Around this time, most of us have made or are thinking about our resolutions for the new year–promises we’re making to ourselves to do better, objectives we are determined to reach. (In my case, I spend the first three months of the year committing to esteemable goals.) Whether your approach to moving your life forward is simple or complex, most of us expect to make some kind of progress in the new year, and that includes with our finances.
Common and laudable goals are to save more, spend less, reduce debt and increase our credit scores. However, I am a firm believer that it is more effective to commit to financial habits, than to money outcomes. If you are making better choices on a day-to-day basis, inevitably you will see the results you want. Here are the three habits you must commit to for the new year that will get you the better money outcomes most of us want.
Habit: I pay myself first. This is likely not the first time you’ve heard this. Paying yourself first is the first rule of money management, but most of us don’t follow it, and many who do, don’t stick to it. Paying yourself first means putting away a percentage of your income, ideally 10 percent, exclusively for long-term savings and investment goals. This “payment” should be treated like your mortgage, rent, utility or any other bill, paid every month, no matter what. That means training yourself and building your budget to live on 90 percent of your income.
So what are you paying yourself for?
Your first goal is to accumulate savings equal to 6 to 9 months of your annual household budget, to be touched only in case of loss or interruption of employment income. After you’ve reached that savings objective, you can earmark additional self-payments towards long-term goals such as a down payment on a home, capital to start a business and building an investment portfolio. Keep this money in an account separate from your main bank accounts, to reduce the temptation to dip into it. Also, pay yourself by automatic deposits from your paychecks–just as income tax, health insurance contributions and other costs are deducted. By the way, your emergency savings fund is in addition to, not a substitute for, the money you should also be saving toward retirement. Consider monies earmarked for retirement as down payments to finance your future. Even if you’re paying down debt, you must still pay yourself, just as you wouldn’t skip a rent or mortgage payment. If you must, you can reduce your self-payment to 5 percent of your income, building back to 10 percent as you eliminate debt and/or increase your income.
Habit: I do not live on debt. Of course, to make this habit a way of life, you have to be serious about reducing the debt you have. One way to go is to focus on paying off your smallest debts first, quickly getting rid of them so that you can apply those payments toward progressively larger debts. For example, you might pay off the $500 credit card balance, then move on to the card with the $900 balance, before focusing on the one with the $2,000 balance. Knocking out the smaller debts quickly can provide you with the positive motivation to attack the larger debts.
Another way to go is to focus on the debts charging the highest interest rates and work your way down to the ones with the lowest. This really makes sense if you are still carrying debt on high-interest rate cards. This approach will help you save money on interest payments in the long run. Again, as you eliminate each debt, apply those payments to the remaining debt.
No matter which way you go, always make at least the minimum payments on all outstanding debt, avoiding late fees by always paying on time (ideally three days before they are due). Also, any payment agreements you’ve made with a creditor or debt collection agency should be given priority in your strategy. Most important: Stay focused on not creating new debt as fast as you get rid of the old. Remember, never use credit to buy anything that you can’t afford to pay cash for.
Habit: I do not spend more money than I make. When it comes to getting your money right and gaining financial freedom, this is the most important resolution you can make, whether your household is in the top 1 percent American earners or one of the other 99 percent. Unfortunately, on average, Americans spend about a dollar and 25 cents for every dollar they earn. How? By not following a spending plan, also known as a budget, and by using credit as a substitute for the cash they don’t have.
Wealth is not a matter of how much you make, but how much you keep. So the person who makes $30,000 dollars a year and manages to save $5,000 of that income by the end of the year, is wealthier than the person who makes 3 million dollars a year, but ends spending $4 million, creating an additional $1 million dollars in debt and liabilities. That’s how so many individuals with high incomes, such as many pro athletes, end up bankrupt. Living beyond your means leads to financial disaster no matter how big your paycheck.
That’s why you need to make live within your means not just a goal to strive for, but a habit today. This starts with reviewing your budget, or creating a new one, that accounts for all of your monthly income and expenses. If the latter is greater than the former, you only have three options: make more money, cut expenses or some combination of both.
Commit to these three habits, and your finances will improve. Without them, the chances of you keeping any other financial resolutions this year are slim to none. It’s about establishing good habits, not just chasing desired outcomes.