Watching your finances can be challenging. The process requires time and discipline. Finances can be particularly difficult for college students and people who are starting careers. Your smart decisions about finance now can have a huge impact over your lifetime.
Create a plan
When faced with a challenging problem, it helps to have a plan. If you create a plan, you’ll build confidence that you can solve the problem. Your plan, in this case, is a monthly budget. One great resource to create a budget is the book, The Richest Man in Babylon.
Enlight provides a good summary of the main points in this book. The ability to “Pay Ourselves First” is an important concept. This term means that the first step in your budget is to set aside money in savings. Saving money is comparable to paying yourself.
Creating a monthly budget can be simple. Get out a piece of paper. At the top, write down your monthly income. For most people, that’s your paycheck from a full-time or a part-time job. Below your income, you’ll have three categories:
· Savings: This line item represents your savings for a particular month. As mentioned above, this category is your first priority. To avoid confusion, move your savings out of your checking account and into an investment account at the end of each month.
· Fixed expenses: These are expenses for rent, car payments, student loans and other costs that are fixed amounts. Your utility costs can also be included here. These costs aren’t fixed- but the amount you spend each month is predictable.
· Discretionary expenses: Your discretionary expenses are costs you control. This includes spending for entertainment, hobbies and vacation. If you spend money on coffee each morning, include that amount here.
Say that your monthly paycheck is $3,000 after taxes. You decide to save $200 of the total. If you save $200, your fixed and discretionary spending must be covered by the remaining $2,800.
Using credit cards
Many people use credit cards and pay on the balance each month. If you have a credit card balance, the payment needs to be included in your monthly budget.
Creditrepair.com points out the misconception that using credit is bad. People with this view don’t think they should use credit at all. In reality, carefully using credit can be a positive financial choice. If you use credit and make payments on time, you are building a credit history. A good credit history allows you to borrow larger amounts in the future. Individuals with good credit also pay less in interest.
If you decide to use credit, make sure that your monthly budget includes the timely payment of interest and principal. Also, keep in mind that the faster your repay principal (your original investment), the less interest you pay. Make sure that your credit card allows you to repay principal at any time.
The magic of compounding interest
Even a small amount of savings each month can accumulate into a large amount of money over time. Your savings can grow faster because of compounding interest.
Compounding interest refers to the fact that you earn interest on two types of balances. First, you earn interest on your original investment. Say, for example, that your $100 balance earns an annual interest rate of 4%. Your principal balance of $100 would earn $4 over the next year.
When your compound interest, you choose to reinvest the interest you earn. When you reinvest, you also earn interest on the interest payments. Using the same example, the investor has $104 after year one. If they invest the entire $104 at 4% in year two, the investor earns ($104 * 4%), or $4.16. The additional 16 cents in interest is generated by investing last year’s $4 in interest.
That’s the magic of compounding interest. The concept helps the saver accumulate money faster. Moneychimp provides a table you can use to learn more about compounding interest.
Financial decisions can be challenging. However, if you make smart choices along the way, the long-term payoff can be huge. Use these tips to get on track financially.