Where do I start with personal finance?

As I mentioned in my last post, it can be tough to know where to start with personal finance. If we stick with a basic definition of making sure that our wants don’t outstrip our means, though, there are a few good first steps. Ultimately, personal finance is just that, though – personal. These are often the best places to start, but everyone’s circumstances are different. 

1. Do a budget.

Measurement helps! Just knowing what you spend on is an important first step, and is usually the best place to start in personal finance. I think people find this stressful because they feel guilty about how they spend the money, or think that their budget categories should be targets. Not the case. A budget is an exercise in information-gathering. It tells you where your money is going. Whether you want to change that or not is up to you, but the place to start is to keep track.

Budgets don’t have to be fancy. Some people swear by YNAB or Mint. I’ve never felt comfortable sharing my bank login information with another app, so I use an excel sheet where I record what I spend, and it calculates the totals. Find something that works for you. Then, do it for a month or two, so you have a sense of where your money is going. No judgment or self-criticism at this stage. Just track the money so you can be aware, in the same way that when you meditate, you stay aware of your thoughts without judging yourself for them.

2. Build an emergency fund

Now you know where your money is going. Next, you need to be ready for the unexpected. Too often, people plunge into investing or tax planning, without getting this basic step right. If your car broke tomorrow, do you have the cash available to fix it? If not, set up an account and start saving up until you could. Otherwise, small problems can snowball. If your car breaks, that might mean you miss work, so your income drops too, and suddenly you are really pinched. 

Common advice for an emergency fund is about 3-6 months of expenses, so if you spent $2000 per month, about 6-12k. That way, if you lose your job, you could be unemployed for a few months while you look for a new one. That might sound like a lot. If you’re starting from nothing, focus on getting the first thousand saved up to start, to cover broken cars, emergency home repairs, or other short-term expenses. My wife and I keep about 6 months of expenses available across the two of us in a savings account. That might be more we need, but it helps us sleep at night.

3. Pay down debt (at least high-interest debt)

Now that you have the basics down–a budget and an emergency fund–there is a bit more flexibility on what you might choose to do next. If you have an employer-match retirement fund, where for every $1 you save they save the same, then you might want to take advantage of that. If not, paying down debt is important.

Debt isn’t always bad: borrowing to pay for education can be worthwhile, and sometimes borrowing to meet a critical need is unavoidable (though better to have an emergency fund!). Borrowing costs money, though: you pay interest. If you’re trying to save more, reducing how much you pay on interest is a great way to reduce spending.

To do that, you have to pay down the debt. Not all debt is equal, though. Low-interest debt (such as student loans), may not cost you very much, and so may not be a priority. High-interest debt, though, such as credit card debt or car loans, is much more expensive.

There is no silver bullet for debt repayment, but two strategies to consider. The financially best strategy is the ‘debt avalanche.’ There, you pay down the highest interest debt first, while making minimum payments on the others. This shrinks your most expensive debt first, reducing your costs.

Equally valid though is the ‘snowball’ method. For this one, you pay off your smallest debt first. The idea is that lets you reduce the number of debts you have fastest, which many people find motivating. That may not be financially the best option, but it can be psychologically the best option. If that’s what helps you get out of debt fastest by keeping you motivated, then it may be the best option for you.

I had meant to cover more about where to start in personal finance in one post, NT, but I seem to have talked a lot already. I’ll break here, but tune in for another post to come on what to do after you’ve got your budget and emergency fund established, and at least your high-interest debts paid off.

What is personal finance and why does it matter?

When you think of Maslow’s hierarchy of needs, or Maslow’s mountain as I charmingly heard it called recently, you typically start at the bottom and work your way up. Without food, water and warmth, it can be hard to focus on prestige or fulfilling your full potential. For me, that’s why personal finance is so important: it gives you the space and freedom to focus on the rest of the mountain.

So what is personal finance?

A lot of people get intimidated by finance. It can seem technical, with a lot of knowledge of markets and business needed. I’ve heard people say they wish they could get into it but find it too hard, or that it’s not for them. If we think of personal finance as a proxy for freedom, though, I think it gets a lot easier. For me, personal finance is just that; it’s about trying to build up enough of a surplus that we are not subject to the vagaries of life’s fortunes. 

If we accept that definition, then two things follow: successful personal finance is about increasing how much we have in reserve, or reducing our needs. Neither of those needs to be complicated. There are plenty of complicated details à la tax optimization, interest rate deductibility, etc., but you can get it 90% right without much effort, and then decide if you want to put the time in to get the final 10%.

It’s more than just money

That definition also means it isn’t just about money. Personal finance is intertwined with ideas of environmental sustainability and reduced consumerism. It isn’t just about making as much as you can, but also about making sure you’re focusing on what’s important, prioritizing the things you care about.

Today, it’s trendy to talk about retiring early. That’s fine if that’s what you want, but that has never had much appeal for me. What I want is the option to retire early; the option to leave whenever I want. If you can’t leave, you are shackled. In contrast, if you know you can leave, then you can choose to stay for all the right reasons.

So much for the philosophy of personal finance, though it’s a topic I could wax on about at length. When you’re trying to get better at something, though, it pays to have concrete steps you can take. Implementation intentions, as they are sometimes referred to in the literature. Given this post is already a bit long, tune in to my next post for just that. You can expect talk of nest eggs, paying down debt, plugging leaks, budgets, and more!