financial planning basics

There are several principles at the core of any good financial plan. The first and foremost is this: spend less than you earn, and do it for a long time. And while that doesn’t sound like a lot of fun, it is the only way to get ahead. Over time the few extra snowflakes you don’t spend can turn into a giant snowball, growing more massive with each passing day. But if you don’t seed that snowball with those first few flakes, all you’ll get is – flaky.

Once you decide to spend less than you earn, you’ll be faced with a question: what do I do with the extra? There are many options, of course, but an excellent place to start is with your employer’s retirement plan. The match that your employer contributes to your plan is all gravy – it’s instant profit. To top it off, all the money in the retirement plan usually has quite a while to grow, and in the investment world, time is money.

Once your retirement plan is on autopilot, you should tackle any consumer debt you have, including your credit card debt. Paying a little extra each month on a credit card with an interest rate is the same as earning that same rate in an investment. What I mean is this: if your credit card is charging you 12.99% on your unpaid balance and you send in an extra $100 next month, that $100 is actually earning you 12.99%. This is a rate of return that’s tough to beat without taking a fair amount of risk. (By the way, if you don’t pay that extra $100, the credit card company is earning the 12.99%. Now you know why they’re so anxious for you to carry their card.)

If your credit cards are properly whipped into shape, you should think about building an emergency fund. This is money that will be available to you in case of emergency, so you won’t fall back into the credit card trap. Start out by building up one month’s worth of living expenses. Now when you have an emergency (and that killer pair of shoes at the unheard of sale price is NOT an emergency), you’ll have the money to cover it. And when you don’t have an emergency, that money is sitting in an account quietly earning you interest.

It doesn’t matter what stage of life you are in, or how many of the above principles you have already addressed. Start wherever you are and just take the next step. Once you have addressed all these principles you’ll be in a much better place to begin to think about other investments.

This post originally appeared in the August 29, 2007, edition of the Greenhorn Valley View.

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