Personal finance is about reaching personal financial goals, whether it’s having enough for a short-term financial expense, planning for retirement, saving for a home, or your child’s college education. It all depends on your income, expenses, living requirements, and individual goals and desires — and coming up with a plan to meet those goals within your financial constraints. To make the most of your income and savings, it’s important to become financially literate, so you can distinguish between good and bad advice and make smart decisions. Let’s look at four reasons why developing good personal financial habits can be beneficial to your life.
Knowledge is power
In a study by the National Endowment for Financial Education, only 24% of millennials demonstrate basic financial literacy. Taking a look at the financial outcomes of an individual with poor financial habits, it is easy to see that a lack of knowledge leads to increased stress over financial matters, reduced savings towards retirement, and poor choices overall that hamper individuals from attaining their financial goals. Financial problems can also lead to divorce, poor health, depression, and bankruptcy.
Many of these financial issues could be avoided with some basic knowledge. Nearly half of Americans don’t have enough cash available to cover a $400 emergency. Getting fired or having a medical emergency without any savings would be devastating. Understanding the importance and ways to set up an emergency fund could prevent this.
Individuals bear a greater financial burden in retirement going forward
Prior generations depended on company pension plans to fund the bulk of their retirement. Pension funds managed by professionals put the financial burden on the companies or governments that sponsored them. Consumers were not involved with the decision-making, typically they did not even contribute to their own funds, and they were rarely made aware of the funding status or investments held by the pension. The other major source of retirement income for past generations was Social Security. Social Security replaces about 40% of the average worker’s pre-retirement earnings, so it’s more like a safety net to provide just enough for basic survival but may not be enough to continue your standard of living in retirement.
Today, pensions are more of a rarity than the norm, especially for younger workers. Instead, employees are being asked to shoulder more and more of their own funding for retirement by participating in defined contribution savings vehicles like the IRA or 401(k), in which they need to decide how much to contribute and what to invest in. Not only that, but the Social Security Administration is currently projecting it will have to reduce Social Security benefits by 25% in 2035, barring any changes to the program. With average lifespans increasing over the past several decades, it looks like we will be spending a much longer period in retirement than prior generations. This means you will likely need more money set aside for retirement than your parents or grandparents if you want to maintain your standard of living.
Retirement planning is likely the last thing on your mind when you’re in your early twenties, but time passes by very quickly. You could move several times, change careers, get married and have a family, and be in your forties before you know it — and you’ll be wondering where all the time went. The key to a successful retirement plan is to start early, evaluate your needs, and set goals that stick to your long-term plan.
Avoid falling into the debt trap
In past generations, cash and checks were used for most daily purchases. Today, they are rarely used. The way we shop has changed as well. Online shopping has become the top choice for many, creating ample opportunities to use and overextend credit — an all-too-easy way to accumulate debt, and fast. While some debt, like mortgages or student loans, can be considered “good” debt, carrying a balance on your credit card is not. If you carry a credit card balance each month, keep in mind that the credit card company will charge you interest, which could end up costing you significantly more over time. If that’s not bad enough, that amount you’re paying toward interest could be directed to saving for your financial goals — but isn’t. So, you could say that you’re paying twice: both in the interest cost itself and the opportunity cost of the lost savings.
While having a good credit record is a necessity for many activities — such as renting a place to live — many people find themselves relying on credit cards regularly and paying more than they should. Learning the dangers of credit cards and high-interest rates are critical, as well as the importance of paying them off.
The dreaded B-word: Budget
When people hear the word budget, it often carries negative emotions with it and can bring up feelings of anxiety and stress, so I prefer to use the term spending plan. Having a spending plan is a great way to work toward your financial goals. Social scientists point out that people who write down their goals are more likely to achieve them. Writing down where and how much you’re spending is no different. Thanks to technology, it’s easier than ever to track your spending and investing activity. This will allow you to see what you’re doing at a glance. Figuring out where your money goes is a great first step to help you make better decisions.
Developing good personal financial habits is important because money is one of the things that will encompass just about every aspect of your life. Think about how much you could learn if you spend some of your time improving your financial knowledge. Don’t wait until something bad happens to start thinking about money matters. If you spend time learning about your finances, and how to improve and make positive changes, you’re that much closer to achieving your financial and life goals.