Before you can look too far into your financial future you need to make sure you are setting it up on a solid Financial Base. You wouldn’t let a Faberge Egg roll around on the counter top, or set a delicious craft beer on a wobbly table? Treat your Financial Independence the same way, and build a sturdy Financial Base.
I was looking back through my posts to date, while there is a ton of great information (unbiased opinion) there was not a step by step process connecting my thoughts. This post is going to connect a few other topics I have written and put them in a sequential order.
7 Steps to Building your Financial Base
1. Assess the current situation
If you have ignored your financial position to date, you don’t know what your current situation is. Areas to focus on:
- Debt – Put together a list of all your debts with the interest rates and balances
- Savings/Investing – How much are you saving and investing every paycheck or month? Is the amount auto-transferred?
- Account Organization – Put together a list of all our accounts and any service that has access to your bank accounts via a direct payment.
- Insurance – List out all the different types of insurance you have (health, dental, life, etc). Figure out the out of pocket maximums and how to contact the company if needed.
Everything you put together in this step will help you complete the other ones. Find a storage system that works for you, personally, I recommend a spreadsheet.
2. Quick Wins
This section could be titled “Stop the Bleeding” because you are going to halt a few money mistakes in a short amount of time.
- Set up auto transfers to savings/investing accounts – Even if its just a $5 transfer to your emergency fund, savings account, Roth IRA or Brokerage account. Get it setup, we will focus on building this out later.
- Common Money Mistakes you Can Correct in an Hour – I wrote this post last month and it fits in nicely here. Lots of Quick Wins that you can knock out in a week.
3. Conduct a Spending Review
If you don’t currently budget or track your spending on a monthly basis you will be surprised where some of your money goes. I still find lines on our credit card bill that surprise me after 5 months of tracking and surveying out spending.
Since we do not use a budget, I go through our credit card line by line to see where our money is going. Earmark anything that you could live without, we will revisit in step six.
You can use a tool like Personal Capital to help track your spending as well.
Income is a huge driver of your savings rate. If you save at least 50% of your raises you can shorten the F.I. path drastically. The biggest question here is “Are you being compensated fairly?”
Maybe it has been a few years since you got a raise or you have taken on some additional responsibility without being compensated. Be objective, but don’t undersell yourself either.
You can also use free sites like GlassDoor.com to compare your salary to others in your area. It is not 100% accurate but should get you in the ballpark.
If you want some tips preparing for a conversation with your boss, check out An Honest Conversation About Salary Expectations.
5. Emergency Fund and Plan
All of the information you gathered in step one will be helpful here. I recommend having an Emergency Fund and an Emergency Plan. The Emergency Fund has cash to cover expenses while the plan is a guide on actions you can take to reduce and organize your expenses for a prolonged emergency.
Few options to funding your emergency fund:
- Prioritize over Debt/Investing – If you at a higher risk for a prolonged financial emergency, I would take this approach.
- Build Up Over Time – If you are in good health and have a stable job you can take more time to build up your fund while simultaneously investing. Just remember, no one sees an Emergency coming, so don’t completely put the fund off.
You will use a lot of the information from step one to build your Financial Emergency Plan.
6. Set Goals
This is my favorite step to building a Financial Base because it holds you accountable and gets you emotionally invested. I have done this for 2015 and 2016 and it has changed our habits dramatically. The biggest benefit is halting lifestyle inflation as our income rose. We put the money towards meeting our financial goals instead of frivolous spending.
Goals you should consider:
- Emergency Fund – Figure out how much you need and set a goal on how long it will take to fully fund it.
- Reduce Spending – Remember your earmarks from step 3? Set goals to reduce spending in areas you identified as unnecessary or excessive.
- Investment Accounts – Depending on your current situation, this could be increasing your 401K contribution or starting a Roth IRA.
- Debt Payoff – Set a specific debt payoff goal for the next year, maybe it is paying off your credit card, an extra mortgage payment or simply increasing your student loan payment every month.
Make sure to write them down and hold yourself accountable. We check in every quarter to see how our yearly goals are tracking and mark which ones are completed. Checking them off every quarter boosts your motivation and helps with the next step!
You can read this post for more information on Investing vs Paying off Debt.
7. Burn in the Habits
Consistency is key to building a base that can hold up Financial Independence. Here is my equation to burning in a habit:
Small Changes + Time + Accountability (Goals) = Long Term Habit
Stay away from the big bang approach, the habit won’t stick. It has taken us a few years to change our financial habits and it is still a work in progress. A few examples:
- It has taken us 2.5 years to get our 401K Contributions to 11 and 13%. The first year our goal was to increase them by 1% each quarter
- I have increased our Roth IRA contributions by as small as $5 a paycheck multiple times (now over $100 goes to each of our Roth IRAs every paycheck)
- After our first spending review, our goal was to cut out $15 on average every week for a month
Use your success as motivation to set bigger and bigger goals, I can’t stress enough how important this is. As you stack up accomplishments you will be come more motivated and find ways to earn, save and invest more.
I will do another post putting more advanced topics in sequential order – thanks for reading!
Some products that can help you:
Personal Capital: Personal Capital has a ton of great Free features, you can track your spending, net worth and even analyze your portfolio. It has top notch security and I am able to connect all of my accounts. Saves a ton of time!
Sofi – I saved a ton of money using SoFI for a Student Loan Refinance. They are great to work with, the process was super easy (compared to my previous refi) and I got a great rate. If you have student loans be sure to check them out.