Barbara O’Neill, Ph.D., CFP®
Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension
Three money problems are common at all income levels. Many people 1. Spend too much in relation to their income, 2. Save too little as a percentage of their income, and 3. Save money, but do not know how to invest. The result is that they live "paycheck to paycheck," have limited financial resources in the event of emergencies, and lose out on years of wealth-building opportunities. Overcoming these problems is not impossible but does require a change in financial management practices.
Below are five cardinal rules of money management to consider:
Make Money Before You Spend It - Learn to ignore marketing messages that encourage you to buy now and pay later. FOMO (fear of missing out) and YOLO (you only live once) are strong emotions and can cause people to overspend. They are the 2018 equivalent to "Keeping Up With the Joneses." With the exception of necessary "big ticket" items such as a house and car, set a personal policy to not buy anything unless you have money in your pocket or in a bank account to pay for it. Instead, save up for the purchase price and/or look for less expensive items. An example is shopping for furniture at a thrift shop instead of a department store. Many thrift shops have great prices on "gently used" items.
Establish an Emergency Fund - "Stuff" happens in life, both good and bad. It is often not a question of "if" something will happen, but "when." Set up a savings account to cover the cost of emergency events (e.g., a car repair or a sick pet) or to cover monthly living expenses if your paycheck stops. Fund it with 3 to 6 months of expenses or whatever amount of savings gives you peace of mind. Replenish the account when an emergency arises. Too often, people are forced to borrow money from family members, sell things, or use credit in an emergency because they don't have an adequate savings account to fall back on when an emergency arises.
Get Control of Your Spending - Overuse of credit is generally due to inadequate emergency funds and living beyond our means. Once an adequate emergency fund is established, people do not have to depend on credit to get through many unexpected events. Once they learn to live at or below their income, they do not have to use credit to support a lifestyle that they cannot afford. Borrowed money always has to be repaid- with interest. In addition, monthly payments on outstanding debt reduce your future standard of living. In other words, when you spend more than you make, you are mortgaging your future. The secret to avoiding this situation is to "live below your means" (i.e., expenses less than income).
Pay Yourself First (PYF) - PYF means exactly what it says: you deposit your savings goal amount(s) before paying other expenses. In other words, savings is given the same "respect," or even more, as a high-priority bill such as a mortgage or rent payment. PYF is often done automatically via payroll deduction. Many experts recommend saying at least 10% of your gross income for long-term goals. Think of it this way. Your car loan payment must be paid on a regular schedule and so should your future. Your car will be repossessed if you don't make loan payments and your bank account will be bare without savings.
Develop an Investor's Mindset - Investors must expect that they could lose money. Their investments could have a negative return, resulting in a loss of principal. Investors cannot assume a guaranteed rate of return or that their money will grow like they can with cash equivalent assets (e.g., money market funds and certificates of deposit). There is no "perfect" investment that is risk-free, tax-free, and earns a high guaranteed return. However, stock returns have exceeded those of other assets over long time frames of 15 to 20 years or longer. As a general rule, don't invest money in stocks that you will need in the next five years. In addition, if an investment sounds too good to be true, it very well might be. Don't invest in anything that you don't feel comfortable with or can't explain simply to another person.