It takes time to get your personal finances sorted. And often you don’t know where to start. And the thing is that no one can really show you how you should sort your personal finance, after all, personal finance is exactly that- Personal.
However, there are several key stages in personal finance that you do need to get sorted. These are the stages that I have gone through to get my personal finances organised- I’m currently at stage 4.
If you want to get started with improving your personal finances you should go through all these stages, you can’t skip or ignore a stage.
Stage 1: Budget
When you want to improve anything, you need to track its performance. Want to be an Olympic swimmer? You need to track your lap times. You track your performance so that when you make tweaks to your training here and there and track weather the tweak has improved your lap time or made it worse. You incrementally make small changes to improve your overall performance.
It’s the same with Money.
Want to be good with money? You need to track your spending. You track your spending so that you know where you are spending it. Then you can review it and make tweaks here and there. And over time you can measure whether these tweak improves your personal finance and ultimately your life.
It’s important to know where exactly your money is going. The way in which you track your money is to create a budget. You can use excel spreadsheets or notebooks, or online tools such as Pocketsmith– It really doesn’t matter, as long as you track several of your pay cycles to determine where your money is going.
Here are some general categories that will be in your budget.
- Rent/Mortgage Payments: Including insurance and rates
- Bills: Essential services- Power, Water, Heat
- Luxuries: Internet/phone, Netflix
- Debt Payments- at least the minimum on all outstanding debts
Your Money Flow when you first start out trying to get your personal finance sorted might look something like this; with money coming in on the left and money going out on the right.
The above money flow diagram is sadly someone who is living paycheck to paycheck. Treading water is another term often used. Don’t be embarrassed if you are in this situation- there are many people in these situations. Especially now, in an environment of low wage growth and easy access to finance. Kiwi’s debt levels have been steadily increasing.
But you can change that by understanding your money flow and budgeting.
Once you have your budget sorted, you should think about what your life goals are. Buying a house? Saving for a car? Save for retirement? We’ll have a look at saving for those goals in the next few stages.
Stage 2: Get Rid of Debt
Once you have your budget sorted and know the flow of your money, you should try to find some spare money to pay down your high-interest debts. These debts can hold you back for a long time- so it’s best to get rid of them as fast as possible.
If you have only one debt outstanding- well done! Take any extra money you have and pay down this debt as fast as possible.
If you have more than one debt outstanding; credit card, car finance, etc, then there are two main methods for paying then off. The avalanche method, and the snowball method.
- Using the avalanche method, you pay the debt with the highest interest rate first. This method is the financially optimal method of paying down debt, as you will pay less money overall compared to the snowball method.
- Using the snowball method, you pay down the debt that has the smallest balance first. This method gives you a phycological boost since paying one entire debt off is rewarding. The downside is that larger loans are paid off later, costing more in interest in the long run.
When you use either method, you still need to make the minimum payments on all of your debts, otherwise, you may ensure penalties and late fees charged by the lender.
In this stage of getting your finances sorted, you need to focus on paying off your debts. This will mean that you will need to sacrifice other aspects of your money flow to pay the debts down faster, you may need to forgo luxuries in the short term that will pay off in the long term.
Your Money Flow when you are paying down debt as fast as possible may look something like the diagram below; with money coming in on the left and money going out on the right.
Stage 3: Kiwisaver
In stage 3, you need to get your kiwisaver sorted!
Ensure that you are at least contributing the minimum rate to KiwiSaver to receive the employer contribution and government contribution.
Where else in your life are you going to make an instant 100% return on investment? If you just contribute $1024 per year, your employer will match that 1024, and the government will help out with another $512 per year. So by contributing $1024 per year of your own money, your kiwisaver will have grown in value $2536.
It doesn’t stop there, you also need to take a look at who your kiwisaver is with and in what type of fund you are invested in. The default fund you were assigned once you became a member may not be the best for you. Your fund might be charging a high fee, or your fund may be in a conservative fund, whereas you’re better suited for a growth fund. Check out the great tools on Sorted to figure out what type of fund suits you and which funds charge low fees.
Simplicity is often recommended by the personal finance community. Check out this post where I compare simplicity to other low-cost kiwisaver funds.
Once you have your debt plan and Kiwisaver sorted your money flow may look something like the diagram below. Notice that once you hit this stage that not all your money is being spent. You are now increasing your net worth through kiwisaver.
Remember, you should be contributing to Kiwisaver even though you may have outstanding debts. If you don’t contribute, you are missing out on your employer’s contribution which is essentially a 3% pay rise, or as others would like to put it- free money!
The employer contribution to KiwiSaver is taxed. The tax called ESCT — employer superannuation contribution tax) is paid to IRD, and the after-tax amount is paid into your KiwiSaver scheme. Therefore, if both you and your employer are contributing 3%, your KiwiSaver scheme will show lower contributions from your employer than from you.
Stage 4: Invest
By this stage in your personal finance journey, you should have paid your debt off! You can use the money that you were paying debt off to invest. By
Stage 5: Save for Other Life Goals
Once you’ve gone through stages 1 to 4 and you have enough money to retire with, there are two broad options for what to do with any extra discretionary income. You could;
- Save more so you can potentially retire early. This is known as FIRE, which is often done by using the 4% rule.
- Save for more immediate goals. Common examples include down payments for homes, saving for vehicles, college funds for children, and vacation funds.
The time frame for these goals will dictate what kind of account you save in. For short-term goals (under 3-5 years), you’ll want to use a bank or credit union savings account, or term deposits. If your time horizon is longer or you can afford to adjust your plans, you might consider something riskier like a mixed stock/bond fund or other mutual funds. The best savings or investment vehicle will vary depending on your time frame and risk tolerance. Feel free to start a thread with the details of your situation and we will help you.
Personal Finance Sorted
That’s the basics of personal finance- it’s the same for us Kiwis as it is with anyone else in the world. The basic outline is very similar – with some subtle differences like Kiwisaver vs 401k. The Personal in personal finance comes from your personal reasons that you have that influence how your money flows.
You may have compelling reasons why you need to arrange your finances in a certain way, and that is perfectly fine. I manage my money in a particular way that wouldn’t suit your situation, and that’s fine. That’s why it’s personal.
But you need to sort the fundamental stages of your personal finances so that they can work for you!
- Pay of Debt
- Sort Kiwisaver