In a Nutshell
Building a financial foundation is a process that takes time. It’s less about hitting a single home run than making smart decisions on a daily basis.Financial success doesn’t happen overnight, and it’s not the result of making the right choice on one major money decision.
We’ve highlighted three key components of personal finance — building a budget, eliminating debt, and savings — to help you build a solid financial foundation for long-term success.
1. Understand your cash flow and build a budget that works.
Budgeting allows you to understand how much money goes in each month and how much goes out, helping you stay on track with your goals and use your money exactly how you want.
If you’ve never made a budget before, here are some steps to get you started:
- Track your cash flow. Write out how much you have coming in each month as well as set costs going out, like your rent, cellphone bill, student loan payments and transportation costs. This will give you an idea of how much of your income you can use for flexible spending on nonessential items and how much you can allocate toward savings goals.
- Start automatic contributions. Setting up automatic deposits from your checking to your savings account means you don’t have to think twice about saving.
- Stick to it. It’s hard but don’t fall off the wagon. If you do get off-track, don’t quit budgeting — simply try something new until you find a system that works well for you.
2. Eliminate debts that drag down your financial health.
If you have debt, allocating some of your cash flow to paying down those balances is the next step in building a strong financial foundation.
In general, “good debt” is debt that allows you to leverage your money to gain an asset. A mortgage, for example, is debt, but it allows you to buy a home today and pay it off over decades. You can also use your home as an asset by renting it and earning income, or by potentially earning a greater return when you go to sell if the value appreciated over time.
Credit card debt, on the other hand, is a type of “bad debt” in the sense that it doesn’t allow you to build an asset. It’s just money you need to repay with interest.
Here are some first steps to help get you on track:
- Get organized. Write down all your debts that you need to pay off in one place. Note the source of the debt, the amount of the balance and the interest rate.
- Pick a payment plan. You could prioritize debt repayment by interest rate and pay off the ones with the highest interest rate first, or prioritize it by smallest balance to largest balance and pay off the smallest balance first to get going.
3. Take your savings to the next level
If possible, your budget should include setting aside money for savings. To start, set a goal of creating an emergency fund that houses 3 to 6 months’ worth of expenses.
From there, you can create other specific goals you want to fund or simply aim to save a small percentage of your income for the future. You can start with just 1% and incrementally raise that rate over time to save more.
But there’s one big downside to having a lot of cash sitting around: It’s not doing much for you. The best savings interest rates hover around 1% to 1.25%. A high-yield checking account may garner more (up to 5%), but these accounts typically have balance caps.
It’s nice that your cash can earn a little extra money for you, but those interest rates probably won’t beat the rate of inflation over time. Also, these interest rates may be subject to change over time.