Wednesday, July 23, 2008

The five most important words in personal finance

Spend less than you earn.

If you spend less than you earn you will never need to worry about money.  If you have debt, you will pay it off.  If you don't, you will never go into debt.  If you spend less than you earn, you will accumulate wealth, reduce stress, have a more harmonious marriage, and generally, improve the quality of your life.

In order to spend less than you earn, all you need to do is know two very important things:  how much you earn and how much you spend.  The first one is pretty easy - most people have a good idea of how much they earn.

This second bit of information - knowing what you spend - trips up many people.  When you consider how important money is to quality of life, it is amazing that so many people go through life without a strategy on how to spend.  If you already track your spending, great!  You are a step ahead of the game.  If not, then don't worry.  It's easy and it will definitely be worthwhile.  All you need to do is track all of  your spending for one month.  If you are not a "numbers person" and aren't really excited about this, then there will be no need for you to continue after the first month.  (Full disclosure: despite my passion for finance, investment, and economics, I do not track every expense every day.)

There are plenty of fancy programs, web sites, applications for your phone, and financial ledgers that can help you track where your money goes.  My advice, particularly if you are not terribly excited about this project, is to pick up a small pocket-sized notebook and write everything down the old fashioned way.

Remember - the goal here is to learn about how you spend money, not to pinch pennies.  Not only is it unnecessary to change your spending habits during this period, but doing so will actually make this exercise less useful.

Back when I was dispensing financial advise for a living, I advised all of my clients to track their expenses for a month.  Few of them actually did it.  However, those that did generally told me that it was the best advice that I ever gave them.

Good luck and have fun!

Some practical notes on tracking your spending:  track everything you spend and in all forms.  It does not matter if you are using cash, check, credit card, debit, or gift card - it all goes in the notebook.  However, be careful not to double count credit card purchases.  If you pay off your bill every month (good for you!), track the purchase when you make them.  Do not also add in your bill at the end of the month.  This would lead to counting these purchases twice.  If you
run a balance on your card, then track purchases as you make them and chalk up your monthly payment as debt reduction.

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