How to Build Financial Security
It's possible for anyone to become more secure by taking the right steps.
For most Americans, the novel coronavirus crisis has been a major wakeup call. The economy was doing well, unemployment was at record lows, and then everything changed on a dime. The pandemic showed how financially vulnerable many people are and how difficult it is to live without a regular paycheck coming in.
If the crisis has left you craving more stability, the good news is that there are proven steps you can take to shore up your financial situation. Getting your finances in shape to see you through both good times and bad will give you more peace of mind. Here are five steps to take.
1. Live on a budget
While it's not exciting or novel advice, living on a budget is the single most important building block towards financial security. Effective budgeting is the key to making all of the other steps work because your budget will keep you on track.
The reality is, no matter how much money you earn, it's far too easy to end up spending it all as you give in to lifestyle inflation. But if you want to be financially secure, you need to make hard choices and sacrifices to save. And budgeting helps you see where your money needs to go so you can ensure you're doing that.
If you've never made a budget before, start by tracking your spending. Then, figure out how much income you have coming in and allocate it to different spending categories. Look for cuts you can make along the way so more of your money goes toward accomplishing your goals. Include savings as one of the key categories and treat it as a must-pay bill.
There are different kinds of budgets, including a 50-30-20 budget (where you restrict spending on needs to 50% of income; spending on wants to 30% and saving to 20%) or a detailed budget where you allocate a destination for every dollar. Any of them can work, as long as you're setting and sticking to limits and making sure you build savings into your budget.
2. Keep your fixed costs low
The best way to become financially secure is to have money to cover the essentials -- even if you stop receiving a paycheck. And the greater those essentials are, the more money you'll require.
For example, if you have a $1 million house with a mortgage and all the costs that go along with it, your monthly essentials will cost a lot more than if you have a paid-off $250,000 house.
If you already have tons of obligations, such as an expensive house, car payments, private school tuition, and a lot of debt, you may want to look into simplifying your lifestyle a little. If you haven't already taken on all those responsibilities, ask yourself whether the big house or other costly items are worth it. You'll need to save more to cover those costs -- or put yourself in a more precarious state when a crisis comes. If you'd rather prioritize financial security, keep ongoing costs as low as you can.
If you can keep your fixed expenses low, you'll have more money to save for the future now and fewer obligations to fulfill during times of financial trouble.
3. Build a hefty emergency fund
A large emergency fund makes you more secure because you can pay your bills even if your income drops or your costs go up.
A good rule of thumb has always been to save three to six months of living expenses. But in light of the economic uncertainty surrounding the novel coronavirus and the chance that future outbreaks will occur, it might be worthwhile to save even more.
Your emergency fund should be accessible in a high-yield savings account and it should be reserved for true emergencies only. Make contributing to it an essential part of your budget and build it up as quickly as you can so you'll know you're prepared.
4. Avoid consumer debt
Borrowing for assets that don't go up in value is a surefire way to make it harder to become financially secure. That's especially true if you do so using high-interest debt such as credit cards.
When you pay interest on debt, you tie up your money and can't use it for other things. And when you borrow, you make a commitment to creditors that you have to fulfill even during troubled times, which increases your living costs.
If you don't have debt already, vow not to borrow unless you need to in order to grow your net worth, such as by buying a house. If you have debt, consider refinancing it to a lower rate personal loan if you can. Work your budget to accommodate a debt payoff plan, with payments that are as large as you can afford without compromising emergency savings or missing 401(k) contributions that get your maximum employer match.
5. Invest in income-producing assets
Finally, you want to have multiple sources of income to become financially secure -- including income you don't have to work to earn. That means investing in assets that produce a return so your money makes money. For most people, the best and easiest way to do that is to get their money into the stock market.
The more you can invest and the quicker you can build up a big nest egg, the sooner you can stop relying on a paycheck. Then you'll know you have the money you need, even if the economy has to shut down for a while.
It's a good idea to invest in both tax-advantaged accounts, such as a 401(k), and a taxable brokerage account in case you need to make withdrawals before turning 59 1/2. You should invest for the long term and avoid putting money into the stock market that you'll need within the next five years. And you should make sure you have a diversified portfolio with a mix of different investments to reduce the risks you take on.
These steps will lead to financial security
Anyone can take these five steps, even if you don't have a large income or know much about money management. By prioritizing investing, being smart about spending, and saving for your future, you can build the financial security you deserve and ensure you're prepared if and when the next crisis hits.
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