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Back to the Basics of Personal Finance
In late 2020, I’m going back to Dave Ramsey’s Baby Step 1 of basic personal finance. That first step is a $1,000 emergency fund. I have to rebuild the emergency fund. My current recklessness just cost me a couple of hundred dollars. Since I need to build back up that few hundred dollars I thought I would create a basic personal finance post.
Practice, Practice, Practice
Why? Star athletes practice constantly. Coaches emphasize the importance of fundamentals. I’ve slowly noticed I’ve become a bit arrogant about finances and need a bit of a reality check. Maybe it might help others; maybe it will get other people on board. Let’s just see where it takes us.
Consistently in my articles I will be asking why. Why do I want to say something? Why is this important? Why am I working so hard for XYZ? So let’s start there. Why is basic personal finance important?
Basic Personal Finance = Behavioral Math
Some questions in personal finance don’t have right or wrong answers. Why? There are differences in personal situations. No situation is 100% the same. Two people with the exact same income can spend completely different, have different budgets and gain value from different purchases.
“Money isn’t everything.”
No, but everything is impacted by money in some general way. Even free things come with an opportunity cost. Which is just a fancy way of saying everything costs time or other form of value.
Without getting too deep, I’ll try to keep it simple. I have extreme anxiety. I’m a worrier with a scarcity mindset. It’s very limiting and it makes the day-to-day a lot more difficult than it should. However, having a financial plan and basic personal finance knowledge does combat the anxiety quite a lot. Feeling secure is definitely a goal of mine. When I started taking control of my money and learning basic personal finance, I felt I had a greater control on life. Back to the medical folly, without the emergency fund, I would be worried about how I’m going to deal with the financial strain. Instead, I can just pay the bills as the come and worry about building up back to $1,000.
So now that I’ve pointed out my why, try to find yours. Why do you think personal finance is important? Why work hard to save a bunch of money if we might die tomorrow? Who cares about money, it is evil anyway right?
Now the Basic Personal Finance Introduction
Income – Expenses = Savings is the same as Assets – Liabilities = Savings
Assets and Liabilities simply put by Robert Kiyosaki, an asset puts money in your pocket, and liabilities take it out. Simple enough.
Paper or Plastic? Do you track your expenses on paper? Would you prefer to put a budget on paper? Do you prefer to pay with cash? Would you rather use digital software to track your expenses and budget? Do you prefer using your debit or credit card to track expenses? What makes sense for you?
The Big 4
There are 4 categories that eat up most of my expenses, which will most likely be one of your biggest expenses. These are the places that can typically be cut the most and have more optimal options that are often overlooked by those who don’t look over their expenses with a “fine tooth comb” so to speak.
Debt – How much are you paying debt? Do you have personal loans, student loans, credit card loans? Auto loans, Mortgage? (The latter two can also be included in other categories, depending on preference). Every penny going to debt is a penny not going into savings or wealth building.
Housing – How much are your housing expenses costing you? 25%? 35%? 50% 75%? If your housing costs are eating up more than 50% you may be “house poor” and might want to reevaluate if you might have “too much house” and wasted space.
Transportation – Arguably one of the largest causes of missing out on millions in opportunity cost is car payments. Car payments can crush the hopes of financial freedom. Many financial experts and early retirees pay cash for cars, avoid payments, and look for great deals. How much is too much? Well if your housing and transportation take over 75% of your expenses, it leaves 25% or less to savings and/or investing.
Food/Groceries/Eating Out – Who doesn’t love comfort food? Grabbing a drink and a hearty meal after work makes the workday seem less tiring right? Well how much of your budget is actually being wasted or just thrown away on food that’s just okay, but you wanted that social atmosphere and the glitz of the fancy restaurant? How much does that fancy meal really provide value for you?
Here’s an example of the 4 “biggies” leaving only 7% for savings and/or other spending. Now imagine if you cut some costs and paid your debts. You could increase your savings rate to 19%. This is the track to retiring early!
How do you cut “the 4 biggies?” Get creative! Make a budget, pay off the debts, buy cars with cash, pay off the mortgage, or save up for half a house (or more!) and really push into early retirement.
But Cutting Stuff out SUCKS!
We like stuff. We like big houses and flashy cars. We like fancy restaurants and traveling around the world, or our other guilty pleasures. There is something out there for everyone to spend on. The goal of financial freedom is to spend on what brings you value, cutting out what doesn’t and working towards your personal goals so you can ultimately get the most value from money and life.
Shifting Your Mindset
One of my favorite quotes from Mr. Money Mustache is “Comfort is expensive, slight discomfort is cheap.” What really are your deal breakers and what are you willing to bend on a little? The more you can be content with and the more you work towards your goals, the faster you can save to be financially free to really spend your money on what matters most to you.
Whether you are new to personal finance or half a step away from early retirement, my recommendation to take action is get back to the basics. What are your assets and liabilities? What’s your basic, bare minimum budget? What do you overspend on that doesn’t bring value? Are you tracking your spending enough? Take a few minutes and do some analysis to answer these questions. Sometimes we need to get back to the basics so we can score that game winning goal under pressure.