This is a guest post from Jonathan Leane, a personal finance blogger at Debt Loans.
On the road to fiscal responsibility, we all suffer our occasional missteps. Whether you’ve fallen along the wayside due to poor luck or bad judgment, you shouldn’t consider yourself out just because you’re down. True, digging yourself out of a hole is far more difficult than avoiding financial trouble in the first place, but with a bit of diligence and a few tips, you can get back on your feet and get your finances back on track.
1. Define Your Goals
The first step towards getting all your finances firing on all pistons again is to define your goals. This may seem simple, but chances are that the reason you’ve landed yourself in a sticky situation is because you’ve lost sight of the bigger picture. Where did all your money go? And where should it have been going? Were you plunking money down on a souped up sports car and a gargantuan flat screen TV when you really wanted to save up for a house? Did you piddle away your discretionary cash on fast food when you would really rather be more active and lose weight?
Most runaway spending is due to everyday indulgences. And the reason we turn to short term gratifications is because we are unhappy and we don’t know what is ultimately going to make us happy in the long run. But if you clearly define your goals (“I want to go to law school,” or “I want to start my own business.”) then saving money, rather than spending money, will be a reward in itself, because you can feel your goals inching closer. Sit down and think about what you really want out of life. Visualize your goal each time you are faced with a decision between saving money and spending.
Recommend reading. For the absolute best advice on defining goals in a personal finance context, check out The Simple Dollar’s guide to defining your Five Main Values.
2. Determine Your Income
If you’re salaried, this may be as simple as looking at your paystub from last month. But if you are planning the finances for your entire family, you should also factor in all the income from the other members of your household, even if they aren’t the main breadwinners. Get a good estimate of how much cash comes in every month – that means the final figure after taxes, retirement savings and insurance premiums.
In addition to the figures that automatically get shaved off your paycheck, take a moment to factor in all the collateral expenses from your job as well. Add up all the money you’ve spent on gas, lunches, parking, dry cleaning and child care and subtract that from your paycheck, too.
You may find the final amount of cash that you are taking home surprisingly (and perhaps depressingly) low. If that’s the case, you may want to re-evaluate your career and your streams of income. But before you consider taking on a second job or running a side business, consider the tips in the next step.
Recommended reading. Get Rich Slowly has a nice breakdown of how to compute your REAL hourly wage adapted from Your Money or Your Life by Joe Dominguez and Vicki Robin.
3. Determine Your Expenses
The relationship between income and spending as far as financial health goes is somewhat analogous to the relationship between exercising and eating as far as body weight goes. If your goal is to have less debt and more cash in your pocket, you’ll get far more mileage by reducing your expenses rather than trying to ramp up your income to match your spending. Trying to do so would be akin to running up 100 flights of stairs to burn off that bacon cheeseburger you had for lunch – it takes a lot less time and effort to skip the artery-clogger in the first place.
Go through all of your credit card statements and categorize all of your spending. Put the necessities – such as rent, utilities and groceries – in one category and all your discretionary spending – such as music, drinks at the bar and movies – into another. Be realistic in your judgment calls. This process can be tedious, and maybe a bit painful. However, it may do you some good if you’re long overdue for a wakeup call. Once this is done, take a moment and consider this figure against your monthly income. If the income doesn’t significantly outweigh your spending, then the problem is clear.
Recommended reading. If you feel comfortable submitting your financial details into the cloud, you can try a service like Thrive, Wesabe or Mint to sort through your transactions for you. If you’d still rather do it by hand, check out some of the personal finance templates from Google Docs.
4. Trim the Fat From Your Monthly Expenses
Giving up your daily luxuries is difficult to do, especially once you’ve developed a deeply ingrained habit. Luckily, there are little ways you can pare down your monthly expenses that are relatively pain free, but really add up over the long run. Try some of the following:
– Turn down your hot water heater just a notch.
– Bump your thermostat up or down one degree (depending on the season).
– Drink water instead of soda at restaurants.
– Look into debt consolidation loans.
– Pack a lunch for work.
– Order groceries in bulk using coupons from Amazon.com.
– Install energy efficient light bulbs.
– Check out movies and books from the library instead of buying them.
– Lose your landline and find cell phone plans that works for you.
As you can see, some of these frugal measures are a bit more intensive than others. Start with as many as you can stand and slowly transition to a more thrifty lifestyle.
Recommended reading. For more tips like these, check out 10 Priceless tips For Saving Money from DebtLoans.com.au.
5. Create a Budget
Now that you have a decent picture of your income and your essential spending, take the time to make a monthly game plan for your finances. This can be as detailed or basic as you want it to be – having even a cursory framework is still better than having no plan at all. The goal of a budget is to be conscious of where your money is going, what you can afford and which indulgences are justified.
Once you have a budget, stick to it. That may be easier said than done, but it’ll be fruitful to keep track of how you’re doing based on your monthly goals, even if you go over a bit from time to time.
Recommend reading. The personal finance templates from Google Docs mentioned above are especially handy in this situation. If you’ve accurately completed steps 2 and 3, then all you’ll need to do to create a budget is plug your numbers in.
6. Clean Up Your Credit
Now that you have a smooth operating plan, the next step is to clear your good name with the lending agencies. With a better credit rating, you’ll be able to negotiate better terms, get lower interest rates and ultimately save money that would normally be eaten up by fees and interest. Many advertisers will urge you towards credit counseling, but this can be an endeavor in itself (especially if you happen upon an unscrupulous credit counselor). To begin with, start with these simple measures:
– Request your credit report for free from AnnualCreditReport.com. Review it for negative items and inaccurate items.
– Pay off any past due bills or other delinquent items.
– Call up your lender to ask them to remove any negative items once you’ve resolved the issue.
– If that doesn’t work, put in a formal dispute with the reporting agency.
– Practice responsible borrowing from here on out.
Squeaky clean credit won’t happen overnight by any means. But waiting for those blemishes to simply go away without taking any action will take even longer.
7. Create a Debt Action Plan
No matter how much money you are saving, it won’t matter if you are still getting bled dry by high interest rate debts. Pay down as much as you can on your high interest debts first (credit cards, auto loans, personal loans) before focusing on some of your more lenient lenders (student loans, mortgages).
If you’re stuck in a cycle of debt though, you may not have any money to spare – or, at least, you may not think you have any money to spare. In that case, you will need to take a drastic course of action. That can mean anything from taking on a second job, selling some valuables, debt consolidation or undertaking a proven method for eliminating debt. Whatever you do, do something. Debts won’t go away, especially if you’re in a negative amortization situation. Take action as soon as possible.
Recommended reading. The method for tackling debt little by little that’s sweeping the blogosphere at present is the snowflaking method, which is a sort of spinoff of the debt snowball method. Check them both out for a manageable debt reduction regimen.
8. Build an Emergency Fund
Oftentimes, it’s unexpected expenses that are the culprit for long term debt. Operating without a safety net means that when you fall, you fall harder and the effects are felt for years to come. To avoid the vicious cycle of late fees and finance charges, it’s imperative to have a nice cushion to dampen the shock from a financial stumble. Paying from your savings is far better than being forced to take out a loan or get dinged with penalties or ply your relatives for a handout when you’re at the end of your rope.
Seed your emergency fund with as much money as you can spare at the outset. Then, build a small contribution of your paycheck towards your emergency fund into your budget. The rule of thumb is to have several months worth of your salary in your emergency fund, though depending on the volatility of the market and the number of dependents you have, you may want to have more.
Recommended reading. ZenHabits has a very helpful post on emergency funds called 21 Strategies for Creating an Emergency Fund, and Why It’s Critical.
9. Get Support
Being in debt is emotionally taxing, and, depending on your values, can be downright shameful. But don’t let your financial crisis turn into an isolating or self-destructive event. If you can’t reach out to someone you know personally, try posting on one of the many personal finance communities on the web. Chances are you will meet someone who has gone through your exact same situation and won’t judge you.
Recommend reading. The Fun Times Guide to Money & Finances broaches the subject of debt support groups and tells you how to find compassionate commiseration. Give it a good read.
10. Stay Strong
Once you’ve gone through all of these steps, be sure to return to them occasionally. Review your budget. Revisit your expenses and income. And most importantly, keep your goals clearly defined and at the forefront of your mind everyday. It may seem hokey, but putting up a visual reminder of your goals in your office or on your desktop can help to keep you on the financial straight and narrow. A simple printout that says, “I will pay off my student loans” or “I will buy her a ring by December” can be a better motivator than any self-help book or debt reduction technique. Give yourself a reason to get your finances back on track, and you’ll find the strength from within.