We talk a lot about financial responsibility. But what does it mean to be financially responsible? What are the steps you should take? There is a lot of information out there and it can be easy to get overwhelmed, so let’s start with the basics. Read on for how to be financially responsible.
What is financial responsibility?
There are a lot of definitions out there, but let’s keep it simple. To be financially responsible, you need to balance your income and your spending. Don’t spend more than you make.
Sounds easy, right? Unfortunately, there’s a little bit more to it.
Spend Less Than You Make
The first step in our “How to be financially responsible” class is spending less than you make. Unless you make a ton of money or live extremely frugally, this is going to take some planning on your part. I recommend that everyone keep a budget. Some people are comfortable with a very general budget where they check in from time to time and make sure that they aren’t spending too much in one area. Other people prefer a much more strict budgeting process where they set spending limits in every budget category and make a point to never exceed those numbers. After years of budgeting, my budget looks a bit more like the former – I set up general budget categories, plan ahead for the month’s expenses, and check in every couple of days to make sure things look good. But any big purchase or things out of the ordinary require checking the budget before anything else.
We’ve all heard that we should save money. But for what? Am I just supposed to put away money for some unknown purpose?
I recommend starting with an emergency fund. Emergency funds can have multiple uses. You’ll hear some people say that your emergency fund should have enough money to cover your expenses for anywhere from two to six months. I don’t know about you, but trying to pull that kind of money together seems overwhelming. So start small. You’re not planning for what might happen if you lose your job, you’re planning for what might happen if your car needs unexpected repairs, at least at first. Set aside some money to be used for those unexpected expenses.
You should also save for the future? What does that mean? Retirement! We all want to retire someday, right? If you work for a company that does a 401k match (meaning they match what you contribute up to a certain amount), you should work to contribute that amount. It’s basically free money. Look at it this way – if you contribute $50 and your company contributes $50, you’ve already doubled your money, even before the investment started to grow. And even if your 401k plan loses money, as long as it doesn’t lose 50% (which it won’t), you still come out ahead.
Pay Down Debts Responsibly
There are all sorts of different types of debts out there. Maybe you have a mortgage or student loans. Maybe you have a car loan. Maybe you have some credit card or other consumer debt. No matter what the debt, you should have a plan to pay it off. And depending on the type of debt, that plan may not be “throw as much money at it as possible.”
Financial advisors recommend putting your money towards the higher interest rate debts first – and that’s usually the credit card debt. Interest rates on credit cards are high, and that debt continues to compound, so those should be your first goal (while still making at least the minimum payments on your other debts as well). If you have multiple credit cards with a balance, some will suggest paying off the smallest balance first to get it out of the way, others say to focus on the highest interest rate, even if it’s the biggest debt. What you choose is going to depend on what keeps you motivated. For me, I’d rather tackle the highest interest rate so I’m not spending quite as much on interest over the long haul.
Then look at your other debts. Sometimes there are benefits to paying them off early (like paying less interest), sometimes the interest rate is low enough that you can continue to pay as scheduled. We currently aren’t putting extra money towards our mortgage, for example, as the rate is low, and we’re instead using that money towards home improvements. (Plus we do get a bit of a tax break for the mortgage interest.)
Should you pay down your debts before you invest in the future? That’s an individual call. If you can, I recommend doing both, because those retirement accounts are important. Maybe consider contributing a smaller amount to your retirement, then put the rest of your money towards your high interest debts.
Check Your Credit Report
Do you know what your credit report looks like? Did you know you can get one for free every year from each of the major credit reporting agencies? Go to AnnualCreditReport.com for your free credit reports – and you don’t have to order all three at once. You may want to space them out and order one every four months so you can keep an eye on your credit and make sure that there are no accounts out there that you have forgotten about or worse, that you didn’t even open.
How to be financially responsible? Pay attention
It’s easy to want to ignore your finances. It can be stressful. But the smartest thing to do is to pay attention. Look at your bank accounts. Look at your expenses, your outstanding debt, and your income. Knowledge is the first step. It’s a big step, but it’s important.
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Megan is a 40-something government employee in the Washington, DC area. She got interested in Personal Finance when she got out of college and realized that her paycheck wasn’t going to go as far as she had hoped. Since starting this blog, she has managed to buy a house and make a solid start on her retirement goals, and hopes to help others do the same. Here is her story:
In 2007, I was a gainfully employed 20-something with no debt but not a lot of knowledge about personal finance. It was a co-worker’s comment about Roth IRAs that sent me to the internet, searching for information. It was then that I realized that I really didn’t know a whole lot about personal finance and that my current financial situation was due a lot to inherent frugal tendencies, generous family members, a fear of debt, and good luck. While that was working for me, clearly I needed a better plan.
While I had no debt, I was also pretty much living paycheck to paycheck and not worrying about going over budget (I say this as if I had a real budget) because I had an emergency fund set aside to cover any overages.
Except that’s not what an emergency fund is for.
So I did a lot of research, read a lot of blogs, and decided that I needed a plan. I needed to budget. I needed to know what I was spending my money on. I needed to prepare for the future.
I decided to create a blog not only to make myself accountable to others but also to share the knowledge that I gained along the way. I’ve learned so much from my fellow bloggers, and I hope that my readers can find something useful in what I have to share as well.