Katherine Gustafson is an author and personal finance expert from Portland, Oregon. She writes about investing for Wealthsimple as well as having written for Forbes, Business Insider, TechCrunch, and LendingTree. Katherine is a past recipient of the Izzy Award for outstanding achievement in independent media. She has a BA from Amherst College and an MA from Boston University.
Many in the U.S. live in fear of an unexpected expense—only 39 percent of households have enough on hand to cover a $1,000 mishap. Yet such things happen with regularity: A tree falls on your roof; your kid breaks his arm; your car breaks down.
Becoming one of those people who can handle such eventualities with ease is not magic. It all comes down to being thoughtful and careful about how you use your money. That includes controlling your spending, knowing how to save for the future, and investing wisely.
Now that we've covered the basics, let's do a deep dive into important money management principles you should know about.
Understand your financial emotions
Before you bust out the calculator and start tabulating numbers, contemplate your feelings about money.
“What you think and say to yourself about money has a huge impact on what shows up in your life,” says Ellen Rogin, a Chicago-based certified financial planner and CPA.
Do you presume that being concerned with money will make you materialistic? That enjoying it will make you self-indulgent? Do you associate money with stress and anxiety? Do you fear there won’t be enough of it? Or assume there always will be? Do you know how much risk you’re comfortable with?
Once you have a better sense of your internal relationship with money, you can take steps to make managing your money a more positive—and ultimately successful—process.
Be honest with yourself. It’s very normal to have tumultuous, confusing, and negative emotions related to money. You learned these associations in your earliest years as you absorbed how your family discussed, spent, saved, and used money.
“The common denominator that I've found over my more than 30 years in financial services is that, when it comes to money, we are often gripped by our emotions,” says Jill Schlesinger, a former Wall Street trader and current financial advisor. “There’s no getting around that we are human beings; we’re not always rational.”
Set some goals
Once you’ve uncovered what's making you tick internally, it may be easier to break through the noise and figure out some goals with a clear mind. Knowing how to approach managing your money depends on what you need it for, which requires planning. The answer will be different for every person and household.
If you'll need all your money in the short term, saving is probably the best course of action. But if you have funds you don't need to access for a long time, you can invest it and reap the potential rewards of the stock market. Knowing what goals you have for your money will dictate how to balance these two strategies.
When setting your goals, think broadly about all the things in your life you'll need to spend money on. A good strategy is to write out all of the things you want to accomplish in life, from buying a house to sending your child to college to visiting Tahiti.
Here are some questions to pose to yourself:
Do you want to buy a house?
Do you want or need further education or training?
Do you want to save for your children’s college education?
Do you want to take nice vacations every year?
Do you want to pursue particular hobbies or activities?
Do you want to start a business?
Do you need to set up an emergency fund?
When do you want to retire?
Write down any life goal you can think of—from the major to the miniscule. Try to estimate the amounts you’ll need to reach each of these goals. This will give you a sense of the total universe of your needs over the course of your life, giving you a better handle on how to approach your money management.
Make a budget
If you’re going to save money, it’s essential to spend less than you earn. And it’s very hard to know how much you can safely spend without putting together a budget. Your budget will guide you as you manage your spending on a daily basis.
The first step in setting up your budget is to add up all your expenses. Be specific and thorough. Look at the exact amount on each bill and figure out an average monthly expense based on those numbers. Estimate things that you aren’t able to be exact on, but try hard not to low-ball yourself. For example, if you’re commuting 100 miles by SUV daily, then you're buying more than one tank of gas a month.
Write down all of your numbers on a spreadsheet so you can see exactly what you’re dealing with. Some of the numbers will be fixed and others may be able to vary widely depending on your behavior. Don’t forget to add line items for various types of savings, such as retirement and college savings, if those are part of your goals.
Once you’ve got your numbers and know the spending you can handle, it’s time to figure out how to match that with your income. There are various ways to do so. One or another of the following systems might work best for you.
Zero-based budgeting assigns every single dollar that comes into your account to a specific basket, including savings. This strategy gives you a full view of your money, making sure each dollar is working toward one of your goals.
50/30/20 budgeting sets specific portions of your income to be applied to a few different purposes. You’ll assign 50 percent of your income to covering your needs, 30 percent to paying for your wants, and 20 percent to paying off debt or to saving.
Digital tracking is a way of budgeting that involves constant surveillance of what you’re spending in each category, so you can adjust as you go. There are a wide variety of apps like Mint can make this task (relatively) easy.
Cash-based spending is a way to restrict yourself if you tend to overspend. Take out as much cash as you think you need for categories like groceries, gas, and entertainment at the beginning of the month, and place each in its own envelope. When each envelope is empty, it’s time to wait until next month to spend more.
Pay bills on time
Paying your bills on time is an essential part of money management. Letting bills go unpaid means wasting money on fees, letting expenses pile up so they become insurmountable, and—with some bills like credit cards—potentially damaging your credit score.
Knowing whether you can pay your bills on time requires tracking how much you will owe and when during each monthly cycle.
If you know that you'll come up short on paying your bills, prioritize whichever expenses are essential and cut back on the rest until you get to a better place. If you know you won’t be able to pay a given bill on a certain month, contact your lender or service provider ahead of time to discuss the situation. They may be willing to extend the due date, cut off service temporarily, or put you on a payment plan of some kind.
Build an emergency fund
Having a chunk of change stored away means you won’t go “underwater” when the washer breaks down or, worse, someone in your household loses their job.
An ideal emergency fund consists of three to six months’ worth of living expenses. But amassing that amount of cash can be extremely difficult.
Start with a number that's realistic for you to save over time. It may be a certain number of months of expenses or it may be a flat amount—say, $10,000—that would allow you to weather a personal crisis.
The trick to saving up that bundle of money is to take it slow and steady. Keep directing a small amount into your savings each month. When you have extra income, such as a bonus or a side gig, pop it into your emergency fund. When money that you were directing toward paying down debt is available again after the debt is paid off, switch to putting that amount in savings instead. Soon enough you’ll be sitting on a comfortable cushion.
Pay off debt
Don’t make the mistake of thinking you can’t get an efficient money-management plan in place until you’ve paid off all your debt. Damir Alnsour a Portfolio Manager at Wealthsimple explains that steady debt repayment should be an essential part of your financial management plan.
Most people are paying pretty high interest rates on their debt. Paying it off should be a priority to improve your overall financial health.
In fact, paying off debt should probably be a top priority among your goals. That doesn’t mean you should focus on it to the exclusion of your other goals, but paying back your debts steadily—and reliably—is a must.
There are various strategies for paying off debt. Two of the most popular are the “debt snowball” method and the “debt avalanche” method.
With the debt snowball method, you pay off your debts from smallest to largest, a strategy that gives you fast wins to keep you motivated but ends up with you paying more over time (unless the smallest debt has the smallest interest and so on).
The debt avalanche method involves paying off your highest-interest debt first and working your way down to the lowest-interest debts, which results in your paying less money overall but doesn’t necessarily provide quick wins.
Use this calculator to calculate how each method will work in your situation.
Understand and manage your credit
Understanding your credit profile—that is, the information that the credit reporting agencies track on you—is a crucial part of managing your financial picture. The agencies use this information to calculate your credit score, an important metric that dictates whether various institutions will grant you access to credit to pursue your goals such as buying a house or opening a business.
If you’ve had trouble paying off your debts in the past you will likely have a low credit score, which will affect how you can manage your finances. It will be essential to improve your credit score in order to set yourself up for a strong financial future. Doing so requires consistently paying off your debts and resisting taking on new debt until your situation has improved.
The first thing you should do as you start getting a handle on your debt management is to request your free credit score. This will give you a sense of what progress you need to make to get to a place where your score won’t hamstring your future efforts at financial progress.
Audit your current financial institutions
The institutions managing your investment accounts, like retirement accounts and mutual funds, are likely to be charging you fees for the work of managing the money. It’s important to know what fees you're paying and assess whether they are too high in comparison to how much the managers’ guidance is benefiting you.
Do your fees seem too high for the amount of return your accounts are showing? Are you getting good support in exchange for the fees you’re paying? Do you have access to smart technology for managing your accounts? Are your accounts rebalanced automatically as your life circumstances change?
Shop around if you think you’re being charged too much and getting too little for the money. Financial management is a competitive field; there are many options.
Ensure you're saving enough for retirement
Saving for retirement is a key part of money management, since that is savings you will definitely need to have in place at some point in your life. If you are employed full-time you likely have access to an employer-sponsored retirement plan, but you also have the option to invest in individual retirement plans.
Employer-sponsored plans. In the U.S., employer-established retirement plans are called 401(k) plans. In Canada they are called Registered Pension Plans (RPP). Your employer sets up a plan into which employees’ can invest pre-tax income. In many cases employers will match employee contributions up to a particular amount.
Individual plans. In the U.S., individuals can invest in IRA plans, including Roth IRAs that allow investing after-tax income. In Canada, these types of plans are called Registered Retirement Savings Plans (RRSP). These types of plans often come with caps on how much you can contribute (and no matching).
The earlier you can start investing in your retirement, the better, since the power of compound interest will help your money grow over time. If you haven’t started yet, don’t panic. Just get enrolled in a plan as soon as possible and start putting money away on a regular basis.
If you have the option, enroll in your employer-sponsored plan and if possible put in the maximum you're able. At the very least the maximum that your employer will match. Employer matches are basically free money for retirement that you can’t afford to leave on the table.
You can use a retirement calculator to figure out how much you need to be contributing every month in order to retire at the time you want with the type of financial support you need. (Here’s one for Canada.)
Get adequately insured
Insurance may seem at first glance like a drain on your finances, but it's an essential piece of effective money management. There will be nothing more devastating to your carefully constructed financial stability than a true emergency that you don’t have insurance to cover: a house fire, a medical crisis, the death of the family’s breadwinner., etc.
Look at your coverage in the following areas and make sure you feel it's sufficient in case the worst happens:
Car, if applicable
These forms of insurance are essential for almost everyone. Your employer may well supply you with medical and dental insurance, as well as short- and long-term disability, and possibly some minor amount of life insurance. If not, you can buy them on the individual market. You may also want to look at other types such as pet insurance or business insurance if they apply to your situation.
Learn more about investing and money management
You may have the impression that investing and managing your money well is extremely difficult and complicated. After all, there is an entire industry around investing, so you might be forgiven for figuring those people know a whole lot you don’t or understand things you can’t.
Here are some ideas that will bring you up to speed on the latest thinking on savvy ways to invest without all the headaches.
Passive investing. In passive investing, your investments gain and lose value in connection with the fluctuations of the market. By contrast, active investing means a human investment manager is buying and selling stocks in your portfolio in an attempt to “beat” the market and make bigger returns. In recent years, passive investing has become much more popular because data shows that over the long term, passive funds tend to do better than those managed actively, despite coming with far lower fees.
Diversification. There is a slew of investment options out there, from emerging market stocks to good, old bonds. Buying a well-balanced mix of these is the most effective investment strategy. One of the best ways to achieve diversification if to use an exchange traded fund (ETF) or a mutual fund. Investing in an ETF can be done passively, and even automatically, via a robo-advisor.
Robo-advisors. Robo-advisors advise you on how to invest based on information you provide about your tolerance for risk. These are a great tool because they come with very low fees—typically 0.50%, in contrast to the 1% or more an active advisor may charge. Robo-advisors rarely require a minimum balance; they do things rapidly; and they are available at all times of the day and night. At Wealthsimple, we think these are pretty cool… because we happen to be one.
Regardless of how you choose to invest the key thing to remember is to stay the course. Just as you must remain steadfast to your budget and reliable in repaying your loans, settle into the investment strategy you pick for the long haul. If you use a steady hand to steer your money-management ship, you’ll eventually come out ahead.
Looking to do some passive and diversified investing with a well-designed robo-advisor? Sign up with Wealthsimple, the only automated investing service to offer all of its clients unlimited human support. Every Wealthsimple client gets state-of-the-art technology, low fees, and the kind of personalized, friendly service you might have not thought imaginable from a low-priced investment service.
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