How to Better Manage Your Personal Finances in Six Steps
Setting up a personal financial system isn’t complicated
By Gregory Ostrowski, CERTIFIED FINANCIAL PLANNER®, CRPC®, Managing Partner, Scarborough Capital Management
Are you looking at your checking account and wondering where all of your money went? People often don’t realize how much they spend. With Starbucks on every corner, the convenience of Amazon shopping and unexpected expenses like emergency veterinary bills, it can be easy for your spending to outpace your income.
If you’re realizing that your current budgeting system isn’t working for you (or if you’ve yet to establish one), not to worry. Here are six steps you can take starting right now to get your financial situation back on track, covering everything from income and expenses, to savings and payments.
- Start with your income
Wait, why don’t I start with expenses? Isn’t that what we’re trying to keep track of?
Yes, but if you start with expenses you don’t know how much you have to actually spend. Establishing your income figure acts as a much better starting point.
I like to use a year instead of a month, as people may have fluctuating income when you factor in commissions or bonuses, or may work in seasonal industries.
Also, don’t forget, this is money you get to take home. Taxes don’t count. An exception to this is if you have money taken out of your check for a 401(k) or other retirement plan you can keep this in, since we’ll account for it in savings.
- Next go to expenses
How much do you spend in a given year? The reason I like to look at a year here is again the simple fact that while fixed expenses remain constant (think mortgage or car payment), our monthly variable spending can, well, vary…and by a lot. For example, the average person will spend more on gifts in December than in February.
To arrive at this number write down everything you spend on…and I mean everything. Groceries, clothes, a new leash for Fido. All of these things add up, and you should know how much they cost. This may even take you a couple of months to get a good handle on. That’s ok, just be patient and diligent.
Now, do you have enough income to cover expenses with some left over? If so, great! If not, see where you can cut, because if you don’t have any money going into savings, you’ll need to figure out a way to repurpose some of it there.
- Set up your savings accounts
The next step here is to allocate your savings. For simplicity, I’ve broken savings into four buckets. You should have:
- A contingency account – If you happen to lose your job or need to cover unforeseen medical expenses.
- A retirement account – This one is for your future self. It can be a company managed 401(k) or your own IRA…or both if you can handle it financially.
- Other people’s weddings/vacation account – This one is big, especially if you’re in your early to mid 20s. Expenses for other people’s weddings can add up fast and it’s better to save for them instead of trying to fit them into your monthly budget. Money you have left over you can send yourself somewhere. Don’t forget though, you may need to strike a balance. While it may be lots of fun to visit the Caribbean for a destination wedding, if your budget isn’t in great shape or you get an invite from someone who’s not a close friend, it may be better just to say no thanks.
Your own wedding/home down payment/rainy day fund account – Even if you don’t want to get married or own your own home, it’s a good idea to have an extra bucket just because. You never know what you may want down the road.
- Set up a budget tracking system
All of this planning is for naught though if you don’t manage your finances afterwards, and this is where a budget comes in.
There are several ways you can go about creating a system to track your income and expenses. One is a simple spreadsheet (or better yet, a shareable Google sheet if you and a significant other are now mixing income and expenses). Another way is to use budget tracking tools like Mint or Quicken. There’s even plain old paper and pen.
There are certainly pros and cons to any system you employ, and it’s ultimately up to you to decide what will work best. Just remember though, automated and hands-off isn’t always better. The more you let the software do, the less you may be able to learn about your spending and saving habits. While this may work for some, it may not for others.
When setting up your categories, you can be as general or detailed as you’d like, but again remember that you need to account for every purchase and also to allocate categories for saving.
While it does take a little bit of effort to establish and get comfortable with, the investment is well worth it. Time spent setting up or improving this system will be small as compared to what you may have to waste dealing with credit card companies and banks trying to get them to waive overdraft fees because you didn’t have enough to cover a bill.
In terms of actually tracking these purchases to make sure you’re on budget, there are a couple of ways to go. One way is to save physical receipts and enter them on a regular, frequent basis. If you’re not into paper, you can review your online credit card statements and enter totals from there. Also, getting invoices and statements sent to you digitally can ensure you won’t lose a bill behind the fridge.
This is kind of like going to the gym. You can’t do it once and expect to be done. It takes consistency and patience to see results.
- How to handle payments
Now that you have your system’s framework established, you can start making some actual transactions. The first thing you’ll want to do after your paycheck is direct deposited (yes, opt for this) is pay yourself.
How much should you be saving for retirement? I like to recommend to my clients about 15% of your gross income. If you have a company sponsored 401(k), money will be taken out of your account before you are paid. After that, pay your contingency and other accounts. Setting up auto payments is the easiest way to make sure this is done every month.
After paying ourselves, now we have to pay for things like our mortgage, car, phone, and any other purchases we’ve made. Again, setting up online billing and auto pay can save several hours down the road in fighting with companies and being put on hold because we were a day late for a payment.
- Reassess annually
Aside from keeping your expenses below your income, another great thing about having this system is that it allows you to make financial decisions based on actual history and not just guess about how much certain things cost.
If you track your spending for five years and see that you’re paying more and more for utilities, you now can take a more objective look to see how you might be able to save. It’s little steps like these that can save you a few hundred dollars in different categories each year, and over time if invested, those funds can grow to be significant.
While setting up a personal financial system isn’t complicated, it does take some work and effort. The question to ask yourself is, would your future self want your current self taking a few hours over a couple of weekends to do this? I think we both know the answer to that.
If you have any questions on your own personal financial situation or need help getting started, talking to a CERTIFIED FINANCIAL PLANNER™ professional can be a great first step.
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