savings could stagnate or decrease.
Following your budget to a T is one of the most effective ways to mitigate lifestyle inflation. Carefully monitor specific expense categories, such as entertainment and groceries/dining out.
Minimize Your Expenses
Maximizing your income and minimizing your expenses is the perfect recipe to accumulate wealth and meet your financial goals. Nonetheless, many people are too busy with their careers and personal lives, leaving them with little-to-no time to cut current expenses.
Even if you have a lot on your plate, make way for a time to review your expenses and see if you can’t lower them. Our tools provide crisp visualizations of your spending, enabling you to find potential flaws in your budget.
You could potentially save several hundreds of dollars per month by following the below steps:
Consolidate Debt
No one wants thousands of dollars of debt to their name, nor do they want to spend a significant amount in interest each month. The grim reality is that the average American has $90,460 in debt. Be it credit card or student loan debt, managing multiple types of debt complicates your budget. Not to mention, you also run the risk of accidentally missing a payment and hurting your credit score.
The solution? Consolidate your debt into one loan. If you can get a lower interest rate, a debt consolidation loan can reduce your monthly expenses and the time it takes to pay your debt. Furthermore, you’ll have an easier time budgeting since you’re now just making one debt repayment each month.
Reevaluate Your Subscriptions
From Hulu to Disney+, the number of subscription-based services available to consumers has skyrocketed over the last decade. Meanwhile, these companies likely make millions from people who no longer use their subscriptions.
If you want to reduce your monthly expenses, you should review reoccurring subscription payments. Ask yourself: “how often do I use this service?” If you struggle to answer this question, it’s best to cancel the subscription. The typical consumer spends around $273 per month on subscription services. Cutting that number in half could lead to $1,638 in annual savings.
Our platform lets you view two years of transactions after you link your bank accounts, making it much simpler to pinpoint subscription payments. You no longer need to log in to multiple bank accounts and scroll through endless pages of bank statements.
Look for More Affordable Insurance
Your insurance (most notably car insurance) tends to increase year-over-year. You’ll also see significant premium increases if you have accidents or speeding tickets on your record. Switching insurance companies is often the best way to cut down your monthly car insurance premiums. Once you get a more affordable quote, you can apply for a policy or use it as a negotiation tactic. Your current insurance carrier might be willing to price match.
Prioritize High-Interest Debt
The general rule of thumb is that you should pay high-interest debt first when it comes to debt repayment. The reasoning behind this is straightforward: high-interest debt takes longer to pay down because a more significant percentage of your monthly payment goes toward interest instead of the principal.
Prioritizing high-interest debt is the driving principle behind the debt avalanche technique. Imagine that you have the following outstanding debt:
- $22,000 personal loan with an interest rate of 15%
- $10,000 student loan with an interest rate of 7%
- $5,750 credit card debt with an annual percentage rate (APR) of 19%
If you follow the debt avalanche method, you would first pay off the credit card debt because it has the highest interest rate.
Want to learn the most cost-effective way to pay debt? Our software features a debt paydown simulation that enables you to find the best ways to minimize interest expense.
Cut Back on Utilities
Utilities – namely electricity and natural gas – likely make up a significant portion of your expenses. For example, the average household spends $117.46 per month on electricity, according to the U.S. Energy Information Administration. Natural gas, on the other hand, costs around $100 per month.
There’s a handful of tips and tricks to help you save money on utilities:
- Run your dishwasher and dryer before in the evening before going to bed.
- Lower the temperature on your water heater.
- Use LEDs instead of incandescent light bulbs.
- Regularly clean or replace your HVAC filters.
- Don’t use heat when temperatures are no longer freezing (i.e., fall and spring).
- Unplug electronics when you’re not using them.
- Compare quotes to see if you can find a cheaper provider.
Take Advantage of Assistance if You Need It
If you find yourself barely scraping by, remember that there are various assistance programs at the state and federal levels. Benefits.gov is a one-stop shop for finding different types of aid, including disaster relief and healthcare and medical assistance.
Federal and state governments can help you:
- Secure education loans
- Put food on the table
- Pay for utilities
- Repay debt
- Receive childcare and child support
Note: You must meet income thresholds to qualify for many forms of government aid.
Plan and Save for the Future
Although we can’t predict the future, we can save money to handle whatever life throws in our direction. If you can master the art of budgeting, then you should have around 20% of your gross income left over for savings. While there’s a ton of reasons that people save money, some of the most popular includes:
- Short-Term goals
- Starting a family
- Retirement
Let’s dive a little deeper into each category and explore how to save your money strategically.
Short-Term Goals
If you’re saving something you plan to buy in the near-term (i.e., a house), you don’t want to risk losing the money. Most financial experts recommend putting your money in high-yield savings accounts, bonds, or certificates of deposits (CDs). However, if you plan to make a big purchase in the next month or two, you may want to keep your money in a regular savings account. Nevertheless, investing your money in a low-risk financial instrument will yield a greater rate of return.
Starting a Family
Starting a family is a significant investment. According to the U.S. Department of Agriculture, the average cost to raise a child through the age of 18 is $233,610. The average American woman has 1.7 children. If you do the math, parents pay approximately $22,063 annually or $397,137 over 18 years to raise their children.
Fortunately, there’s a variety of ways to save for children, including tax-advantaged accounts.
Emergency Fund
Everyone should have an emergency fund – not just parents. However, there’s a higher risk of unexpected expenses when you have kids. You should put three to six months’ living expenses in an easily-accessible savings account. Households with children tend to be more conservative and save six months’ living expenses.
Before you start prepping the nursery or buying diapers, make sure you have a padded emergency fund.
Health Savings Account (HSA)
The average delivery cost ranges from $5,000 to $14,500, which can take a pretty significant hit to your bank account if you haven’t met your annual deductible yet. Many soon-to-be parents use health savings (HSA) to help pay for the cost of childbirth. An HSA is an account that lets you put away pre-tax income for future qualified medical expenses (note: childbirth is an eligible expense). You can currently contribute an annual maximum of $7,200 if you have family coverage.
529 Plan
Time flies when you’re a parent, and before you know it, your little one will be strapping on a backpack and heading to school. You can contribute money to a 529 plan to help fund your child’s education expenses. Although you can’t deduct 529 plan contributions, you don’t have to pay taxes on gains. The IRS allows you to withdraw $10,000 annually to pay for education expenses, including tuition for private primary schools, secondary schools, and public and private universities.
Retirement
Many ask the question, “how much do you need to retire?” Although there’s not a particular amount, many financial experts say that you need to be able to replace 80% of your pre-retirement income. So, where does this money come from? Most retirees receive their post-retirement income from social security, retirement accounts (i.e., 401(k) plans and IRAs), and pensions.
Nowadays, most people use the following plans to save for retirement:
- 401(k)
- 403(b)
- Traditional IRA
- Roth IRA
- Employee stock ownership plan (ESOP)
401(k)
As pensions began to fade away, 401(k) plans started to become the norm. Many employers provide their employees with a 401(k) as a part of their benefits package. A 401(k) plan enables you to contribute a portion of your salary without paying federal or state income tax. At the same time, most employers will match your contribution up to a certain percentage.
The money in your 401(k) typically sits in various financial instruments, ranging from mutual funds to certificates of deposit. Most financial advisors recommend that you put your money in lower-risk instruments (i.e., bonds) as you near retirement.
Employees can currently contribute a maximum of $20,500 per year to their 401(K) plus an additional $1,000 if they’re at least 50. Note: the IRS frequently changes the annual limit, so it’s essential to stay aware of the most recent guidance.
You can withdraw money from your 401(k) penalty-free when you reach the age of 59 ½. Although money in a 401(k) grows tax-free, you must pay ordinary income tax on distributions. It’s also important to note that the IRS will assess a 10% tax penalty if you withdraw money from your 401(k) before you’re 59 ½.
403(b)
A 403(b) is similar to a 401(k), but it’s a retirement plan for employees of tax-exempt organizations. Although both retirement plans are incredibly similar, there’s a handful of key differences between the two. To begin, 403(b) plan holders can only invest their money in annuities and mutual funds. Those with a 401(k) can invest in the same financial instruments plus stocks and bonds.
It’s not as typical for a public school district or charitable organization, for example, to offer an employee match with a 403(b). If they offer a match, they must adhere to the Employee Retirement Income Security Act (ERISA).
Traditional IRA
Employers may provide employees with an individual retirement account (IRA), but they’re far less common than a 401(k). According to research conducted by Investment Company Institute, only 37% of households in the United States had an IRA. You can open an IRA through various financial services companies:
So, how does an IRA compare to a 401(k)?
The IRS allows you to contribute a maximum of $6,000 annually to an IRA and subsequently deduct your contribution on your tax return. Like a 401(k), the IRS lets you fund your IRA with an extra $1,000 if you’re over the age of 50. After putting money into an IRA, you have complete control over your investments. You can buy stocks, bonds, and mutual funds, to name a few. Moreover, you don’t have to pay taxes on gains – one of the most significant advantages of an IRA.
You must be 59 ½ and made your first deposit into the IRA at least five years ago to avoid a penalty when you withdraw money from the IRA. For example, if you made your first deposit when you were 57, you would have to wait until you’re 62 to avoid a penalty. You’ll have to pay a 10% penalty tax if you withdraw your money early. And since the IRS allows you to deduct your IRA contributions, you must pay ordinary income tax rates when you withdraw funds from your IRA.
Roth IRA
A Roth IRA is another tax-advantaged retirement account that’s very similar to a traditional IRA. There’s one main difference: you contribute after-tax dollars to a Roth IRA. Consequently, the IRS doesn’t allow you to deduct Roth IRA contributions from your taxes. Like a traditional IRA, there’s also a five-year waiting period with a Roth IRA, and you must be 59 ½ to withdraw without facing penalties.
Gains in a Roth IRA grow tax-free, and because you contribute after-tax dollars, you don’t have to pay taxes on withdrawals. However, if you withdraw your money early, you’ll have to pay a 10% penalty.
A Roth IRA is similar to a traditional IRA in that you can invest in various financial instruments – stocks, mutual funds, CDs, bonds, and so forth. Almost all financial services companies that offer traditional IRAs also offer Roth IRAs.
Employee Stock Ownership Plans (ESOP)
Many publicly traded companies offer employee stock ownership plans (ESOP). Like a 401(k), an ESOP is a retirement plan in the eyes of the IRS. In a nutshell, the employer purchases shares of its stock on behalf of the employee and puts the stock in a trust. An ESOP creates an incentive for the employees because their shares are worth more if the company performs well.
Employees who participate in a company ESOP don’t have to pay taxes until they receive distributions from the plan. Furthermore, they may not be entitled to all the stock right away. Many companies maintain vesting schedules, meaning that it takes a few years for employees to have full rights to their stocks.
Personal Finance 101: A Final Glance
Managing your personal finance can be overwhelming. From maintaining a budget to saving for retirement, there’s a lot to juggle. Fortunately, you’re not alone. We have a suite of tools that empower you to take control of your finances. Track your credit utilization ratio, receive financial alerts, simulate debt paydown, and more with our comprehensive platform. Now that you know the core elements of personal finance, it’s time to put your knowledge into practice.