If you feel stressed out about your personal finances, you are not alone. In a survey by the Federal Reserve, 52% of households could not handle a $400 emergency without having to borrow or sell off possessions. While this number is startling, it is not completely unsurprising. One of the best parts of my job is getting to dive in deep with my clients to help them get their finances in order. While many are already in great shape, it is not uncommon to find families struggling to make ends meet.
What do you do if you are struggling to make ends meet? The first thing is to start measuring. It might be uncomfortable and may make things more stressful initially, but one of the keys to improving at anything is being able to measure. An easy way to start is with mint.com. Recognizing where your money is going is often an eye-opening experience. Once you are able to see where your money is going, prioritize the following (order is important):
1. Emergency Fund – Cut expenses back so you can accumulate $1,000 dollars in savings. This will help prevent any surprises from setting you back. Hopefully, this can be accomplished in a month or two.
2. Consumer Debt Payoff – Once you have saved $1,000 in the bank, now is time to start paying down debt. Pay the minimum on everything except the debt with the lowest balance (typically credit card). Pay as much as you can on that debt until it is paid off. Then use those funds on the next lowest balance.* Keep rolling until all debt is paid off (excluding mortgage). For more information, google the debt snowball and you'll find plenty of tips on making this work. Depending on how much debt you have, it can take a few months to a year or two.
3. Savings Fund – Once debt is paid off, now it is time to build a real savings account. It is recommended to have at least 3-6 months worth of cash in the bank at all times. Now that you have your debt paid down, it should be easy to use the cash flow that you were using for debt to save. This should only take several months to a year at most.
Once you have these three steps done, then it is possible to focus on things like saving for retirement and possibly college. It is important to always make sure you have a solid foundation to keep your finances from causing stress in your life.
"Report on Economic Well-Being of U.S. Households in 2013." Board of Governors of the Federal Reserve System. 2013. http://www.federalreserve.gov/econresdata/2014-economic-well-being-of-us-households-in-2013-executive-summary.htm.
*an earlier version of this article misstated the debt snowball (it said highest interest rate as opposed to lowest balance). We have since corrected that error.