Financial independence starts with margin. That’s the extra breathing room you have in your budget that keeps you from panicking about money.
But in a sad statistic, Go Banking Rates reports that 58% of Americans have less than $1,000 in savings. If you’re in that category, and you don’t want to be, you can get out of it.
But it all comes down to learning the fine art of how to manage your money.
Since managing your money has so many moving parts, we’re laying out a roadmap in this article to help you master money management.
With greater knowledge and a willingness to commit to the strategies below, how to manage your money may not seem so mysterious anymore.
Table of Contents:
Determine Your Starting Point for Managing Your Money
Here’s an equation that’s the foundation of how to manage your money:
Accountants use it to calculate the net worth of businesses, but it also applies to individuals. You’ll need to be aware of your own personal net worth if you’re serious about how to manage money.
Example of Calculating Your Net Worth
Your personal assets include your:
- bank account ($5,000)
- house ($200,000)
- retirement account ($25,000)
Adding all three numbers together, your total assets are $230,000.
But you also have liabilities that include:
- mortgage ($180,000)
- car loan ($10,000)
- credit cards totaling $5,000
Your total liabilities are $195,000.
Your financial situation looks like this:
Net worth is probably the single most important number in your financial life. It indicates your overall financial position. It should be a positive number. The larger it is, the stronger your overall financial position.
However, it’s often negative. The more negative it is, the worse your financial situation is.
Before you can become better at managing money, you’ll need to start with determining your net worth. To do that accurately, you’ll need to use actual numbers. This is because some people cheat by using “ballpark numbers”, that inflate assets and underestimate liabilities.
Make a list of all your assets, assigning a reasonable value to each. Then list your liabilities. This is best done by taking the latest debt numbers on any loans you owe. Don’t leave any out either!
Once you total up your assets and liabilities, subtract the liabilities from your assets, to get your net worth. That’ll tell you exactly where you’re at financially.
If you don’t like the number you see, or any specific components, prepare to implement each of the following five strategies.
1. Make Money: The Most Critical Step
Before you can learn how to manage money, you’ll first need to earn enough to manage. Barely getting by is sometimes a necessary part of life. But in order to move forward, you’ll need to earn more.
Unfortunately, while budgeting can help, if you’re not earning enough to cover your bills and save and invest for the future, your progress will be very limited. That will need to change.
If you’re finding your current income is insufficient to pay your bills – with extra available to pay off debts and save money – your first challenges can be to increase your income.
Here are a few ideas on how you could increase your income to help you in your next steps of managing your money.
Increase Your Income At Work
Never overlook the obvious when it comes to making money. Look for opportunities to increase your income at work. That can include taking on overtime, participating in bonus programs, and even looking into any commission opportunities available.
For example, your employer may have programs in place where you’ll be paid bonuses or commissions for referring new employees or new customers. If so, take full advantage of both.
The other option is to create a second income. That can be a part-time job, but you should also consider developing a side hustle. That doesn’t need to be anything complicated either.
Think about what skills you have, either from your job or your personal life, that you can offer to either small businesses or to the general public to generate extra income.
They can be basic skills, like babysitting or lawn cutting, or it can be more specific skills, like web design, graphic arts, writing, editing, or becoming a virtual assistant.
Once you develop a second income, be certain the money is dedicated to either paying off debt or filling your savings account. It should never be used to increase spending.
2. How to Manage Money through Budgeting
If you’re serious about how to manage your money, you’ll need to create and work within a budget. Budgeting is simple in concept, but much more difficult in the execution.
The most fundamental idea is to rearrange your finances so that you live beneath your means.
For example, if your net income is $4,000 per month, you’ll implement a budget that will enable you to live on $3,500, or even less. That will give you the extra breathing room to pay off debt or save money. And that’s the whole purpose of a budget.
How to Start a Budget
Start by making a list of all your regular monthly expenses. Then track all expenses for the past several months.
That will accomplish two goals:
- It will show you exactly where your money goes, and
- Help you determine which expenses need to be either reduced or eliminated.
#2 is particularly important. How effective you are at this step will determine how strong your budget is.
If you’ve never had a budget in the past, it can be a difficult transition – almost like going on a diet. You may need help, and fortunately, you can get that help – often free of charge.
For example, there are free budgeting apps available through Personal Capital, Mint and Trim. You can aggregate all your financial accounts on these apps, and they’ll show you your entire financial picture on a single screenshot.
That will give you a visual representation of where your money is coming from, where it goes, and how you can reallocate it toward better money management. The app won’t redirect your money for you – you’ll have to do that yourself. But it will show you where to do it.
3. Save Money: It’s Not How Much You Make, It’s How Much You Save
This is critical to any attempt at improving your finances. The most basic benefit of savings is that it creates breathing room in your financial life.
For example, let’s say you get an unexpected car repair bill of $1,000. If you only have $200 in your bank account, you’ll probably panic. But if you have $10,000 in savings, the bill may be annoying, but it won’t threaten your lifestyle. Put another way, savings open up a lot more options in your finances.
That’s why savings are important.
You should have three primary savings goals:
- Emergency Fund: This is your most basic savings. Ideally, you’ll accumulate enough in this account to cover at least three month’s living expenses. It should be doing nothing more than sitting in a safe savings account, earning interest, and waiting for an emergency.
- Goal Based Savings: This is a type of savings tied to specific spending goals. They’re usually intermediate in nature, say two years, three years, or five years into the future. Goals can include saving for a vacation, the down payment on a new car, or replacing your roof.
- Long-Term Savings: The main savings type here is retirement. You should begin funding a retirement plan as soon as possible, to take advantage of compound investment earnings. You’ll usually get a tax deduction for contributions, as well as tax deferral of earnings. You should take advantage of both to the greatest degree possible.The best way to fund any savings plan is automatically. You can use payroll deductions to fund all three of the above account types. This is another reason why it’s important to make extra room in your budget through some type of budgeting plan.
4. Invest Your Money: The Key to Managing Money for Your Future
Savings are of course integral to better managing money and you wish that they would teach a great savings strategy in college! But it’s not enough to simply save money in a low interest savings account. That’s certainly fine when it comes to an emergency fund, or even goal-based savings accounts.
But for longer-term savings, particularly retirement accounts, you’ll need to invest your money to make it grow. The combination of regular contributions and steady investment earnings are how people become retirement millionaires.
For most people who know little about investing, the best way to do it is through index funds. These are something like mutual funds, except they’re based on popular investment indexes (markets), and carry much lower investment fees.
For example, you can invest in an index fund that’s based on the S&P 500 index. That index represents the 500 largest publicly traded corporations in the US. It will give you exposure to most industries in the economy. That’s an excellent place to start, because the S&P 500 index has returned about 10% per year on average going all the way back to 1926!
Some of the most popular index funds are available through Vanguard and iShares. You can invest in these funds through popular brokerage accounts, like Fidelity and Charles Schwab, two of the biggest brokerage firms in the industry.
The sooner you begin investing money, the more quickly your savings will grow. You should start as soon as you have some money available to do so.
5. Develop a Plan to Get Out of Debt
This strategy will depend on what your current debt situation is. If you have a lot of consumer debt, particularly credit cards, you’ll want to pay them off as soon as possible. The high interest rates they carry make them too expensive to maintain effective money management.
If you have student loan debt, you’ll want to eliminate that as soon as possible as well. It’s unsecured debt, and very long-term in nature. That means it can haunt you for years.
As you increase your income and improve your budget, you should allocate some of the additional room in your budget toward debt pay off. Since you also need to save money, you’ll need to find a workable balance.
Debt Snowball Method
There’s no need to engage in a crash pay off strategy. Just increase your monthly payment on each debt you want to pay off. Then be consistent in making those higher payments, and be patient about the process. Work to pay off your smallest debt first, then go after the next smallest. This is referred to as the debt snowball method made popular by Dave Ramsey.
While you’re working to pay off your debts, you should also pay close attention to your credit. That includes monitoring credit activity and regularly checking your credit score. Not only will that help you to avoid fraudulent use of your credit, but it can also help to improve your credit score. Higher credit scores mean lower interest rates and greater likelihood of loan approval. Take advantage of one of the many credit monitoring services available to help you in this effort.
Fortunately, as you pay your debts down, your credit scores should gradually increase. But knowing what’s in your credit will give you an opportunity to do what’s necessary to correct any errors and avoid future problems.
The Final Step: Never Give Up!
When it comes to managing your money, this is both the easiest and hardest step. It’s the easiest because it’s not a specific strategy you need to implement. But it’s the hardest because it requires a long-term commitment.
How to manage your money better isn’t a one-time event – it’s ongoing. It’s even permanent! It’s one of those efforts that fits neatly within the saying it’s not a destination, but a journey. While a short-term effort may improve your financial situation a bit, only a long-term commitment can move you toward financial independence.
It can help if you can list your goals – the reasons why financial independence is desirable. Think of it as a mission statement, and display it in one or more places where you’re likely to see it every day. It will serve to reinforce the reasons why you need to become better at managing your money.
In a real way, managing your money is a kind of psychological warfare – against yourself. To make long-term changes, the kind that are necessary to reach financial independence, you’ll have to change your mindset. Focusing on the end goals – the benefits of financial independence – are one of the best ways to get across that elusive finish line.
Money management requires both discipline and sacrifice. You’ll need to find ways to motivate yourself during the process. Creating and frequently referring to your mission statement will help keep you on track.
By constantly reminding yourself of why you need to better manage money, you’ll dramatically increase the chance of succeeding with all the various strategies required.