Personal finance is not rocket science. It’s actually straightforward, but many people get it wrong because it’s not something that you learn early in school.
My first encounter with personal finance was at university when I studied BSc in Finance. I didn’t have much money then, so it was easy being frugal and living within my means. But now when I am 28 years old, it takes more self-discipline to keep my lifestyle inflation in check. Especially when my income keeps increasing every year.
I am working as a financial analyst so analyzing my personal finances comes naturally to me. I have done it for the past 10 years and with some luck, I have avoided major financial mistakes. However, many of my friends have been in serious trouble. They took too many risks and made several personal finance mistakes.
Below I will explain key personal finance rules that I am applying in my everyday life that help me to stay on track, achieve my life goals and avoid serious financial setbacks.
Track Your Income and Spending
For almost all of my expenses, I pay with my debit card (I don’t use cash). That’s the easiest way to record all my transactions in one place. At any point in time, I can go back and check what I have spent in a given year, month or even a day.
Every January, I export my previous year’s spending into Excel and do a quick analysis and budgeting of my income and spending. When analyzing my past expenses, I look for the following things:
- Average monthly income
- Average monthly expenditures
- Did I spend less than I earned in all of the 12 months (excluding one-off purchases and investments)
- What were the key expense categories – is there anything I can save money on next year?
- By how much my income increased year over year – to see if I am on track with my career plan
- Is there anything odd in my spending (checking for potential fraud)
This way I can be on top of my personal finances without putting in too much effort. Tracking these things gives me a general idea where I am earning and spending my money and if I am living within my means.
The person who doesn’t know where his next dollar is coming from usually doesn’t know where his last dollar went.
Spend Less Than You Earn
As you see from my bank account analysis, I always check if I spend less every month than I earn. For calculation purposes, I exclude one-off items like apartment repairs or investments, which I have planned in advance.
Living below your means seems to be very difficult in an age where most people buy things on credit. To me, it just seems stupid. If you buy things on credit (for consumption), it means you can’t afford them. It’s a recipe for financial mediocrity.
Here are some tricks that I use to live below my means:
- Avoid impulsive purchases – wait 2 weeks after you get the urge to buy something. If after 2 weeks you still want it and think that you need it, go and buy it.
- Think of the opportunity cost when buying something. Is it worth buying something when you can invest that money or save for your emergency fund or invest it in learning a new skill?
- Cut meaningless expenses. I don’t have a TV, I don’t pay for Netflix every month and I don’t drive a fancy car. I don’t pay for these things because they will consume more money, more time, cause less stress and definitely won’t lead to my financial and life goals.
- Don’t use a credit card (the opposite of what most Americans would advise you). The same logic applies here – why buy something if you can’t afford it? If you are using your credit card just to earn points and never miss any payments, then you can keep using it, but remember that this might still incentivise you to spend more money and consume things that you don’t really need!
- Live in a home that’s the right size for YOU. Why people in the UK can happily live in a 76sqm (818 sqft) apartment but Americans want to live in homes that are 3 times bigger? There are better things you can spend your money on than repairs, heating or insurance.
- Don’t compare yourself to your friends, coworkers, influencers or random people online. Compare yourself to you! Set your own goals and be proud of them. For me, deleting most of the social media helped me a lot to stay focused and stop comparing myself to others.
- In many cases, you can buy second-hand products that are perfectly fine instead of buying new.
- Find cheap hobbies. Running, hiking, reading, travelling within your country (something that we discovered well this year with Covid-19) are great hobbies and cheap as well.
If you successfully manage your personal finances by living below your means you will be less stressed, have more freedom and less risk in case something unexpected happens.
It is not the man who has too little, but the man who craves more, that is poor. by Seneca
That man is richest whose pleasures are cheapest. by Henry David Thoreau
Have an Emergency Fund
There is no question if you should have an emergency fund. The answer is always yes. The only exception is if you are a millionaire.
A small problem can become a huge one when you least expect it! The emergency fund will help you manage these risks by creating a safety net of funds that you can use to cover the emergency expense if it occurs.
Benefits of an emergency fund:
- Avoid accumulating more debt (especially high-interest debt)
- Peace of mind
- Help your family when they need
- Think and plan long-term
- Avoid bad financial decisions
When it comes to the actual structure of your emergency fund, I suggest to keep it in a current account without a linked debit card to it. It will be separate and still easy and fast to access.
When you are thinking of how much you want to save, think what you are scared of the most and how much money you need to set aside to reduce that fear. You should take into account the chances of losing your job, your current debt level, whether you have a mortgage to pay and whether your income is regular/irregular. If you are not highly confident about your income stability, then it would be good to save at least 6 to 12 months’ worth of your expenses to cover small and medium emergencies.
Keep in mind, your emergency fund is for reducing risk, not earning an investment return!
Nobody has ever complained about how they wish they never had an emergency fund.
Be Careful With Debt
Debt can be used wisely but when people use it to buy things (typically houses and cars) that are way too expensive for their current income and needs, it can become a huge obstacle when it comes to reaching your financial and life goals.
If you don’t have any debt – great. You don’t have many financial risks to worry about. However, if you are loaded with student loans, car payments, a mortgage and a credit card on top, you are in trouble.
The only way you can improve your personal finances is by paying off your debts. First, you should follow the first three points I wrote above – track and budget your income and spending, live below your means and have an emergency fund.
Second, you should pay off your debts, starting with the one that has the highest interest rate (typically that would be short term consumer loans, credit card debt and car payments).
Try these tips to help you pay off debt more quickly:
- Reducing unnecessary expenditure
- Sell stuff you don’t need or that you don’t use
- Look for ways to increase your income
What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience? by Adam Smith
A Short Summary of My Own Personal Finances
My only unpaid debts are a student loan that costs me 1.1% per year and a small mortgage at 6%. Right now, I am trying to pay off my mortgage as fast as possible.
I drive the same car for the last 6 years and its value is roughly my one month’s salary. I have to say, it was one of my best purchases since I have no worries about it and it is very cost-efficient. My plan is to drive it as long as I can.
By living below my means, I am able to save more than 50% of my income every month (except in December due to Christmas expenses). Recently, I have started investing more in my education and health. I started learning a new language, doing online courses, reading more books and picked up cycling a year ago which I still love.
In terms of financial investments, I am very much in cash right now as I believe the market is overvalued. I am a big fan of real estate and timberland as asset classes. My next larger investment will likely be in one of these assets.