Updated: Aug 15, 2020
There are hundreds of millions of blog posts, videos, and podcasts on the internet talking about personal finance. A lot of that information is really great and you could spend hours every day soaking it all in and never really scratch the surface.
What if you don't have hours a day to commit to learning about money and personal finance or what if you are just getting started and need to know the most important things about personal finance?
When it comes to personal finance and managing money there are six things you need to know.
What's your "why."
Where your money is going.
How much you need in an emergency fund and how to save that money.
How to invest your money in a rational way.
A proven strategy to pay off debt.
How to make smart decisions about your biggest expenses in life.
In this article, I'm going to review each concept in detail.
1. You need a "why"
If you are just getting started on your financial journey the very first thing you need is a "Why".
As you begin to educate yourself on how to manage your money you will be exposed to a tremendous amount of information and tools that will help you achieve your financial goals.
All of that technical knowledge is important. But, you need to know that life is going to punch you in the mouth a lot along the way on your journey to financial independence. Knowing the smartest way to invest or the fastest way to get out of debt means nothing if you don't follow through on that knowledge.
Changing your habits and turning your finances around is hard. Achieving your financial goals is not something that happens overnight. It could take months or even years before you start seeing real changes.
Financial Freedom is a lifelong pursuit and there will be a lot of obstacles and setbacks between where you are right now and where you want to end up. It’s important to have a strong motivation and a sense of clarity as to why it is important for you to take control of your finances.
When I made the commitment to turn everything around in my life and my finances, I had a very clear why: I never wanted myself or anyone I care about to feel desperate ever again.
My desire to accomplish that goal makes all of the sacrifices required to achieve that goal worth it.
That “why” has made it worth it to me to work 40+ hours a week at a day job, write 3 articles a week and create an online course all while my wife and I are expecting our first child.
I know, I can achieve any goal I set for myself because I have a powerful “Why”.
Action item: Before you read another word, take a moment to think of your "Why" and write it down. Then place it somewhere you will see it everyday like on the fridge. Next time life punches you in the moth and you feel like giving up, remember your "why".
2. Where is your money going?
If you want to turn your finances around, you need to know where your money is going every month. Have you ever got to the end of the month and thought to yourself "where did all the money from my paycheck go?". If you've thought that, it's because you're not tracking your spending.
If you don't know where your money is going, you will have a hard time freeing up cash to help you achieve your financial goals.
I hear people say things like "I don't have enough money to save for retirement". The people who say that are typically the people who don't track their spending. If they knew where every penny went every month they could free up hundreds of dollars that could be used to save for retirement or pay down debt.
Start tracking your spending and begin cutting out expenses that aren't adding any value to your life.
Action item: There are so many tools to help you track your spending these days. Simply go to Google and type "free expense tracker" and you choose the one you like best. You can also click here and receive the free expense tracker I created. It breaks down each purchase you make into hours of your life you had to give up to make that purchase.
3. An emergency fund is the foundation of any good financial plan
When people think about "managing money" they probably think of investing or paying down debt. You might be surprised to learn that the first thing you need to do before building wealth is setting aside some cash in case of a financial emergency.
You might be thinking "shouldn't paying off debt be my number one priority?" It's a good question, but no. Building an emergency fund is your number one priority.
The short answer: Don't forget life is going to punch you in the mouth. When it does, you'll need some cash on hand to keep the ship afloat. If you want the long answer as to why an emergency fund is your number one priority, read this article.
The next question is "how much do I need in an emergency fund?". Most financial experts recommend having 3-6 months' worth of basic living expenses in your emergency fund.
Action item: If you want quickly learn how much you need in your emergency fund and how to save that money, enroll in the class I teach about emergency funds on SkillShare. You can also sign up for two free months of Skillshare here.
4. But after your emergency fund is set up you need to stop saving and start investing
Lot's of people are great savers but never build any wealth. Once you have enough cash to cover financial emergencies, it's important to stop saving money and start investing money.
Let's illustrate the difference between saving and investing with an example.
Let's say you are saving $1,000 per month for retirement. You can choose between two savings options;
Putting the money in a savings account or
How much would you have after 30 years if you chose the savings account and how much would you have if you invested? To answer this I simply plug some numbers into a compound interest calculator.
I'll also assume the following:
Your stating with $0 currently saved.
Inflation is 2% per year.
The savings account interest rate is 2% per year.
Investment returns are 7% per year.
If you chose the savings account
You would have $360,000 after accounting for inflation.
Every single penny of that $360,000 have would come from your savings as inflation was exactly equal to the interest rate you received.
If you chose to invest
You would have $832,258 after accounting for inflation.
Your total contributions would be $360,000
Investment returns would make up the additional $472,258.
By choosing to invest rather than save, you would have accumulated an additional half a million in real wealth without doing any additional work.
This should make it clear why you need to stop saving and start investing if you want to build wealth and reach financial independence.
Action item: Figure out how much you need to be investing for retirement each month. You can start with this free retirement savings calculator.
5. You need a proven strategy to pay off your debt
There are two tried and true strategies that anyone with multiple credit cards and loans needs to know.
The snowball method
The avalanche method
The Snowball method
The “snowball method” to debt repayment was made popular by Dave Ramsey. It is a four-step process.
Step 1: List your debts from smallest to largest.
Step 2: Make minimum payments on all your debts except the smallest.
Step 3: Pay as much as possible on your smallest debt.
Step 4: Repeat until each debt is paid in full.
The avalanche method
Rather than paying off the loans with the smallest balance first, you pay off the loans with the highest interest rate first. It is also a four-step process.
Step 1: List all your debts from the lowest interest rate to the highest interest rate.
Step 2: Make minimum payments on all your debts except the debt with the highest interest rate.
Step 3: Pay as much as possible on your debt with the highest interest rate.
Step 4: Repeat until each debt is paid in full.
Action item: If you want to learn more about how to implement the snowball and avalanche methods check out this free resource for a more detailed overview.
I've also created a debt repayment calculator here.
6. Focus on your biggest expenses in life
Most people's largest expenses are their housing and their car. If you are struggling to free up cash to achieve your financial goals, even after cutting out all of the small expenses you will need to reevaluate your housing and transportation costs.
Luckily you can hack your housing costs and your transportation costs.
The concept of house hacking is pretty straight forward. Find a way to generate rental income from your home to offset your personal living expenses.
There are a number of different ways to do this.
Rent out a room in your house.
Rent out your entire house on Airbnb when you are out of town.
Buy a multi-family property, while living in one unit and renting out the others.
If you rent and live alone, taking on a roommate is even a