Sunday, December 26, 2010

One Less Thing to Worry About


From the DLM Blog:

The 7 Step Guide to Increasing Your Financial Peace

Posted: 07 Nov 2010 06:30 AM PST

Financial peace. Those are two words that don’t typically go together. Money struggles often consume our lives…daily. For example, over 61% of Americans live paycheck to paycheck, meaning one job loss, vehicle meltdown, or sickness could send most people spiraling out of control financially. This doesn’t have to be case though. If you desire to strengthen your financial position and experience calm, then here are 7 tips that will enhance your financial peace.
  1. Educate Yourself
    Perhaps not intuitively obvious, but educating yourself can do wonders for increasing your financial peace. Here’s why: many of us have never been taught personal finance. As a result, few of us have a strong basis in it. Some of the financial anxiety that we experience is the consequence of uncertainty and misinformation. If you read even three books on personal finance, you will often understand the mechanics infinitely better than so many people. That’s certainly not because three books is a magic number (although it is a great start!), but rather it’s a reflection of the general disinterest in or even intimidation by the subject. By learning more about personal finance you will:

    • Decrease your general fear
    • Become more discriminating about what you hear and read
    • Gain more confidence in your ability to handle your family’s finances
    • Become a resource for your family and friends

  2. Live on a Budget
    Yes, it’s the dreaded B-word. Budgets are a tremendously powerful tool for achieving financial peace. Your written budget is you telling your money how to behave instead of your money dictating your life. This is critical. So many financial failures are the result of lack of proper prioritization. How else do you explain people who are foreclosed on but wear designer duds? Some people will pay Visa before they pay their electric bills just because Visa has a more aggressive collections division. That’s not in the right order.

    Of course, you want to pay everything that you can, but if the resources are tight, you must develop a plan to derive the greatest benefit from your available dollars. Alternatively, some people who have excess funds believe that budgeting is only done to get out of a financial bind. Unfortunately, it really doesn’t matter whether you make $40,000 or $400,000 per year, you can still be broke without a plan. That’s exactly what a budget is: a plan for your money.

  3. Have an Emergency Fund
    Your emergency fund is a critical component for your financial peace. It essentially puts distance between you and costly life events. For example, you can imagine that having a sudden and unexpected failure in your HVAC can run you several thousand dollars. If you have already allocated funds for an emergency, although the repair will be aggravating, you’ll be able to make it just fine.

    Typically, a fully funded emergency fund consists of 3-6 months worth of expenses. Of course, if you know of an imminent emergency, the fund can be increased. This money should be liquid: easily accessible without penalty. This is important because many will borrow on a credit card in an emergency to avoid the penalty of cashing out a c.d. or a selling stock during a down market.

    Remember, it’s not an issue of “will an emergency happen?” but rather “when will an emergency occur?” An emergency fund helps you be prepared!

  4. Track Expenses
    Do you know how much you spend on clothes and groceries annually? According to Thomas Stanley (The Millionaire Next Door), most millionaires do. It is important to know where your dollars are going to see if you are sticking to your plan and if not why? It could be that the plan is unreasonable or incomplete and needs to be adjusted. Knowing your expenses can tremendously decrease your stress over money because you know in advance your household operating costs. Running an economically productive house is one of the hallmarks of millionaires. Not only is it hard to assess productivity without tracking your expenses, without looking at your numbers it’s hard to plan for the future. Thomas Stanley said it this way: “most millionaires look to the future. They are very likely to compute the lifetime costs and benefits of various activities that have some potential in saving money. This type of behavior is a high correlate of accumulating wealth…” There’s no need to become obsessive, but do educate yourself with your real numbers. This is one of your best opportunities to grab hold of your household finances.

  5. Plan Big Expenses
    Christmas, birthdays, and anniversaries come at the same time every year, so plan for them financially! Big expenses that aren’t a surprise should be planned for, so that your emergency fund and budget can remain intact. It is no fun to still be paying for Christmas into February, yet without a plan it is certainly possible.

    According to the National Retail Federation, Americans spend an estimated $832 on average for gifts, food, and decorations each Christmas. That means that it is prudent to anticipate such costs and adjust your household budget accordingly. Planning decreases stress because you focus your energy on solving a problem rather than being caught off guard.

    Dr. Steven Covey’s classic discussion of the Time Quadrant is relevant here. He clearly distinguishes between “urgent” and “important” tasks. For optimal performance, you should focus your effort on non-urgent, important tasks. If you value your holidays and celebrations, why not plan for them in advance (while non-urgent) to make sure that they are stress-free successes.

  6. Money Ratios
    Managing your money ratios well is among the most important things one can do financially and can substantially contribute to your financial peace. In his book Your Money Ratios: 8 Simple Tools for Financial Security, Chris Farrell discusses eight of the most important money ratios. Here are some that you should consider monitoring.

    • The Savings Ratio – What percentage of your income do you save? This should at least be 12% and typically increases as we age. (It’s okay if you are not there yet, but it’s something to be working towards). Chris says the savings rate should be 15% by the time you are 45, but I personally think that is too low. It is a great start though!

    • The Capital to Income Ratio – How productive are you at accumulating wealth? Your capital ratio to income ratio is your: Net worth (not including home equity) / annual income. Prodigious accumulators of wealth typically are worth (excluding homes) at least twelve times their income by age sixty five. If you are closer to 40, then Chris argues you should have 2.4 times your income.

    • The Debt to Income Ratio – Are you over-leveraged overall? This ratio will tell you. Now ideally, you should be working aggressively towards becoming debt free (discussed later); however, if you want to know where you stand, calculate this ratio.

    • The Mortgage to Income Ratio – Do you want (or have) too much house for your income? In Will Mortgage Rates Really Drop to 0%?, I discuss two formulas that you can use to gauge where your house falls with respect to fiscal conservatism.

    • Life Insurance Value- Financial ruin can occur in less than 24 hours. Is your family protected from financial crisis? In 5 ways to protect your cash flow like the rich, I discuss five vital but often overlooked types of insurance that you should seriously consider.

  7. Eliminate Debt
    More than anything, I believe eliminating debt can dramatically enhance your peace. It is so easy to spend your entire life working for the bank. While you are mired in debt, the creditors are getting rich and simultaneously diminishing your chances of achieving financial independence. Your debts are their assets, and every penny spent on interest goes towards making them wealthier. This is why 75% of the 400 richest Americans (Forbes 400) believe that "the best way to build wealth is to become and stay debt-free."

    By avoiding and eliminating your debt, you place yourself in an awesome position to build wealth because you are no longer borrowing from tomorrow’s prosperity to finance today. Even if you made the median income in North America, which is $50,000, with no debt and reasonable expenses, you could build some substantial wealth over the long-term. More importantly, because you have no debt, your expenses are significantly lower. Your dollars go a whole lot further when you don’t have to pay Master Card, Discover, GMAC, and Sallie Mae. Quite simply, becoming debt free can revolutionize your finances.
In aggregate, I have outlined 7 ways to tremendously increase your financial peace. Financial peace doesn’t have to be elusive. It’s totally achievable and with some work. Remember, these wise words from Thomas Paine.

Those who expect to reap the blessings of freedom, must undergo the fatigue of supporting it.

Written on 11/7/2010 by Roshawn Watson. Roshawn writes at Watson Inc. on eliminating debt, investing money, and building wealth. Get my free eBook Your Foundation to Wealth by signing up for my email updates (no spam I promise). Get my RSS feed and connect with me on Twitter @roshawnwatson too.Photo Credit: kevindooley

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