Personal Finance: How To
Introduction
Personal finance at its core is fairly simple. It is managing your money so that you can do the things you want to do. I find many around me in a situation where they’d like to do something, but money is always an issue. This inevitably leads to an unfulfilled life, wondering where it all went wrong. So let's talk about how to avoid that scenario by building an Excel spreadsheet to get you up to speed on your finances.
If you’d like my example spreadsheet that is already complete, you can find that here.
To edit it, make a copy of it to your google drive and put your information within the yellow boxes!
Income
Everything being explained from here on out will be relative to how much money you make. It is important to do this calculation properly so you can plan for the future accurately. If you are paid by salary, this step is much easier and more accurate. To arrive at your monthly income when paid hourly, you will need the following information:
Hourly Pay
Average Hours Worked Per week
Number of Weeks Between Paychecks
Tax Rate
To get your tax rate, there are plenty of websites online where you can insert your yearly pay, and it will tell you your estimated tax rate, considering both state and federal taxes.
To get to your estimated paycheck and monthly income, you can use the following formula:
Paycheck = ((Hourly Pay)*(Avg Hours Per Week)*(# of Weeks Between Paychecks))*(1-Tax Rate)
Monthly Income= (Paycheck)*4
It should look something like this:
Paycheck Splitting
Within your bank account, open 3 accounts: 2 checking and 1 savings (you can usually open them online without a fee). Your paychecks will be directly deposited into Checking Account 1, name it “Paycheck Splitter.” Your bank should have an option to schedule auto-transfers online. Every payday, set up automatic transfers from the Paycheck Splitter into your savings and Checking Account 2 (Spending Account). How should your money be split up? It depends on whether you have debts or not:
Has Debt:
50% Spending
30% Debt Payment
20% Saving
No Debt:
50% Spending
30% Investing
20% Saving
A note on debt:
If you have debt, you should be paying off that debt as it’s usually subtracting a higher interest rate than you can otherwise get through investing. You should not invest if you owe debts. With debts paid off, it is then time to invest. I personally split my paychecks 45% into spending and 35% into investing, as I have very little living expenses and am blessed to not have accumulated any debt.
To get the specific amounts relative to your paychecks, take your pay and multiply it by the percentages in each of your given categories, and you should end up with something similar to this:
Note that my savings account is called “Emergency Fund”, more on that later.
Spending
Within the spending 50%, it should be broken down into:
30% Housing Expense
10% Groceries
10% Insurance & Bills
Convert that into portions of your monthly income, and those are the budgets for your monthly spending. This is called your financial baseline. This is the minimum amount of money you need to live month to month. If you are spending more than that, you are doing yourself a disservice and will not see results as fast as you would like. Again, to see the exact numbers for your case, multiply your monthly income by the percentages:
Saving
Recall how my savings account was called “Emergency Fund”? This is because you don’t want to continuously save money, as money in your bank accounts earns you lousy interest and is actually decreasing in value due to inflation every year. You only want to save 3-6 months of living expenses. In effect, you’ll want to take your financial baseline and multiply it by how many months you’d like to keep on hand in case of an emergency. This money is for:
Car Accidents
Emergency Hospital Expenses
Losing Your Job Unexpectedly and Still Needing to Pay Rent
Your emergency fund will act as a buffer to unexpected expenses and will allow you to rest easy in the event of a crisis. Your table should look like this:
The number of months you wish to save for will depend on what type of person you are. If you feel comfortably only 3 months, great, but if you are more risk adverse, I would recommend a full 6 months.
After you’ve accumulated your desired number of monthly expenses in your fund, stop sending 20% to spending and instead, start funneling it into your investments.
Investing
I recommend investing in the “S&P 500” which is a chart of the top 500 companies, put together by “Standard and Poor” which is a data company. This is also referred to as “The Market”. An investment I recommend as general advise is called “VOO” which is a “Mutual Fund” provided by “Vangaurd”, the second largest equity firm in the world, that simply takes your money and invests it into the index Standard and Poor has provided for the S&P 500 using computer automation. There are no fund managers manipulating the fund, they set it and forget it generally speaking. This is called passive management.
On average, the market provides a return of 10% each year. So whatever money you put in the market, you can expect on average 10% return every year, which is VERY hard to beat. Only 1% of money managers consistently outperform the market. In addition, historically the market has been very stable, making it a relatively safe investment, as safe as equity investment can get anyway.
Compound Interest
Unfortunately, compound interest is not talked about as often as it should be. It is one of the most important concepts that seemingly applies to a lot more than just finances. Compound interest is the idea that something grows, let’s say 10% (for the sake of an investment example), every year. What you need to understand is that whatever amount you put in today will grow by 10%. So you will have 110% of the money you started with at the end of the year, technically speaking.
Now this is where it gets interesting: assuming you don’t put in any more money, in one year, your 110% money will grow by another 10%. But what you really need to understand is that you’re gaining 10% on the additional 10% you earned last year, essentially meaning you gained 11% on the original deposit you made 2 years prior. You now have 121% of the money you started with. Next year, you will have 135.1%. Because you’re gaining 10% on the 21% you previously accumulated, plus the 10% on your initial deposit.
See how that works? I would highly suggest you check out the compound interest calculator that NerdWallet has on their website. It has a very nice graph to visualize this concept, and it is truly inspiring to see how much money you can have, given how much money you start with and how much you’re willing to invest every month. I am by no means affiliated with NerdWallet, but you can check that out here. Enter your numbers and input 10% for the estimated rate of return and make it compound annually.
There is no doubt in my mind that you will want to stick with your plan after seeing what your future can hold.
