Before you embark on a journey to having an effective personal finance, you need to know where you stand, and then decide where you want to be. Having established these two points, you can now develop a personalized strategy. Let’s find out where you are using the Five-Point Personal Finance Coordinate System consisting of loans, relationship between income and expenses, emergency fund, insurance, and investments.
After knowing the right principles/mindsets you need to have for a good start in your journey to an effective personal finance, you should now be in a better position to objectively look at where you stand. This assessment allows you to see what’s missing in order for you to have a solid foundation in your journey. These are the basics – The Five-Point Personal Finance Coordinate System.
Are you able to pay off both the capital and the interest on time, and according to the payment schedule?
All of us had to take loans at one point in our lives. Loans helped many people tide through difficult times so loans are not really bad. If you are to pay for college tuition, a loan is good; otherwise, you may not be able to pursue your studies. If you are sick, and the insurance has run out, you may need to get a loan, either from the bank or from your friends and relatives. If you are retrenched, a little financial help might be needed until you find the next job. The point is loans can be helpful.
However, loans can be crippling if they are not handled well. Credit card interest rates are at 24% per annum. Some bank financing can cost you 10-15% per annum. And you have not even started looking at compounding of interests! Some people claim that Einstein said that one of the greatest inventions is the concept of compounding. I’m not really sure if it is true that he said that but I know that compounding spells bad news, especially if you can’t even pay the capital.
So look at your loans. Are you able to pay off both the capital and the interest on time, according to a payment schedule? If yes, or if you don’t have any loans, then you have a solid foundation on this one.
2. Relationship between your income and expenses
Although the norm right now is still having a fixed income through employment, many are jumping into the freelancing bandwagon and have variable incomes. However, the principle in budgeting still remains the same. Your income must always be greater than your expenses.
Today’s credit system makes it possible for many individuals to live beyond their means. Their expenses are higher than their income, thus they are forced to max out their credit cards. The novel ‘Confessions of a Shopaholic’, which was turned into a movie, epitomizes the case of supporting expenses beyond one’s income through the credit cards. Eventually, the credit limit is reached, and you’ll have to start paying off your loans.
The only rational solution is to start living within your means. If you find that your expenses are greater than your income, find ways to either lower your expenses, or to augment your income. There are many ways to do this, so it’s your pick.
Look at your expenses. If your income is greater than your expenses, then you have it going good in this point.
3. Emergency Fund
Do you have a readily accessible amount of money good for 6 month's expenses?
If something happens tomorrow where you will need a huge amount of money, do you have readily accessible cash?
What happens tomorrow is not certain. You can lose your job, you can meet an accident, your house might catch fire. I’m not wishing you ill, but you never know when you’ll need that extra money for unforeseen necessary expenses.
So you have to make sure you have an emergency fund. An emergency fund is a sum of money which you have easy access so you can use it immediately. Typically, the emergency fund is about 3 – 6 months of your monthly expenses. It’s expenses, not income. That’s why it pays to minimize your expenses, which we just talked a while ago.
However, you need to also factor in the circumstances and times where you live. If you are an employee, research shows that it takes about 6 – 12 months to get a new job. That may mean 6 – 12 months without an income. So I really suggest you take a look at your emergency fund and realistically establish how much you need.
So where are you at building your emergency fund? If you have about six months’ worth, then that’s good. I know it might be a huge amount of money but better be ready than be sorry.
Are you adequately covered by insurance?
I would recommend you work on this concurrently with the emergency fund. But you may want to vary this based on your needs, and if your employer provides insurance for you.
The key question: Are you adequately insured?
The same with emergency fund, you never know what can happen in the future. You need to plan for accidents, disabilities and early critical illnesses. I really wish I could say it’s easy to be healthy these days, but nope. So get yourself protected from the financial stresses that come with getting sick. You can choose to start small. But the important thing is to start.
As for the coverage, really take time to understand what you need. There are many insurance schemes with riders, and not all are created equal. So go ahead and talk to your agent. Don’t be afraid to say ‘No’. Really understand the coverage you need before you decide.
For me, I decided to forgo having an accident plan. I thought that if ever I have a major accident, I’ll need to be hospitalized anyway, and with that, I’m covered. My insurance agent was telling me that I could even use the insurance if I cut my finger. So I calculated how much I’d probably have to spend for that one finger as compared to my premium. I decided that the probability was against me. If ever I cut my finger, a Band-Aid will do. But I have hospitalization and life insurance plans.
What about you? Are you adequately covered by insurance? If you are, then that’s another point that puts you in a good place.
Do you have investments? Are you happy with your investment strategy?
What would you consider an investment?
An investment is something that you acquire at a lower value to be sold at a higher value on a later date. An effective investing requires a personalized strategy.
Remember that our investment styles are different, and it should be. Your investment strategy must take into consideration the following:
Personality: What is your risk appetite? Can you take the heart-pumping rollercoaster ride in the stock market? How patient are you with wanting your returns? Do you want to have a direct control or are you willing to let others run your investments for you? Would you rather have a business?
In reality, we all have your different preferences. Don’t hesitate to acknowledge this when you are planning. After all, you’ll be in it for the long haul, so make sure it suits you.
Lifestyle: How much time can you spend to take care of your investments? How much money can you set aside with your current lifestyle for investment? Are you willing to make changes to your lifestyle?
When you start investing, don’t forget to live in the present as you invest for the future. Enjoy the ride.Plan gratification, don’t delay. So make sure that it investing fits well into your lifestyle.
How can you make investing and your current lifestyle complementary? Learn about the different vehicles of investing. Read books, learn from others. And decide for yourself. Own your decisions.
Your goals: Endeavors can only be successful if there is a clearly defined goal. Otherwise, you’ll run around in circles, and many things will not make sense. Investing needs a clearly defined goal specially because it can be demanding.
You need to know why you are investing and what you hope to achieve.
Do you have investments? Are your investment strategies personalized? Are you comfortable with them? If yes, then that’s a good place to be in.
This wraps up the article on knowing where you are. How did you do with the Five-Point Personal Finance Coordinate System? Where are you right now?
In the next article, I will talk about setting financial goals. Together with this article, you should have a better idea what you need to do for your personal finance.
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