Perhaps you are a young professional new to your first job. Maybe you’ve been working for a few years, just got married, and have a baby on the way. Or maybe you have young teenagers and are wondering how you are going to budget for college. What if you are in your late forties, and empty-nester, and wondering how you can afford to retire when the time comes?
Wherever you are in life, it is never too late to overhaul your treatment of your finances and the way you think about your money.
This article IS about avoiding bankruptcy, but more importantly, it is about establishing good financial habits at any age or stage of life, organizing your finances so you can pay for what you need to pay for, and creating a feeling of financial security.
Financial Tip #1: Avoid Carrying Credit Card Debt
This is number one for a good reason. Credit cards are convenient, often provide additional protection for purchases and against fraud, and tempting – who among us hasn’t seen something they’d like to have NOW and think, I’ll just put it on my credit card?
Bad idea. You’ll pay dearly for having whatever it is you want immediately.
Let’s say you have a credit card with 14.99% interest. You think, that’s a pretty good rate, and on average you are correct – some credit cards charge as much as 22% or 24%! You are shopping with a friend and you see a watch that you love and think would enhance your business wardrobe, so you put $1200 on your credit card and walk out of the store wearing it.
You determine to pay as much as you can toward that debt each month, but end up being able to afford to pay only $100 a month. At that rate, it will take you 14 months to pay off this debt, and you will have paid $108 in interest. This is assuming that you don’t charge anything else to the card.
Let’s say you could only pay the monthly minimum on the credit card, which is $30. At that rate it will take you 56 months to pay that debt off – that’s 4 years, 2 months! – and you will have paid a whopping $473 in interest, because of this you can be drowning in credit card debt in no time.
Using Credit Cards for Emergencies
Relying on credit cards for emergencies is unwise use of your money. Here’s why.
Let’s say the week after you purchase that nice watch you have an emergency car repair in the amount of $4500. You don’t have that cash, so you charge it because you can’t go to work or function otherwise without transportation.
You already charged that watch, so your credit card balance is now $5700. You resolve to put that same $100 a month toward that debt, which happens to be the monthly minimum payment. It will take you 101 months (almost 8½ years!) to pay it off, and you will have paid $4237 in interest over that time. That’s almost as much as the car repair initially cost.
What a waste of your money. Read on to find out how you can fund emergencies from your own savings, and save the money you would have spent in exorbitant credit card interest.
Financial Tip #2: Start an Emergency Fund
Conventional wisdom dictates that everyone should have 6-8 months’ worth of expenses saved for emergencies. Why? Because if a financial emergency arises and you don’t have ready cash to pay for it, you will probably rely on your credit card. In the last section we explored what a waste of money that is, so if you don’t have emergency savings, start saving now.
Open a savings account and arrange for direct deposit of 10% of your after-tax income. This way, you will start to build your emergency savings slowly but steadily, and compound interest will be on working for you, helping your emergency fund grow.
The Effect of Compound Interest
For example, let’s say that after taxes you take home $1200 a pay period and get paid on the 15th and the last day of the month. You’ve found an online bank offering 1.25% interest on savings accounts, and you’ve set up direct deposit to that account in the amount of $120 a pay period. That’s $240 a month saved at 1.25% interest.
In three years you will have deposited $8,400 in that account, but your account balance will be $8558.46. That’s $158.46 earned in interest – not an enormous amount, but your money was at least working a little bit for you rather than sitting in your checking account doing nothing. And these figures assume that your income is static over those three years, but in reality, most workers receive a raise or two in that time period so you may be able to deposit slightly more.
In this scenario, you have almost fully funded your emergency savings, because $8558.46 divided by your monthly take-home pay of $1920 (after directly depositing to your savings account) is about 4.5 months’ worth of expenses. Good job!
The whole point of having emergency savings is to have ready cash to spend on emergencies, so don’t be concerned if an emergency comes up and you have to withdraw from that account – that is what it’s for! Just begin to save again as you have been doing.
For example, if that $4500 emergency car repair happened only a year and a half into your savings plan, you would have had enough money to pay for the repair in cash – saving you $4237 in credit card interest. Wouldn’t that feel better than charging it to your credit card and hoping you can pay it off sooner rather than later?
What if I’ve Had No Emergencies?
If you have been fortunate enough to have no emergencies and you have fully funded your emergency savings, meaning, you have saved 6-8 months of expenses, you have options as to where to put your money next.
Do you have children? Start a tax-deferred 529 plan for their college education expenses. Do you have home renovations you’d like to do? Start saving for that. Do you have a Roth IRA? You might consider opening one. Are you curious about investing? There are myriad online investment vehicles to explore, many with a minimum initial deposit of $500 or $1,000.
Think about where you can put your money to make it work for you, your family, your interests, or your lifestyle. Then be prepared to shift back into emergency savings mode if an emergency arises and you have to withdraw from that account.
Financial Tip #3: Contribute to Your Employer’s 401(k)
If your employer offers a 401(k), contribute to it – especially if your employer offers a matching contribution.
Why? First, if you don’t contribute at least up to the amount your employer will match, you are refusing to take free money. Second, contributing to your 401(k) with pre-tax dollars reducing your taxable income, putting you in a lower tax bracket, so that while you save, you are paying less income tax on the money you do take home.
Financial Tip #4: Create a Budget and Stick to It
This is a must. List all of your monthly expenses, including household, insurances, transportation, personal grooming, holidays and gifts, and tithing to your religious institution. Add it all up. Are you able to pay all of your expenses on your income minus your contributions to your 401(k) and your emergency savings?
If not, find ways to cut back a little. It does not have to be painful. Perhaps turn the heat down a bit in the winter, and turn the AC down a bit in the summer. Maybe go out to eat twice a week instead of three times. Look for a less expensive cell phone or cable or internet plan.
Making a habit of living within your means will serve you well throughout your lifetime, and into retirement. You will also provide your children with a good financial role model.
Financial Tip #5: Insure the Family Breadwinner’s Income Stream
If your income is your family’s primary source of income, you should have life insurance. How much coverage you need will depend upon how old your children are, whether you own a home and how far you are into paying off your mortgage, your spouse’s income, and your lifestyle.
Establish these five healthy financial habits and you will not have to worry about bankruptcy. Start today – only you can give yourself the peace of mind that good financial management brings.
About the Author
Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.