Many people follow financial rules that they create either consciously, or sub-consciously, meaning the rules we learned from our parents or other adults in our lives.
There are three financial rules to follow that have the most significant impact on your financial well-being. Are you following them?
- Pay off expensive debt
To get ahead, we must not carry expensive credit card debt. The rates charged on credit cards is often much more than you could ever even hope to earn on any investments.
The annual cost of credit card fees and interest charged in the US is estimated to be $104B and rising. $104B of under-utilised funds for millions of Americans.
The average amount of credit card debt in the U.S. is approximately $6,400. Even at a lower interest rate of 17% a year, (the average interest rate is 19.99%), this would take 169 months (over 14 years) to pay the principal amount back. The cost of interest over those 14 years is approximately $10,500.
Consider that if you increased your monthly payment by $20? You could forego a bottle of wine a month, or a few Starbuck coffees, the same amount would only take about 101 months, or eight years and four months to pay off. And, more importantly, your interest charges would be reduced by close to $5,000.
The above equations are the reason we suggest you start with paying off your most expensive debt first.
- Spend less than you earn
Some call this one “Pay yourself first”, and it seems like a no-brainer, right? Many of us are over-burdened with debt and fearful with the expectation of rising interest rate that we don’t follow the rule. If this is you, you need a plan to get out of debt.
The 50-30-20 rule-of-thumb applies 50% of your income toward necessities, like housing and bills, 20% toward financial goals, like paying off debt or saving for retirement, and 30% of your income to wants, like entertainment. Remember, this is a rule-of-thumb. The important thing is to bank some of your income.
Let’s say you save 10% of your take-home pay. If you take home $50,000 a year, you should be saving $5,000 a year or $417 a month. Just think, if you do this and it earns 5% after tax a year, that $5,000 can grow to about $65,000. Income earned and income on that income earned and reinvested is compounding your funds. You deposited $50,000 that is now worth $15,000 more.
When you are younger, paying off student loans and focusing on your net worth could be your focus. As you pay off those debts, say in your early 30’s, savings should become your top priority. The sooner you start with this good habit, the easier it will be to maintain it.
- You need an emergency fund
Experts recommend that everyone should have an emergency fund that can cover between three to six months of living expenses. This amount varies depending on how secure your income source is and whether there are any other sources of income in your home.
The Federal Reserve’s Report on the Economic Well-Being of U.S. Households in 2017, noted that 40 % of adults stated that if faced with a $400 unexpected expense, they would either not be able to pay it or would do so by selling something or borrowing money.
Imagine that panic, pit in your stomach, horrible feeling that a $1,000 bill might cause. If you had that easily accessible account with your emergency fund in it, you could pay off that bill without selling anything, or without incurring debt and related interest charges that put you further behind.
These three rules are not complicated and can become a money soundtrack in your mind. It might not be easy at first, but it is worth it.