Are you overwhelmed thinking about all the work required to get your finances in great shape? Well the good news is that you can do a complete financial overhaul (or if you're in less dire straits, a tune-up) in 30 simple steps. Yep, that's it. In 30 steps you can go from a financial zero to a financial hero.
To get this new year started on the right foot, FMF will be posting a series called 30 Steps to Great Finances. It will be running the first several days of January and is designed to take readers from the very basics of money management to the point where they have set themselves up to become wealthy.
No matter your age or stage in life, it is never too late to improve your finances, and the 30 steps I will share over a series of posts will show you how to improve your financial well-being. If you're deep in debt and don't know how to make it to next week, these steps will help (a lot). If you're a millionaire and want to make your finances even better, these steps will give you an extra boost. If you're just starting out after graduating from college, these steps are perfect for you -- apply them now and you'll do very well financially over your lifetime. And if you're older and looking for a way to slide into retirement financially healthy, these steps will get you there. No matter what your financial situation, using the tips I'll be sharing will make it better.
I understand you may be skeptical at this point. All I ask is that you read along and see for yourself. I know the power of these steps because I've personally taken them over the past couple of decades and my finances are much better off as a result. I hope the same for you -- that you'll apply the steps I share and you will be able to reach the financial goals in your life.
Today we'll be covering the first three steps.
Step 1: Know Where You Stand -- Calculate Your Net Worth
You know the old adage, “You have to know where you are before you can figure out where you are going”? That is true with your finances too. The first step to financial hero is to determine where you stand financially.
We've previously discussed the fact that your net worth -- how much you own after all your assets are sold and all your debts are paid -- is the true measure of your wealth. That's why step one on your path to financial prosperity is to calculate your net worth.
Simply list all your assets (investments, home, and so on), subtract your debts, and that's your net worth -- how much you truly own.
See, that was pretty simple, wasn't it?
Determining your net worth is so important because it gives you a quick snap shot of your financial health. Plus, it will give you a benchmark to measure your progress against as you make your way through the 30 steps. So do it NOW, before you begin step #2.
Step 2: Track Your Spending for 30 Days
To get a handle on your finances, you have to know where you are spending your money and where all the slow leaks are—the pop you buy every time you get gas or your morning coffee shop coffee can add up more than you think they do. Tracking your spending will show you this.
There are three main ways to track your spending, but those are for a future step. For now all you need are two simple items: a pen and some paper (I prefer a small notebook that fits easily into a pocket or a purse.)
For the next 30 days you are going to write down both the amount and the payee (where the money went) EVERY SINGLE TIME you spend money. When you pay your mortgage with a check, write it down. When you transfer money to your utility company via your bank, write it down. When you pay for a coffee with a credit card, write it down. When you put $1 into the vending machine at work, write it down. When you give your son a quarter to buy a gumball, write it down. Write down every single way you spend money for 30 days.
If you've never done this, believe me, it will be very enlightening. It will show you where your money is really going (versus where you think it is going.) I've had a few hundred people do this exercise over the course of the past 20 years and there are ALWAYS surprises -- even for those people who think they know where every penny is going.
So write down your spending (and if you're in a family, this includes everyone in the family who spends money) for the next 30 days. Don't question it. Don't dismiss it. Just do it. If for no other reason, simply humor me and do it.
Your financial well-being is worth the effort, right? I thought so.
Step 3: Know Where Your Money is Going -- Develop a Cash Flow Plan
Some people refer to this as a budget, but I like "cash flow plan" because it's more descriptive of what you're doing. Besides, cash flow plan sounds less restrictive and more proactive, don’t you agree? :)
Quite simply, the gap between what you earn and what you spend is one of the most important financial numbers you need to know and work to expand. With a big and growing gap, you're on your way to financial security. With a small or (heaven forbid!) negative gap you are going nowhere money-wise. And the way you know and grow your gap is by developing and managing your cash flow plan.
To make a cash flow plan, figure out how much you make each month, and then use the information you gathered from tracking your spending in step 2 (as well as by looking at past records) to calculate the amount you spend each month. Subtract the latter from the former and what you have left over is your monthly gap (and hopefully it's a positive number.)
If your gap is negative, low, or simply in need of being increased to super-charge your savings, the only two ways to improve it are to increase income and/or cut spending. And that's what will follow over the next several steps -- ideas on how to increase income and decrease expenses.
That's it for this round. Get started on these tasks right away. The next steps will be coming soon...
Update: Click here to read steps 4 to 6.