The Amateur Financier

Last time, we covered cutting down your expenses and having proper insurance coverage.  Those are the preliminary steps; we’re just getting started with controlling our expenses.  Now is when things start to get interesting!

Step 3: Fund Your 401(k) or Equivalent Plan Up to the Employer Match

This one is pretty basic; if your employer offers to match the contribution to your 401(k) (or one of the 401(k)’s kissing cousins, 403(b)s and Thrift Savings Plans (TSPs)), you should jump at it.  Taking advantage of such an offer is usually (although, not always) a good idea.  Turning down a match is equivalent to giving up free money.

Don’t believe me?  Let’s run through a quick example.  Your employer offers a fifty percent match on your money up to 5% of your salary; that is, for every dollar you contribute to the plan, the company adds fifty cents, at least until you are contributing 5% of your gross salary.  So, if your yearly gross income is $30,000, you can add up to $1,500 to your account, and your company will add in $750, for a total investment of $2,250.  (Plus, because you contribute pretax dollars to a 401(k), the decrease in your spending money is going to less than the full $1500 you added.)  Look, you have made a profit of 50% on your money, before any investment return.

You can even stay ahead if your investments fall.  Let’s say that we have a repeat of 2008 after you’ve made this contribution; your chosen investment(s) decline in value by 30%.  But, because of the added money in your 401(k) from your company, your investment is still at $1575, a profit of 5% even in a horrible market.

In short, a company match is a wonderful aid to your investment goals, and the return on investment with a good match is hard to beat.  It should be one of your first financial goals.

Step 4: Create a Small Emergency Fund

Before we get into the heavy lifting of debt repayment, it’s useful to have a small emergency fund available.  It will provide a psychological boost to you, knowing that you have extra money set aside for any unexpected events.  You can also avoid falling back into old habits and breaking out your credit cards for any emergency you encounter.

The size of such a ‘starter’ emergency fund is a matter of much debate.  I think enough to cover one month of your regular expenses should be enough for most of the minor emergencies you are likely to encounter, but that’s just my opinion.  A better way to decide how big to make this emergency fund is to sit down and consider what could go wrong in your life over the next few months.  Are any of your appliances on their last legs?  Does your car need serious work?  Is your family prone to catching colds and missing work?  Use the answers to these and other questions about your current situation to come up with a figure that should cover the foreseeable ‘emergencies’ you’re likely to face in the next few months, and regularly reconsider just how much you need, adjusting the size of your fund accordingly.

Once you know how much to have available, decide where to keep your emergency fund; somewhere safe, secure, preferably with a decent interest rate, and accessible if the need arises.  A good money market mutual fund or online savings account should do nicely.  Just make sure you only withdraw the money for a genuine emergency, and not for random spending.

Now things are starting to get tougher; hopefully, you’ve been able to make it through these first few steps without any serious problems.  The next two steps are where we really begin to make progress; stay tuned!

All this week, we’re going to cover ten steps you can follow to take control of your money and get your financial life in order.  Today, we cover two initial steps you can take to prepare for retaking your financial life.

Step 0: Help Those Who Are Less Fortunate

It was pointed out to me after I created this list that I forgot one of the most important elements of being satisfied with your financial life: helping others.  Now, if you find yourself short on cash, spending nearly as much (if not more) than you earn, with tons of debt, no emergency fund, and virtually no savings, you’ll be hard pressed to come up with a large amount of money to give to charity. If you absolutely cannot find money in your budget to give to the less fortunate, I’m willing to look the other way while you work to complete the steps to get your own finances in order.  (Don’t worry; one of the later steps will have you contribute to charity as well, so don’t think you won’t be helping out the less fortunate.)

That said, I’d encourage you to search your budget for at least a small amount of money to give to the less fortunate.  Even one percent of your income, while being an amount you will barely miss, can be enough to make all the difference for someone less fortunate in the country (to say nothing of the world).  Giving will make you feel better, and who knows, a little good karma might accrue to you as you attempt to improve your financial situation.  As you work your way through the rest of these steps, continue to give to charity, and periodically re-evaluate your giving to see if you can be just a bit more generous.

Step 1: Earn More Than You Spend

This is the key to making any progress in your financial situation.  If you are spending every penny that you make, or worse, going into debt in order to do all your spending, you need to change your spending habits, cut down on your expenditures, and work on earning more money.

Three possible methods to consider are cutting your voluntary spending, working overtime, or downsizing your lifestyle.  There are numerous ways to cut your spending, from asking your credit cards to cut the interest rates to eating out less often to canceling cable service.  Similarly, if your company doesn’t consider you an exempt employee or otherwise ineligible for overtime, working a few hours each week will increase your income.  Changing your lifestyle is the most complicated way to earn more than you spend, but it has the biggest potential: buying a smaller house, moving to a less expensive neighbor hood, or going back to school to get a better job can all drastically increase the amount of money you have available.

No matter what method(s) you choose, your goal should be to have at least some money left over each month that can be put toward all of the other goals in your life.  The more money, the better, of course, but even if you can only manage to trim $100 from your expenditures, it will help you meet your financial goals.  But, before we start getting into those goals, one more bit of prep work.

Step 2: Have Adequate Insurance to Protect Yourself and Your Family

In every life, there will arise problems and troubles.  Insurance is designed to provide a buffer against the worst possible outcomes when things go wrong.  There’s a variety of insurance types you might need, depending on your circumstances.  Here’s a quick overview of some them:

-Life Insurance: If you have anyone who depends on your income for their livelihood, it’s good to have insurance to care for them if something happens to you.  Your best bet, in most cases, is to get term life insurance in a large enough amount to provide for them if you should happen to die.

-Automobile Insurance: Besides protecting you and your family if there is an accident, in many cases auto insurance is required by your state.   Insurance can cover collisions, the liability if any damage occurs during the use of the car, and comprehensive coverage that covers most other incidents.

-Homeowner’s/Renter’s Insurance: These policies will cover the contents of your dwelling (and the property as well, for homeowner’s insurance) from damage or loss.  It will also protect you if someone is wounded on your property.

-Health Insurance: Frequently provided through your employer, if you aren’t covered or want additional coverage, adding health coverage will protect you should you get sick or injured and need to see a health professional.

Hopefully, ensuring you have complete insurance coverage hasn’t eaten up all of your extra funds; tomorrow, our money management really starts to get fun.