Managing Your Money
While April has been traditionally designated Financial Literacy Month, reviewing your finances at any point during the year can be beneficial. Whether you have a detailed understanding of your household's finances, or you are looking for a quick refresher, below are some helpful hints for spending less money, saving more, or both.
Know Your Cash Flow
While many consumers have a good idea of how much money they make each month, fewer know how that money is being spent. To learn how to spend less and save more, it's critical to know where your hard-earned dollars are going - down to the last penny.
First, understand the relationship between your "gross" pay (before taxes and other deductions are taken out) and your take-home, or "net", pay (what's left after taxes and other items are taken out). Look closely at all of the deductions being taken from your gross pay - federal and state taxes, insurance, Social Security, employer's retirement savings plan, etc. If you receive a large income tax refund each year, that amount is being lent interest-free to the government. Instead, consider adjusting your exemptions so that fewer tax dollars are taken from each paycheck (it's a good idea to consult your tax advisor first or visit the IRS website at http://www.irs.gov/individuals/page/0,,id=14806,00.html to calculate your withholding amount). If you are contributing to an employer's retirement savings plan, be sure to note this deduction as "savings". The point of this exercise is to not only understand how much money is being taken out of each paycheck and for what, but to evaluate if any adjustments might be needed.
Once you have a good understanding of how your gross pay is impacted by various payroll deductions and taxes, take note of where your net pay is being spent. Review your checkbook registers, bank account, credit card and other financial statements to better understand your spending patterns. If you no longer have the paper statements, you may be able to request or access them online.
Another good exercise is to have your family record each purchase they make for 30 or 60 days. Not only will this provide good spending information, it will help raise awareness about the importance of effective money management. Be sure to record every expense - from recurring, larger expenses, like mortgage and auto loan payments, to smaller expenses, such as coffee shop purchases, to changing expenses, like annual insurance premiums or doctor visits.
When you've identified and recorded all household expenses, group them to better understand how much money is being spent in each category, including food, housing, clothing, transportation, healthcare and others. Using the Federal Bureau of Labor Statistics Consumer Expenditure Survey (link below), you can then compare your family's expenses against the average U.S. household.
Using the financial goals you have set for your family as motivation, make adjustments in how you are spending money, and consider redirecting additional dollars to savings or investments.
Your Credit Score
Any discussion about managing money wisely should include at least a brief mention about credit scores. Credit scores, calculated by credit reporting agencies based on information provided to them by creditors (such as lenders, utilities and service providers), are an indicator of the likelihood a potential borrower will pay back a loan on time. The higher the score, the better. FICO® scores, one of the most common credit scores, range in value from 300 to 850. Aim for a FICO score of 720 or higher - this will make it easier for you to not only be approved for loans and credit cards, it can also increase the chances you'll qualify for a lender's best rates and terms.
Information on your credit report, including credit scores, is not only used by lenders when reviewing potential borrowers' applications for credit - they also are used by potential landlords and employers, and even auto insurance companies when making underwriting decisions. If you have never seen a copy of your credit report, make it a priority to get one, even if you are not seeking a loan or credit card. The federal government allows all U.S. consumers the ability to receive a free copy of their credit report once every 12 months from each of the credit reporting agencies through a law called the FACT Act (the Fair and Accurate Credit Transactions Act). Your report is free, but you'll have to pay a nominal fee to also receive your credit score. Visit www.annualcreditreport.com to request your free credit report.
Some of the recent regulatory changes under the Dodd-Frank Financial Reform Law will ensure that free credit scores are provided to applicants who have been denied for credit. While these changes have not yet gone into effect for lenders, they will eventually assist you in understanding your credit score more thoroughly.
Once you have seen your credit report and credit score, be sure to visit YourMoneyCounts.com to help you further understand what they mean and learn how to manage them. In particular, the following links share information on how to strengthen your credit report and raise your credit score:
Set Goals and Save
While it can make you feel patriotic to help support the economy by spending money (and it certainly benefits the country's economic health when consumer spending is up), there is a time and place for everything. Make it your priority to ensure your family has financial goals and is saving and investing on a regular basis to meet those goals.
If your household has short-, medium- and long-term financial goals - good for you. If you do not have financial goals, make a commitment to set them. Goals can range from smaller ones that are a year or less into the future, to ones that may be 30 or more years away. Examples of each include:
- Saving for a down payment on a new auto in a year or two
- Saving for a newborn's college education
- Saving for retirement (even if it's 40 years or more away!)
- Saving for a vacation home or enough money to start a small business
Be sure your financial goals are detailed enough to translate into monthly action items. For example, if you are aiming to save $5,000 for a new car in three years, know that you'll need to save about $138 each month in order to reach this goal ($5,000 divided by three years, divided by 12 months in one year). Go through a similar process for each of your goals.
Finally, if you don't already have one, create an emergency fund that contains enough money to cover all of your monthly expenses, including mortgage or rent, for at least six months or more. The money should be saved in an insured, easily-accessible account (i.e., regular savings or money market account, certificate of deposit, etc.), that does not put your money at risk for loss.
Auto Pilot
One way to further enhance your money management efforts is to automate your finances. You can choose to have bills paid electronically on the same day each month to avoid forgetting to mail in a payment, which can hurt your credit score. You can also elect to have your paychecks deposited directly into a savings or checking account. And to help you save, you can even designate a dollar amount - $50, $100 or more - to automatically transfer from a checking account into a savings or investment account each month. This enables you to slowly and steadily build savings as well as avoid the temptation to spend money.
Review Periodically
Having a detailed understanding of your cash flow (the money coming in each month vs. the money being spent), knowing your credit score and what's on your credit report, and how much to save and invest each month to reach your goals are all very important, yet there's another critical step. Be sure to periodically review your progress toward your financial goals every six months or at least annually to compare how you are doing vs. the goals you've set.
Circumstances can change for the better or worse. Make adjustments as your finances change, either because there is more money coming in (due to a raise, promotion or even a reduction in spending) or more money being spent (due to unplanned emergencies). Doing so will help you and your family stay on track for achieving your goals.
Enjoy spring, enjoy Financial Literacy Month, and importantly, be sure your finances are properly tended to so they can fully bloom each year.
