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Best Rules to Improve Your Financial Health

The term “personal finance” refers to how you manage your money and plan for your future. All of your financial decisions and activities have an effect on your financial health. We are often guided by specific rules of thumb, such as “don’t buy a house that costs more than two-and-a-half years’ worth of income” or “you should always save at least 10% of your income toward retirement.”

While many of these adages are time tested and helpful, it’s important to consider what we should be doing—in general—to help improve our financial health and habits. Here we discuss five broad personal finance rules that can help get you on track to achieving specific financial goals.

KEY TAKEAWAYS
“Personal finance” is too often an intimidating term that causes people to avoid planning, which can lead to bad decisions and poor outcomes.
Take the time to budget your income vs. expenses, so you can spend within your means and manage lifestyle expectations.
Aside from planning for the future, start putting away money today for savings goals, including retirement, leisure, and emergency purposes.

Do the Math—Net Worth and Personal Budgets, Money comes in, money goes out. For many people this is about as deep as their understanding gets when it comes to personal finances. Rather than ignoring your finances and leaving them to chance, a bit of number crunching can help you evaluate your current financial health and determine how to reach your short- and long-term financial goals.

As a starting point, it is important to calculate your net worth—the difference between what you own and what you owe. To calculate your net worth, start by making a list of your assets (what you own) and your liabilities (what you owe). Then subtract the liabilities from the assets to arrive at your net-worth figure.

Your net worth represents where you are financially at that moment, and it is normal for the figure to fluctuate over time. Calculating your net worth one time can be helpful, but the real value comes from making this calculation on a regular basis (at least yearly). Tracking your net worth over time allows you to evaluate your progress, highlight your successes, and identify areas requiring improvement.

Equally important is developing a personal budget or spending plan. Created on a monthly or an annual basis, a personal budget is an important financial tool because it can help you:

Plan for expenses
Reduce or eliminate expenses
Save for future goals
Spend wisely
Plan for emergencies
Prioritize spending and saving
There are numerous approaches to creating a personal budget, but all involve making projections for income and expenses. The income and expense categories you include in your budget will depend on your situation and can change over time. Common income categories include:

  • Alimony
  • Bonuses
  • Child support
  • Disability benefits
  • Interest and dividends
  • Rents and royalties
  • Retirement income
  • Salaries/wages
  • Social security
  • Tips

General expense categories include:

  • Childcare/eldercare
  • Debt payments (car loan, student loan, credit card)
  • Education (tuition, daycare, books, supplies)
  • Entertainment and recreation (sports, hobbies, books, movies, DVDs, concerts, streaming services)
  • Food (groceries, dining out)
  • Giving (birthdays, holidays, charitable contributions)
  • Housing (mortgage or rent, maintenance)
  • Insurance (health, home/renters, auto, life)
  • Medical/Health Care (doctors, dentists, prescription medications, other known expenses)
  • Personal (clothing, hair care, gym, professional dues)
  • Savings (retirement, education, emergency fund, specific goals such as a vacation)
  • Special occasions (weddings, anniversaries, graduation, bar/bat mitzvah)
  • Transportation (gas, taxis, subway, tolls, parking)
  • Utilities (phone, electric, water, gas, cell, cable, internet)

Once you’ve made the appropriate projections, subtract your expenses from your income. If you have money left over, you have a surplus, and you can decide how to spend, save, or invest the money. If your expenses exceed your income, however, you will have to adjust your budget by increasing your income (adding more hours at work or picking up a second job) or by reducing your expenses.

To really understand where you are financially, and to figure out how to get where you want to be, do the math: Calculate both your net worth and a personal budget on a regular basis. This may seem abundantly obvious to some, but people’s failure to lay out and stick to a detailed budget is the root cause of excessive spending and overwhelming debt.

Most people who make more money end up spending more money, a potentially dangerous phenomenon known as “lifestyle inflation.”
Recognize and Manage Lifestyle Inflation
Most individuals will spend more money if they have more money to spend. As people advance in their careers and earn higher salaries, there tends to be a corresponding increase in spending, a phenomenon known as “lifestyle inflation.” Even though you might be able to pay your bills, lifestyle inflation can be damaging in the long run, because it limits your ability to build wealth. Every extra dollar you spend now means less money later and during retirement.

One of the main reasons people allow lifestyle inflation to sabotage their finances is their desire to keep up with the Joneses. It’s not uncommon for people to feel the need to match their friends’ and coworkers’ spending habits. If your peers drive BMWs, vacation at exclusive resorts, and dine at expensive restaurants, you might feel pressured to do the same. What is easy to overlook is that in many cases the Joneses are actually servicing a lot of debt—over a period of decades—to maintain their wealthy appearance. Despite their wealthy “glow”—the boat, the fancy cars, the expensive vacations, the private schools for the kids—the Joneses might be living paycheck to paycheck and not saving a dime for retirement.

As your professional and personal situation evolves over time, some increases in spending are natural. You might need to upgrade your wardrobe to dress appropriately for a new position, or, as your family grows, you might need a house with more bedrooms. And with more responsibilities at work, you might find that it makes sense to hire someone to mow the lawn or clean the house, freeing up time to spend with family and friends and improving your quality of life.

“You may know what you need/But to get what you want/Better see that you keep what you have.” – Stephen Sondheim, from “Into the Woods.”