There are various stages of the financial literacy game. The above example would be akin to having your nose right at the water line, sometimes dipping below for short periods. You may feel like you're suffocating. Let's call this the Survival Stage. Much like Maslow's Hierarchy of Needs, you have to fulfill the base line physiological needs first before you can move up to Safety and then Love and Belonging.
Another stage of Financial Literacy, once the basic bills are covered, would be more akin to wants. I want to buy a new car. You don't need a car since you could rely on public transportation, but having a new car would make you feel good. In this stage you would need to learn how to save first. You're no longer living paycheck to paycheck once you reach this stage, although it may still feel like it since everything that is left over at the end of the month goes into savings. But at least you're saving for something you want, not something you need. Your chin is above the water line and as long as you don't gulp you'll be OK. We'll call this stage the Want Stage.
Another stage would maybe be involved in larger purchases. Again, you have to learn to save. But now, instead of wanting a new car which depreciates, you want to build a family and buy a house that is considered an investment. It's no longer about you and how the purchase makes you feel. You're planning into the future and realize that appreciation (value grows over time) is better than depreciation (value decreases as time passes). I like to call this the Realization Phase. You realize there's a future beyond the end of the month.
During the Realization Phase many times a first time home buyer is just learning to plan. They find a house they like and speak to a real estate sales person who tells them how to get a loan. In order to secure a loan to buy the house you desire you'll need a down payment. Typically for first time buyers this down payment should be 10% to 20% of the purchase price, depending on how well you managed your credit in the past. You can save each month until you reach that goal or you can ask a family member to gift you the down payment. Either way requires some planning. Family members don't tend to give you money like that until you've shown them some level of responsibility, right?
When you meet with the loan officer of the mortgage company they will go over your budget to come up with a score. They compare your expenses to your income to determine how much money they can lend to you. Again, this requires a plan. You may have had some credit cards you built up a balance on…those have to be paid down in order to meet the score requirements to get the loan you need to buy the house you want. Or you can take on a part time job to increase your income side of the equation. You save the money needed; you pay down debt; you increase your income. This is all part of the plan.
Sometime after the Realization Phase you may move into a phase of saving and making more money and growing your nest egg. Are you suddenly aware that you need money for retirement? Maybe your motivation is opening a business. Or you just want to live the good life…whatever that is for you. A big house on the hill? A luxury car? You've entered the rat race and you're going to win! You just want to send your kids to a nice university so they have a chance to live the good life. Whatever that motivation is, you decide it's time to build something. I call this stage the Wealth Building Stage.
In the Wealth Building Stage you have more focus on saving than any of the previous stages. Any financial Literacy Counselor you talk to will tell you to begin this stage you have to do a couple of things. First, pay down your debt. There are arguments about which debt to pay down first but everyone agrees that paying interest to use someone else's money is never a good thing unless it is being used to leverage (using someone else's money to build something that makes you more money). A house can appreciate more than the total interest paid on the loan…this makes sense. A student loan can increase your earning potential…this makes sense. But never borrow more than you absolutely need for the investment to pay off. Some students borrows hundreds of thousands of dollars to get a degree and then struggle for 10 or more years to pay off that student loan during the years that your salary is the lowest of your new career. The Wealth Building Stage requires more planning than any of the previous stages. If planned and executed properly this stage can have the biggest rewards for you and your family.
Have you noticed the use of the word "Plan" throughout this blog? No matter what stage of financial literacy you are in, you need a plan. A written plan makes things more real. You can hold yourself accountable to something. Without accountability you may never leave the Survival Stage. The plan is your road map to success.
So how do you develop the plan? It should start with some guidance. There are many organizations out there to help. Wells Fargo has a great website with lots of advice from building a plan to choosing credit wisely located here; https://www.wellsfargo.com/financial-education/basic-finances/build-the-future/short-long-term-planning/financial-plan/. A quick Google Search on "creating a financial plan" will give you more options than you'll know what to do with.
Any plan you develop needs to have steps and goals identified. The first step is going to depend on your current financial situation. Consider the following and decide which items should be a part of your plan.
Identify you sources of income. Wages from work. Government Assistance. Alimony and child support. Interest on stocks/bonds. Your family's estate.
List out all expenses and categorize them.
Mortgage/Rent. Debt payments. Medical care. Child care. Most of these are fixed expenses.
Food. Toiletries. Gas. Phone. Utilities. These are variable expenses. Estimate high so there's no surprise.
Car insurance. Vehicle maintenance. Home maintenance. Medical expenses. These are expenses don't come up every month and often times surprise us when we are in the Survival Stage.
Gifts. Vacations. Clothing. Entertainment. Subscriptions. Charity. These are discretionary. This is an area to trim first to supplement savings.
Speaking of Savings. This should be the first line item of your budget expenses. I've heard some counselors say "Pay yourself first". What it means is you have to have savings. Determine the amount you save and consider this money to be gone. It's not available to pay bills from. Your goal when first setting up a plan is to have a minimum of three months of expenses in savings. This should be done before paying down debt. I prefer to have a year's worth of expenses in savings because if I lost my job I do not want to step backwards and start selling off assets to cover my lifestyle while I search for a new job. I want to take my time looking for that new job. I don't expect it to take a year, but what if I have to accept a lower salary in the beginning? Having savings gives me more options so I feel like I am in control.
Determine your ultimate goal. Write it down. But write it down on the bottom of the page. Now identify the steps you need to take to reach that goal and writes those steps out backwards, working your way towards the top of the page. Each of those steps should have a goal that is measurable and possibly have a reward associated with it.
Ask yourself tough questions. What do I want to be? What will it take on my part to achieve this goal? Who else is going to help me achieve this goal and what are they responsible for? How much will it cost me in terms of time? How much will it cost me in terms of money? How much will it cost my family? These tough questions tell you if the goal is achievable. If everyone agrees that the investment is worth it, the plan will make it achievable.
Determine how to cover the cost. If it's money, where do you get the money? Will you have to borrow? Can you increase your family income to achieve it? Remember the rule stated above to never borrow more than is necessary to achieve the goal. Make sacrifices elsewhere to keep from borrowing more than you need. The less you borrow the sooner you will reap the rewards of your efforts.
Career College of Northern Nevada provides assistance in developing a budget in the Financial Aid Office. In order to plan for college expenses to pay tuition you may want to read the following document published by the US Department of Education: http://www.financialaidtoolkit.ed.gov/resources/fin-lit-guidance.pdf. Our staff can assist you with planning a budget for your college expenses and finding ways to cover the cost of attendance. Is going to college a step in your financial plan? Will it help you increase your earning potential? Take the Career Training Readiness Quiz at http://ccnn.3.virtualadmissions.com/register?lead_src=website.