“Where do I start? I want to get my financial life in order, but I don’t even know where to start!” I’m sure that sounds familiar to a lot of you. Getting started can be overwhelming, so we will try to lay out a basic framework for DIY financial management.
Step 1: Figure out where you’re at currently
Make a list of all your assets (bank accounts, investment accounts, real estate, etc.) and a list of all your liabilities (student loans, credit cards, car loans, mortgage, etc.). Now subtract your liabilities from your assets and that’s your net worth.
Step 2: Figure out where you want to be
Do you want to be debt free? Your answer should be YES! Do you want to buy a home? When do you want to retire? How much money will you need to retire at that age? These calculators can help you determine when you can retire and how much money you’ll need.
Step 3: Take a long hard look at your debt
If you have debt, look at your interest rates. High interest debt can be crippling for individuals and families trying to build their financial future. Start there and pay off high interest debt aggressively. We will go into more detailed strategies for getting out of debt in future articles, but if you have significant debt we recommend reading The Financial Peace Planner. Dave Ramsey is the king of getting people out of debt and is the ultimate authority on the subject.
Working towards getting out of debt isn’t sexy, but it’s 100% necessary. If you have significant debt, especially high interest debt, you need to be extreme about eliminating it.
Step 4: Learn about the investment options your employer provides
Does your employer offer a 401(k), 403(b), pension, or employee stock purchase program? If you have a 401(k) or 403(b) find out if your employer matches contributions. It’s common for employers to match $0.50 for every dollar an employee contributes up to 6% of the employee’s salary. In this example if an employee makes $50,000 annually, and contributes 6% of their salary, they would contribute $3,000 annually. Their employer would then contribute $1,500. Your $3,000 becomes $4,500 which is a 50% return! Where else can you get a guaranteed 50% return?
If your employer offers an employee stock purchase program (ESPP), do they have a discount or look back? Some of these perks can offer incredible built in returns, so make sure you educate yourself on what is available to you.
Step 5: Compare the potential returns to the interest rates on your debt
Should I just pay off my debt or invest money first? It depends… but you did the homework in steps 1 thru 4 to make figuring it out easy. If you have a 401(k) match that offers a built in 50% return through the employer match, it would be hard to find a situation where it doesn’t make sense to take advantage of that. But let’s say your employer offers a match that equates to a 5% return and you have credit card debt with a 19% interest rate. The math is simple, pay the debt! And be extreme, don’t pay the minimum, pay as much as you can every month. Cancel your cable, pack your lunch, and work overtime to pay that debt.
In short, it doesn’t make sense to invest money when you still have debt unless that investment has a guaranteed return, like a 401(k) match, or unless it’s very low interest debt like a home mortgage.
Steps 1-5 are a great start, but some you are already past that point. Stay tuned, step 6 and beyond are coming soon…