Introduction
Would you like to sort out your finances but don’t know where to begin? Well these are the first four steps I took to get my finances in order. By the end of these steps you’ll have figured out where you’re at currently with your finances, where you want to get to and set into motion how you’re going to get there.
Disclaimer
All information is not financial advice and is purely meant for educational purposes only. Investing involves the risk of loss of capital as well as its gain. Any investments mentioned on this website are meant as examples not specific recommendations. Always do your own research and/or gain the help of a financial advisor.
1. Assessing Your Net Worth
This is a great activity to find out where you are currently in your finance journey. You might have heard the phrase net worth in terms of the Forbes list where they dealing with the billionaires of the world. You’ll likely be working on a much smaller scale but don’t get disheartened as its a very useful metric to calculate. Net worth is easy to calculate by using the equation Assets take away liabilities. Assets are everything you have in terms of money saved up, investments, properties and big ticket items for instance cars, jewellery/watches or even art. Liabilities are what you owe this includes debt of any kind including mortgages, car loans, student loans, credit card debt and anything else.
For this exercise calculate a total for all your assets and a total for your liabilities. Take these away and voila you have your current net worth. For a lot of people they may be in the negative especially if they are still paying off a mortgage or just finished university. Don’t worry about it too much this is just to show your starting point and what you’re currently working with. I like to complete this exercise yearly so I can track my progress. As long as my assets are increasing year on year and my liabilities are decreasing they I’m generally on track. For this reason I also like to include my current salary for that year even though this doesn’t factor into the actual calculation. This helps me stay accountable with my current earnings and how I’d like to progress.
Recommended Reading: Understand what makes up the basics of a robust personal finance plan with The 5 Pillars of Personal Finance.
2. Goal Setting
Now you know what you’re working with its a good chance to set out what you want to achieve with your finances. Maybe you want to become debt free, save for a house deposit or aim for an early retirement. What ever it is, get those goals written down. I’d usually aim for three. Two short term so within 5 years and one being retirement planning. Personally I think everyone should have a general retirement goal no matter your age as the earlier you start the better. Do remember these are extremely personal to you so don’t just follow the crowd really think about what you want and what would be best for your situation.
When setting these goals be as specific as possible including a target figure and when you want to achieve it by. The more specific you are the easier it will be to identify an accurate figure and so create a plan around achieving it. Do not skip this step as without it it’ll be extremely difficult to set up a budget as you wont know how to allocate your spending.
3. Current Spending
Now we’re going to create a mini financial audit, assessing your spending from the last three months. This is a bit admin heavy but should be extremely enlightening for you. Firstly get out your last 3 months of banks statements or go through the transactions on your mobile banking app. Now establish your income for the three months calculating a total and a monthly average. Next, for all the outgoing transactions categorise them as essential or non-essential spending. Any money moved to savings or investments should be noted but not assigned as the whole figures will have been accounted in your net worth assessment.
Once completed you will have a good idea of your monthly spending habits including ways you could reduce your spending if necessary.
4. Budgeting
The final step is planning your budget. I’ll be going over this topic in detail in future posts but the way I like to split it up is into three categories. Living Expenses, Savings and disposable income usually aiming for a split of around 60/20/20. Designing a good budget relies heavily on your findings from both step 2 and 3. From step 3 you’ll know your current average monthly income and your essential living expenses. You can also add any other yearly costs you can think to your living expenses as their monthly cost. From your monthly living expenses is there any ways you can think of to reduce these? You can then minus this from your total monthly income to understand how much you’ll have remaining to split between savings and disposable income.
Prioritising your goals from step 2 are key. Are they feasible with your current income and within the timeline you set? If not can you extend the time saving, free up more to save from your disposable income/living expenses or increase your income. A little and often approach to many of the longer term goals is a good strategy when allocating your savings budget harnessing the compounding effect. This can allow you to prioritise towards your shorter term goals.
Any money you do not spend from your disposable income can either be saved for future months or added to savings/investments portfolio. Can you think of any areas to reduce your spending without heavily impacting your quality of life? The more unnecessary costs you cut the more you can save and spend on the things you can enjoy! Just remember the important thing is to find a balance that works for you.
Conclusion
I hope these steps helped you begin your personal finance journey or helped add value to your current plans. I currently use these steps yearly to help assess my current plans and it’s worked wonders for me. I’ll be looking into budgeting in more depth in the next post but any questions feel free to post a comment below.
