Your financial position is determined by how well you manage your income and your investments. Some people simply spend whatever they earn. When they need extra cash, they use their credit cards or borrow money from some other source.
Their savings are very limited and, in many instances, they do not have a financial cushion to fall back on. A financial crisis brought on by a loss of employment or a medical emergency can have a deeply negative effect on their lives.
It is essential that every individual should develop a financial plan. This can help to meet the requirements for cash that arise periodically and also provide money for retirement.
What is the best way to manage your finances? Are there any rules that you can follow to make the most of your money?
While the following list in not exhaustive by any means, it should provide a framework around which you can build your own financial plan.
Rule #1 – Spend less than you earn
If you don’t follow the “spend less than you earn principle,” you are going to face a financial crunch sooner or later.
How can you adopt this rule? A good way to start is to closely monitor your spending for a month. This will help you to identify where your money goes. You could then decide on the areas that you want to cut back on.
Rule #2 – Regardless of how much you earn, invest a certain percentage
There will always be demands on your money at every stage in your life. When you start out, your income may be low, but you may need a relatively small amount of cash to meet your essential needs. At this stage of your life, you could be tempted to increase your discretionary expenditure.
Subsequently, when your income rises, it is likely that your financial responsibilities will also increase. You may find it difficult to save any amount at all.
The fact of the matter is that it is never easy to put money into long-term investments. But you must do this if you want to build your wealth.
A practical solution to this issue is to invest a certain percentage of your income regardless of the circumstances. This will instil a sense of discipline in your financial life and turn investing into a habit.
Rule #3 – Start saving as early as you can
An early start gives you a tremendous advantage. Over a period of time, the return that you make on your investments generate returns of their own. This “compounding effect” can yield very large returns over an extended period.
A hundred dollars invested every month for a period of 25 years at a rate of interest of 5% will give you $60,000. Keep at it for 50 years and the sum becomes $268,000. In 25 years, your original investment increased by a factor of two. In 50 years, the sum that you have invested will grow 4.5 times. That’s the power of compounding.
Rule #4 – Liquidate your credit card debt
Rolling over the balance on your credit card statement is possibly the worst step that you can take. The bank will charge over 24% per year on the unpaid amount. You could also be liable to pay a penalty if you miss a payment. In addition to this, you lose the free credit period on the subsequent purchases that you make on your credit card.
As a result, many individuals fall into the trap of paying interest to their credit card issuers.
A bank can provide you with a credit limit of up to four times your monthly income. When you get a new card, it is quite easy to forget to keep track of your expenditure. Before you know it, you may be in a position where it is impossible to pay off the entire amount that you have spent.
So, if you have accumulated credit card debt, it is advisable to pay it off as soon as you possibly can.
Rule #5 – Make a net worth statement
If your financial plan is to succeed, you must know where you currently stand. The way to obtain this information is to make a personal net worth statement.
This will give you a snapshot of your assets and your liabilities. Making one periodically, maybe once a year or every six months will provide you with an idea of the direction that your financial worth is taking.
A net worth that increases on a consistent basis will serve to reassure you and provide you with evidence that you are on the right track. If on the other hand, it shows a declining trend, it is probably time to take some corrective action.
A higher income will not necessarily make you richer
It is a common misconception that if your earnings go up, your wealth will increase as well. While a higher salary will definitely help, it does not guarantee that you will become well off. This can happen only if you follow a consistent practice of investing part of your income regardless of how much you earn.
Start this practice early and let the power of compounding do the rest.
This is a guest post by ZUU Online, an Asian-based Finance Education Portal aimed at helping individuals to improve their knowledge on personal finance and money, through educational articles on business, investments, property and insurance.
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