The Stages of Personal Finance
When you say you want to be better at handling your money, what does that mean? The answer to this question depends on the person. It could mean early retirement, higher income, more savings, and a variety of other things. But is financial improvement merely a numbers game? What do you aim for if you’re unclear about how a certain lifestyle will cost? Surely there must be other ways to measure improvement.
Because of this, I prefer to think of financial growth in stages. It doesn’t include a specific net worth amount, nor a minimum income level. After all, there’s no such thing as “one size fits all” when it comes to personal finance. What exists instead are different psychological and emotional stages, and the numbers corresponding to them vary from person to person. What I’m measuring in this case is one’s sense of comfort, freedom, and security which, frankly, is more telling than the numbers themselves.
So what are the different stages of personal finance?
Stage Zero: Ignorance
Why start with zero and not the number 1? Well, because zero is what’s going on here. The idea of handling money hardly makes a blip on your radar. Not to sound too harsh, but stage zero is the stage where you are ignorant about money. That’s okay, everyone starts here.
While you may know about saving or investing, you’re not really doing them. You feel like you should save or at least do something about your money, but this thought soon disappears as you go back to your daily life. You don’t know how much your monthly expenses are, either. If you’re unlucky, you’re already in financial trouble but are vaguely aware of it. If you’re lucky enough to avoid trouble, this is mostly because of chance. Any minor event such as a toothache or “therapeutic shopping” is bound to rock your financial boat.
Stage One: Awareness and Action
Finally, you’ve realized that it’s time to take control of your finances! You start asking around, reading books, and learning all you can about how to do things right. Then, you actually do something with this new information.
If you have debt, you’re creating plans to reduce or eliminate it. At this point you are also forming new habits such as getting your spending under control and managing your money. If a lot of damage has already been done, you may be far from financial stability – but at least you’re taking steps towards it.
Stage Two: Stability
By this time your actions have paid off and you’re taking consistent measures to keep it that way. You have no debt, or if you do, it’s completely under your control. You have an emergency fund that is suited to your needs, and you’re on track when saving or investing for retirement. Your income is also consistent and you spend less than you earn. You may even be sleeping easier.
Stage Three: Freedom
In this stage, you’re earning passive income that’s equal to or greater than your living expenses. You don’t have to rely on your job to live. Where are you getting this passive income? It could be from a business that you’ve invested in but don’t personally run, stock dividends, or the sale of information products (such as ebooks). The only downside is that because of the high level of knowledge, time, or capital needed for this stage, not everyone ends up here.
What stage of personal finance are you in right now? What stage do you hope to be in by the end of the year?
Read MoreDay#24: Write down your ideal income and expenses.
This is Day #24 of “25 Days to Healthier Finances”, a series of blog posts where Frugal Pinoy readers and myself work on 1 task a day to make our financial lives better. Please stay tuned for the final installment of this series, which will be up tomorrow. Here’s today’s installment:
In the income and expenses spreadsheet I use (which I also refer to as my budgeting spreadsheet, though that’s inaccurate), I include an extra sheet titled “Ideal”. This sheet contains my ideal expenses and income. While you don’t need to use a spreadsheet, I think it’s important that we all have a written record of our ideal income and expenses somewhere.
Today’s Task: Write down your ideal income and expenses.
The first thing to do is to grab a sheet of paper (or create a new document in your computer) and write down your ideal income. It’s not enough to write the amount itself, also note where the money will be coming from. How much will come from your job? A side business? Investments?
Read MoreDay#23: Do a financial review of your year so far.
This is Day #23 of “25 Days to Healthier Finances”, a series of blog posts where Frugal Pinoy readers and myself work on 1 task a day to make our financial lives better. Please stay tuned for the next installment of this series, which will be up tomorrow. Here’s today’s installment:
It’s nearing the end of 2009 so it’s just the right time to look back on the past year and review our experiences – whether they are positive or negative.
Today’s Task: Do a financial review of your year so far.
Collect your documents. These would be your latest bank and credit card statements, payslips, and other documents that are relevant to your finances. If you have a budget notebook or spreadsheet, take those out too.
Get a pen and paper or open a new document in your computer. You’ll need to write down your financial review so that it’s concrete, and you can review it next year to see how well you’ve improved.
Note the following information:
- Debt status. If you currently have outstanding loans and debt, look at your most recent statements and see how much you still owe. How much longer do you need to repay all your debt?
- Income. How much gross income did you earn this year? How much is it after deducting taxes? Apart from the pay you get from your regular job, don’t forget to include any subsidiary income you received such as money from side gigs, selling, or investments.
- Savings. Look at the statements from your savings accounts. How much did you end up with this 2009? How are you allocating these savings? (In other words, how much is for your emergency fund, retirement, or other items?)
- Spending. If you collect detailed expenses like I do, look back at all the information you gathered last year. What major expenses could’ve been avoided? Where did you succeed in minimizing expenses?
- Investments. If you invest any money in bonds, stocks, mutual funds, or businesses, how did your investments do by the end of this year?
Your financial review can be as simple or as detailed as you want. You don’t need to jot down your month-by-month activity if you don’t have to. Just start with the basics above, and if something seems wrong or if there’s a specific part you’d want to improve for next year, that’s when you can choose to be more detailed. Also: if there are certain aspects of your finances that you’re not too proud of, don’t dwell on it! Just make an action plan to avoid making the same mistakes next year. Let’s keep this exercise positive.
Have you reviewed your 2009 finances yet? Which areas did you do well in? Which ones need more improvement?
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