One of the most important life skills that you can develop at any age is financial management. This is an area that many people struggle with and end up in a financial hole that is very hard to get out from. However, it doesn’t have to be so, money management is not rocket science. It is something that all of us can get better at no matter our level of income. You don’t have to be good at Maths or even stress much about it.
We can agree that we all need money in one way or another. Money helps us meet our basic needs. That is, we are able to have food on our table, pay/facilitate proper housing for our shelter, and for our clothing. Money also allows us some life pleasures, for example, funding our leisure activities, vacation trips, paying for our education and that of our children, etc. In short, money is a means to an end to so many things needed for our survival.
Therefore, knowing how to manage your money is a life skill that everyone should have. This guide outlines some habits that you can adopt that will help you manage your money. We have also shared some manageable tips that will help you hack money management and put you on a wealth creation trajectory. . But before we get to the list of steps building up to desirable habits to manage your money, let us have a look at why it is important to learn how to manage your money.
Table of Contents
• Why is Money Management so Important?
• Steps to follow to effectively manage your money
• What is the 30-day rule in money management?
• What is the best method to use to clear off my debts?
• How to manage financial windfalls?
• Does money management means I become frugal?
Why is Money Management so Important?
There are so many reasons why it is important to have a good hold of your money and finances in general. Here are the main ones;
Meet your current and future obligations.
Having an effective plan for your money not only helps you meet your current money needs but also ensures you have enough money to meet future needs e.g your child’s college fees, vacation expenses, etc.
Cushion against unexpected events.
Sometimes life is full of so many uncertainties. You might lose your job (hence income), have a spouse who is the breadwinner die, a pandemic adversely affecting the economy could arise, accidents that can cost you so much money could happen, or any other unforeseen events. While you might not anticipate all these events, having a good money management plan (savings) can come in handy to cushion you for the money needed during such events.
Improves your net worth
To calculate your net worth, you have to get the difference between your total assets and liabilities. A figure below zero indicates you are highly indebted and your net worth is negative. One of the ways to improve this value is through growing your assets as well as minimizing your liabilities. The efforts to continuously grow your assets while reducing your liabilities are at the core of money management.
Avoid extra charges
When you are on top of all your money activities, you are able to properly plan for all bills that need to be paid up, prioritize them hence avoiding extra charges that may be in the form of penalties for late payment or interest.
Peace of mind
It is liberating to know that you are in control of your financial situation. Through a good money management plan, you are able to enjoy your work, vacation, retirement, and life in general since you have your money matters sorted.
Steps to follow to effectively manage your money
You should consider managing your money as a continuous process that helps you be in control of all your income and expenses. It might be challenging to start with but once you build a habit out of most of the steps, then it will get easier and better with time. Effective money management will mostly involve budgeting, saving, and well thought through the spending of your money. If you haven’t started already, follow the following steps to start an effective money management plan.
- Know your financial situation
- Have personal financial goals
- Draw up a budget
- Plan for your debts
- Eliminate nonessential expenses/debts
- Have an emergency fund
- Save for your future
- Use resources and tools to help you manage your money
Know your financial situation
Being familiar with your financial status is the best initial step in managing your money. You cannot manage that which you do not know. To start with, identify and record all your income and expenses. You will be surprised when you note them down. Most people can state what their income is for a given period but have no clue as to what their expenses for the same period are. What may seem harmless or insignificant such as groceries cost when summed up can become a very significant amount. Realizing this is a wake-up call that can make your need to learn how to manage your money more fitting.
So the biggest task in this step is to create a habit of recording all your expenses whether it’s in the form of saving up all cash receipts for everything you spend your money on (however trivial the spend may seem) or tracking the expenses from your bank/credit card statement. You can go ahead and categorize these expenses so that let’s say at the end of a given time period (e.g week or month) you can attribute certain expenses to groceries, utilities, subscription payments, insurance, etc. and identify areas that use up most of your money If you make your payments mostly using cash, you can try to make this a daily habit so that you do not leave out any item.
The goal of this step is to make sure that you create so much personal awareness of your finances so that if anyone asks you how much you spend on anything in a given time, you can state it clearly.
Once you have a clear record of what your income and expenses are, you are able to draw comparisons from previous records and create/predict a trend. This will assist greatly in budgeting as well as proper management of certain bills going forward.
You should strive to always have fewer expenses compared to your income. This way, you will be able to plan for your long-term financial goals such as paying off your debts, planning for big purchases, increasing your savings, etc.
Have personal financial goals
After you have had a footing of what your financial state of affairs is like, you are set to shape /determine what you want to accomplish with your money. These are your financial goals.
Spare some time to note down all your goals. These can be categorized as long-term financial goals e.g early retirement, purchasing a home, etc and short-term goals such as saving up for a weekend dinner date or minimizing the use of a credit card.
When categorizing the goals, it is a good practice to prioritize them based on factors such as their urgency or personal priorities and values. This will help in working towards achieving them. For example, someone may value spending quality time with their family over going out for a weekend trip. This may necessitate an increased expense in housekeeping services to free up their time. If the family is situated in another location, then an increased spend on transport cost can be justifiable.
Long term financial goals need not be shelved because of their lack of urgency. Always purpose to work towards achieving them alongside the short term goals.
Pro Tip: Set realistic and specific financial goals. This will not only make it easy to follow through with the plan to achieve them but will keep you focused when working towards attaining them.
Draw up a budget
Now that you have a good understanding of your financial situation and are aware of what your financial goals are, the next step is to come up with a budget.
A budget is important in managing your finances as windscreen wipers are to a vehicle in the rain. Consider the budget as your financial plan or blueprint towards good money management. A budget is the most crucial tool in money management. It enhances your plans to achieve your set financial goals. A good budget is future-oriented in that it will help you meet current money needs but is also geared towards enhancing your financial future. Without a budget, one may find themselves spending money carelessly hence failing short on their financial goals.
Most people have no problem creating a budget, the challenge is following it through. However, this challenge can be overcome by setting achievable goals, carefully planning them out in milestones, and being disciplined to faithfully stick through the plan. Break down your budget into weekly or monthly cycles for accountability. After each period, make it a habit to review your performance so that you can identify areas you improved on, those that you fell short in, and also to appreciate your efforts. Having a budget should not be a gateway to being mean to yourself and or others, it is to get you in full control of your money.
The following tips can help you stick to your budget;
1. Always plan out big purchases
Big purchases will have a significant effect on your budget. Think through them to ascertain if they are really necessary. Sometimes when you critically evaluate such purchases, you may realize that their benefits will be outweighed by the cost on your budget. Most big payments come along with payment plans that might take quite some time to pay off, these payment plans also have an element of interest or other additional costs. Planning them out in your budget can help you avoid such and also empower you to have the money to pay in cash.
2. Make it fun
Budgeting need not be miserable, neither should it refrain you from doing the things you like. You can make it fun e.g by appreciating your efforts through occasional rewards whenever you are successful in achieving your plans. The bottom line is, do not make it boring since it will demotivate you from continuing, make budgeting something you enjoy doing.
3. Have a flexible budget
Situations change and factors outside of your control can affect your budget e.g loss of a job hence income. Also, sometimes one’s priorities can change. Your budget should be cast on stone that it is not to be changed. A good budget is flexible enough to accommodate certain changes. You shouldn’t work for your budget but should actually let the budget work for you.
4. Find some workable hacks and tricks
Some day to day fun tricks and hacks can make budgeting fun and easier for you. For example; where possible, pay all your bills on the same day. This can be the case for recurrent payments such as rent and utilities. By doing so, you are able to account for most of your payments, make the payments in good time avoiding penalties and other related costs for late-payments and you can be sure not to miss out on any payment. You can also refrain from events/things/people that trigger you to spend money unnecessarily.
Another trick is to challenge yourself to a spending freeze or spend free days. For example, other than eating out, you can make your own meals, if possible take a walk/bike to save on transport costs, improvise on readily available resources other than buying, etc.
Some other hack can be in the form of slowly changing your mindset towards money. Having the money does not mean it is to spend all at once.
5. Paying the best price.
Thinking of payments in advance other than making impromptu purchases can save you some money. Sleeping over some expenses can help you avoid unnecessary costs. Also, you can make it a habit to check around for the best alternatives, compare costs to make sure that you are getting the best return for your money. This is not only in terms of the price but also consider quality and durability.
6. Make use of available tools and resources to help you.
These days there are so many good tools to help you out in budgeting. From basic tools such as an excel spreadsheet to advanced ones such as mint.com, these resources can help you create, organize, track your budgeting. Some of these applications are even capable of linking up your accounts to capture all your money in one place. You can also set up bank drafts to check off some payments from your income before you receive it.
7. Create personal rules
There is the famous Elizabeth Warren’s 50-30-20 rule on income. That you should spend 50% of your income on needs, 30% on wants, and 20% on savings. There is also the 30-day rule. These rules are to help you gain control of your spending.
Based on your financial circumstances, you can adopt these rules or create a personalized rule for yourself. For example, you can have a zero budget rule whereby once you allocate a certain percentage to savings then the rest of the income is used up on expenses.
The 50-30-20 rule explained in a video
8. Be realistic
Breaking your budget down into small achievable milestones and steps makes it more tenable and real. Avoid overstretching your budget in the name of savings and fail to meet necessary obligations. While it is good to be ambitious, always strive to work with what you have and with what is reasonably achievable.
Another way of being realistic is remaining true to yourself and learning to say no/not now/not today if your budget does not allow it regardless of what other people will say or are doing.
9. Find an accountability partner
It is okay to realize that you have a weakness in sticking through your budget. One way to work towards improving this is by seeking help from a spouse, roommate, friend, guardian, etc. Their help can be in the form of cheering you on, grounding you, and sharing workable hacks and tricks to keep you focused. For example, if you are married you can involve your spouse/partner in the budgeting process. This way you are both committed to your shared goals. Budgeting can actually save you from arguments regarding money.
10. Periodically review your budget
If you just create a budget and don’t look back at your past performance you may lack the motivation to keep going. Reviewing your budget also helps in ensuring that you are realistic and on track with your financial goals. Certain things may come up e.g areas that you need to work on, budget items that you need to revise, and also appreciate your efforts. During the review, you may also discover that there is a surplus from your budget which you can decide to channel to your savings, reward yourself or pay off a debt.
Plan for your debts
Sometimes it is unavoidable to get into debts e.g a student loan. However, one must always be conscious of the fact that debt comes at a cost in the form of interest payments, high penalty fees for late/no payments, and other lost opportunity costs. One should therefore strive to pay off their debts as soon as possible.
One of the ways of planning for your debts is exploring the options to consolidate all your debts into a single item that has a lower interest rate. Another way is through refraining to spend more than your budget allows so that you keep off any new debts.
The following are other habits you can adopt to keep off debts or manage your existing debt;
- Limit your use of credit cards. If you cannot entirely avoid credit cards, then ensure that you consistently make the minimum payment towards the card to avoid penalties.
- Have an emergency fund to cushion you against unanticipated expenses.
- Create a debt paydown plan which can be in the form of tackling one debt at a time and use the money designated to make repayments continually until all the debts are cleared.
- Work towards getting additional income e.g by getting a part-time job and channel that income solely for the purpose of paying off debts.
- Slash off some unnecessary budget items or hold off non-pressing expenses until all your debt is repaid.
- Where possible, save up on big purchases other than getting into new debts or payment plans and use cash in the purchases.
Properly planning for your debts will improve your credit report which positively impacts other areas of your life such as the rental lease you can get, insurance rates for your car, better employment terms, and future access to credit if necessary.
Eliminate nonessential expenses/debts
In the budgeting step, we mentioned that you need to review and evaluate your budget periodically. The review should be followed by the ways in which you can continually make your money management effective. According to Parkinson’s Law, the more you accumulate more money, the more your expenses will increase as well as your risk exposure.
The review is therefore very important to keep at bay the rising expenses. Keep on slashing inessential expenses and saving up on the surplus or using it to clear off your debts. Another way to eliminate unnecessary expenses is by making conscious efforts to avoid extra spending at all costs. For example, making efforts to be tax-effective can save you a significant amount of money. This does not mean refusing to pay up taxes (there will be consequences) but there are avoidable taxes such as saving through a pension scheme, making use of mortgage deductions, etc.
Have an emergency plan
Unexpected stuff happens and it is a good practice to always be prepared for the worst. For example, an earthquake could occur rendering you homeless, you could have a car accident that will require significant repair costs, you could lose your source of income, you could fall sick and require a considerable amount of money to clear off your medical bills, the list is endless.
An emergency fund will set aside some money that can cater for these unexpected misfortunes or any unplanned increases in expenses that have to be met. The fund is sustained by savings that you set aside for emergency situations and not any other need. To determine how much to maintain in an emergency fund, consult your budget to determine the amount of money you spend for survival or other items. For example, you can set aside what you use to maintain your upkeep for a month multiplied by 3-4 months. That is the ideal cushion for an emergency fund. However, you can top it up if need be to ensure that your basic life elements are not significantly affected until the situation causing the misfortune improves.
Some of the best practices of having an emergency plan are;
Having insurance covers is one way of taking care of unknown misfortunes. Some of the insurance covers are mandatory but even if they are not, it is advisable to have at least on the minimum;
- Health insurance for yourself and immediate dependants
- A homeowner insurance for your home/ renters insurance
- Auto insurance for your vehicle (s)
Contrary to popular opinion, an emergency fund need not be a savings account with little or no interest rate as well as prone to adverse inflation rates. While the goal is to create a financial cushion for let’s say at least 3 months, you will most certainly not require all the money in the fund at once. You can therefore consider having a tiered emergency fund.
A tiered emergency fund can be in the form of distributed savings in cash, government securities, a checking account, short-term money market products, etc. You will realize that less liquid assets have a fairly high rate of return but a limited access rate. These will be of great advantage to you if you make it out without the need to use the emergency fund. However, no matter the method/type of emergency fund you choose, make sure it meets the following criteria;
- The money in the fund must always be accessible especially when you need it. Otherwise, it beats the purpose to have an emergency fund and not a savings account.
- The fund must have a reliable return as well as low risk. You do not want to lose out on money saved for an emergency.
Save for your future
Retirement may seem far off but you may be surprised at how fast time can fly by. While the average retirement age for most people is 65 years, statistics indicate that the average American retires at 62 years. Very few people want to work until age 70 just because they did not save enough for their retirement. Most people want to enjoy their golden years in peace and enjoying their years of hard work.
In this guide Retirement calculator, we mentioned that the goal should be to save as much as you can towards your retirement. However, other than saving blindly, you should wisely select a plan that will maximize your retirement saving in the form of compounded returns. When deciding where and how to save for your retirement, consider retirement plans that allow you to defer taxes and that is not subject to income tax. You should also check the accessibility of the money saved should you choose to have an early retirement. The most popular retirement savings plans are;
- 401(k), 403(b), and 457 which are popular with employees as they are mostly managed by employers on behalf of employees.
- Individual Retirement Accounts (IRAs) and Roth Individual Retirement Accounts (Roth IRAs)
- Pension plans (Individual and employer plans)
- Long term Investment funds such as stocks, commodities trade, bonds, real estate, and mutual funds.
Click here to learn more about these plans, their differences, and tips about saving for retirement.
Pro Tip: Health costs such as mental health and other illnesses associated with old age can significantly affect your retirement savings if you are to meet them yourself. You, therefore, need to consider certain health insurance products early enough before your retirement. There are other schemes available such as Medicare which are available to retirees above 65 years.
Use resources and tools to help you manage your money
Today there are so many available resources in the form of applications and tools to help you manage money. With access to relevant information, these tools are able to do all the hard stuff for you as well as make smart suggestions for your consideration. To effectively use these tools, you first need the knowledge on how to effectively manage your money. You can find this knowledge in blogs, books, article guides, videos, and podcasts. Here are a few such resources;
What is the 30-day rule in money management?
The 30-day rule is meant to limit impulse spending. It states that if you want to buy something that you have not budgeted for, stop and sleep over it for 30 days. This period will enable you to critically evaluate if you really need to make the purchase, discover better price alternatives as well as plan out how that cost will be catered for in the current budget or next. Most of the time, by the end of the 30 days, the need to spend might have waned off. If it will be persistent then that means the item is necessary and by this time you have all the relevant plans and information to accommodate it in your budget.
What is the best method to use to clear off my debts?
There are two popular methods of paying off debts. These are;
- The Avalanche method prioritizes debts in terms of the interest rate. In this method, you pay off high-interest rate debts first and move on to the low-interest debt types. It is a good method since it saves you the cost of paying high-interest rates. If one is able to maintain the repayments made on the first debt on subsequent debts, they can clear off all their debts faster.
- Snowball method. In this form of payment, priority is given to small debts as you move to higher debt balances. This method is preferred by people who need a morale boost once they realize the number of outstanding debts is reducing at a faster rate.
Watch this vide to understand more about these two methods of clearing debt nd choose the best one for you.
How to manage financial windfalls?
Windfalls are big amounts of money that are unexpected. For example, you could win a jackpot, receive an unexpectedly large sum of money from an inheritance or a court settlement, etc. You should avoid counting on windfalls because you most likely have no control over them. Until the money becomes yours, that is when you can plan for it.
To start with, the moment the money from the windfall is in your account, try not to get overly excited about it that your judgment is clouded. Carefully take a considerable amount of time to think of a plan. For example, you can improve your retirement savings, pay off your outstanding debts, before you squander all the money. If you feel overwhelmed about it, it is also advisable to consult a trustworthy financial advisor.
Does money management means I become frugal?
Not al all, being good with your money doesn't mean you become frugal and avoid spending on what you consider fun. It simply means that you have planned for it and provided it within your budget but within your means. This way, you can still enjoy life's pleasures without getting into a financial hole.
Just like most good things, it takes time to learn how to manage your money. You do not wake up one day and voilà! find yourself good at it. With this in mind, work towards understanding your financial status as well as situation, have set plans and goals that you want to achieve then commit yourself to continually work towards the set goals until the habits become part of you.
Managing your money is such a personal initiative that cannot be transferred to someone else. It requires a lot of discipline and self-control. From the words of Jonathan Clements, “If you want to see the greatest threat to your financial future, go home and take a look in the mirror.” We cannot agree more. However, we are lucky that in modern times, there are so many resources to help you with this process. We mentioned that it is advisable to enlist the help of certain tools and resources to assist you in money management, put them to good use.
No matter the stage of life you are in, or the financial situation you are in, it is never too late/early to start managing your finances. In fact, the sooner, the better.