Unfortunately, personal finance has
not yet become a required subject in high school or college, so you might be
fairly clueless about how to manage your money when you're out in the real
world for the first time. If you think that understanding personal finance is
way above your head, though, you're wrong. All it takes to get started on the
right path is the willingness to do a little reading - you don't even need to
be particularly good at math.
To help you get started, we'll take a look at eight of the most important
things to understand about money if you want to live a comfortable and
prosperous life.
1.
Learn
Self Control
If you're lucky, your parents taught
you this skill when you were a kid. If not, keep in mind that the sooner you
learn the fine art of delaying gratification, the sooner you'll find it easy to
keep your finances in order. Although you can effortlessly purchase an item on credit
the minute you want it, it's better to wait until you've actually saved up the
money. Do you really want to pay interest on a pair of jeans or a box of
cereal? (To learn more about credit, check out Understanding Credit Card
Interest and our Debt Management feature.)
If you make a habit of putting all your purchases on credit cards, regardless
of whether you can pay your bill in full at the end of the month, you might
still be paying for those items in 10 years. If you want to keep your credit
cards for the convenience factor or the rewards they offer, make sure to always
pay your balance in full when the bill arrives, and don't carry more cards than
you can keep track of.
2.
Take
Control of Your Own Financial Future
If you don't learn to manage your
own money, other people will find ways to (mis)manage it for you. Some of these
people may be ill-intentioned, like unscrupulous commission-based financial
planners. Others may be well-meaning, but may not know what they're doing, like
Grandma Betty who really wants you to buy a house even though you can only
afford a treacherous adjustable-rate mortgage.
Instead of relying on others for advice, take charge and read a few basic books
on personal finance. Once you're armed with personal finance knowledge, don't
let anyone catch you off guard - whether it's a significant other that slowly
siphons your bank account or friends who want you to go out and blow tons of
money with them every weekend. Understanding how money works is the first step
toward making your money work for you. (To find out how to have fun and still
save money, see Budget Without Blowing Off Your Friends.)
3.
Know
Where Your Money Goes
Once you've gone through a few
personal finance books, you'll realize how important it is to make sure your expenses
aren't exceeding your income. The best way to do this is by budgeting. Once you
see how your morning java adds up over the course of a month, you'll realize
that making small, manageable changes in your everyday expenses can have just
as big of an impact on your financial situation as getting a raise. In
addition, keeping your recurring monthly expenses as low as possible will also save
you big bucks over time. If you don't waste your money on a posh apartment now,
you might be able to afford a nice condo or a house before you know it. (Read
more on budgeting in our Budgeting 101 special feature.)
4.
Start
an Emergency Fund
One of personal finance's
oft-repeated mantras is "pay yourself first". No matter how much you
owe in student loans or credit card debt and no matter how low your salary may
seem, it's wise to find some amount - any amount - of money in your budget to
save in an emergency fund every month.
Having money in savings to use for emergencies can really keep you out of
trouble financially and help you sleep better at night. Also, if you get into
the habit of saving money and treating it as a non-negotiable monthly
"expense", pretty soon you'll have more than just emergency money
saved up: you'll have retirement money, vacation money and even money for a
home down payment.
Don't just sock away this money
under your mattress; put it in a high-interest online savings account, a certificate
of deposit or a money market account. Otherwise, inflation will erode the value
of your savings.
5.
Start
Saving for Retirement Now
Just as you headed off to
kindergarten with your parents' hope to prepare you for success in a world that
seemed eons away, you need to prepare for your retirement well in advance.
Because of the way compound interest works, the sooner you start saving, the
less principal you'll have to invest to end up with the amount you need to
retire, and the sooner you'll be able to call working an "option"
rather than a "necessity".
Company-sponsored retirement plans are a particularly great choice because you
get to put in pretax dollars and the contribution limits tend to be high (much
more than you can contribute to an individual retirement plan). Also, companies
will often match part of your contribution, which is like getting free money.
(To learn more, see Understanding The Time Value Of Money and Retirement
Savings Tips For 18- To 24-Year-Olds.)
6.
Get a
Grip on Taxes
It's important to understand how income
taxes work even before you get your first paycheck. When a company offers you a
starting salary, you need to know how to calculate whether that salary will
give you enough money after taxes to meet your financial goals and obligations.
Fortunately, there are plenty of online calculators that have taken the dirty
work out of determining your own payroll taxes, such as Paycheck City. These
calculators will show you your gross pay, how much goes to taxes and how much
you'll be left with, which is also known as net, or take-home pay.
For example, $35,000 a year in California will leave you with about $27,600
after taxes in 2008, or about $2,300 a month. By the same token, if you're
considering leaving one job for another in search of a salary increase, you'll
need to understand how your marginal tax rate will affect your raise and that a
salary increase from $35,000 a year to $41,000 a year won't give you an extra
$6,000, or $500 per month - it will only give you an extra $4,200, or $350 per
month (again, the amount will vary depending on your state of residence). Also,
you'll be better off in the long run if you learn to prepare your annual tax
return yourself, as there is plenty of bad tax advice and misinformation
floating around out there. (To learn all about your taxes, visit our Income Tax
Guide.)
If meeting monthly health insurance
premiums seems impossible, what will you do if you have to go to the emergency
room, where a single visit for a minor injury like a broken bone can cost
thousands of dollars? If you're uninsured, don't wait another day to apply for
health insurance; it's easier than you think to wind up in a car accident or
trip down the stairs. You can save money by getting quotes from different
insurance providers to find the lowest rates. Also, by taking daily steps now to
keep yourself healthy, like eating fruits and vegetables, maintaining a healthy
weight, exercising, not smoking, not consuming alcohol in excess, and even
driving defensively, you'll thank yourself down the road when you aren't paying
exorbitant medical bills.
8.
Guard
Your Wealth
If you want to make sure that all of
your hard-earned money doesn't vanish, you'll need to take steps to protect it.
If you rent, get renter's insurance to protect the contents of your place from
events like burglary or fire. Disability insurance protects your greatest asset
- the ability to earn an income - by providing you with a steady income if you
ever become unable to work for an extended period of time due to illness or
injury.
If you want help managing your money, find a fee-only financial planner to
provide unbiased advice that's in your best interest, rather than a
commission-based financial advisor, who earns money when you sign up with the
investments his or her company backs. You'll also want to protect your money
from taxes, which is easy to do with a retirement account, and inflation, which
you can do by making sure that all of your money is earning interest through
vehicles like high-interest savings accounts, money market funds, CDs, stocks,
bonds and mutual funds. (Find out all you need to know about insurance in Understand
Your Insurance Contract, Five Insurance Policies Everyone Should Have
and Insurance 101 For Renters.)
A Financial Basis for Life
Remember, you don't need any fancy
degrees or special background to become an expert at managing your finances. If
you use these eight financial rules for your life, you can be as personally
prosperous as the guy with the hard-won MBA.