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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Delayed gratification in financial planning has created an impression that the ultimate gratification is achieved further down the road - when one is retired. This may not work for many since this asks us to live for the future and 'forsake' the present. Instead of delaying, plant gratification. Don't feel guilty; plan to splurge and reward yourself along the way to keep yourself motivated. The key word is plan.
Delayed Gratification in Financial Planning
Delayed gratification, or deferred gratification, is the ability to resist the temptation for an immediate reward and wait for a later reward. Generally, delayed gratification is associated with resisting a smaller but more immediate reward in order to receive a larger or more enduring reward later (Carducci, 2009).
Instead of just delaying, have a concrete plan in your financial planning to reward yourself handsomely in the not so far away future. Don't feel guilty about it. After all, you need to live in the present, and plan for the future. So make sure you cover how you'll live in the present while you are planning for the future.
How to Plan for Gratification?
In delayed gratification, you need discipline and self-control to delay actions. In planning for gratification, you need discipline to follow through your plan.
Ask yourself these questions.
What are my treats?
Identify what you enjoy doing.
What you enjoy might be different from what others enjoy. Some might enjoy traveling, but you might be the person who enjoys fine dining. You may be a shoe collector, or a bag collector, or an action figure collector.
It's different from everyone. So know that treats that make you happy. A lot of my friends enjoy touring different countries, but right now, what I enjoy most is eating good food. I have selected my treat. What's yours?
What are the things I can only do now?
Know if the treat is something you must do now, because you may not be able to do it in the future.
Money lost can be recovered. But time lost is forever lost. There are moments that call for splurging - like treating your loved ones once a year. Like what MasterCard says, some things are priceless. (This is as far as I would agree with credit cards).
I hate to remind you of this, but your body is also not going to be young forever. While in Australia, there is no maximum age limit to skydive, your physical body will dictate if you can still jump out of that plane and land safely.
There are just some things that cannot be postponed.
Can I afford it with what I have now?
Don't go in debt just to treat yourself.
The next question to ask is whether you can afford it with your current finances, with your savings and investments.
As I said earlier, I don't entirely agree with MasterCard. I strongly recommend that you don't use your credit cards to fund your treats if you are going to use the future money that you don't have right now. Although I know it's a credit card, I always treat mine as a debit card. Unless it's a matter of life and death, my credit limit does not dictate how much I will charge on my credit card. How much money I have in the bank does.
There are two reason why I'm saying this. And I would like to emphasize this point.
1. The interest rates are hefty.
2. What will happen in case of emergency?
Which brings me to my next point.
Do I already have an emergency fund?
Make sure you have funds to cover unforeseen events.
Good planning includes contingency plans. Having an emergency fund is one of my requirements before I would even think of having a very big treat (meaning about 2 - 3 month's worth of income) for myself. After all, unexpected things happen. And since I'm advocating planned gratification, this is part of good planning as well.
Typically, an emergency fund is worth your six months' monthly expenses.
Do I have a financial plan for retirement?
Living in the present doesn't mean you do not plan for the future. The future is still part of our life.
Indeed, YOLO is the in thing right now. You Only Live Once. But if you live in the future, that life is part of your one life that you live.
Always make sure you have a plan in place for retirement. You may plan not to allocate funds to your retirement immediately, but you have to identify a practical date when to start, and stick to it.
How Long would you delay?
From my perspective, you have to decide how long.
Ask yourselves the questions above. The last three questions dictate how long you will delay. There is no fixed time because everyone's goals and plans are different. But remember, don't feel guilty about treating yourself. You have to keep yourself motivated and you deserve to live in the present.
As I said earlier, the discipline is in planning, not delaying.
To understand more about personal finance, you can read some books below.
- Be the master of money.