Four Financial Skills you need to Master

For many people the idea of having more than enough money may seem foreign to them. According to a recent UK money habits study, 53 percent of people in the United Kingdom struggle to make their monthly payments and only 46 percent of people have a monthly budget. 

It is possible to have enough money to pay your bills each month and build up a healthy savings account as well as a retirement fund. 

But, if you want to become free from financial stress, there are financial skills you need to master first.

If you are on a low income, make sure to take advantage of money help such as grants and benefits, this can reduce certain financial pressures which can help you avoid the temptation of loans, especially short-term loans.

Pay off your debt:

One of the first things you need to do is pay off any debt you have. If you don’t have any debt, keep it that way. Credit cards and loans can be tempting. The idea of paying for something later is appealing, particularly when you aren't making very much money. The problem with this is that interest rates compound daily which means you could end up paying a lot more than what you actually spent.

If you are currently in debt, cut up your credit cards and start paying down your debt as quickly as possible. Say goodbye to paying extra fees and interest rates for things you've already enjoyed.

Have a budget:

You cannot be financially successful if you don’t have a budget. Unless you are using 100 pound notes as dish rags (and if you are, stop it and send a few our way…) you need a budget so that you know how much you make and you know how much you spend. 

Trying to become financially sound without a budget is like trying to build a tower without instructions, you may be sort of successful, but you’ll have success much faster if you have a guide. Kick Jiminy Cricket to the curb and let your budget be your guide.

Live on less than you earn:

This principle actually ties in really well with paying off your debt. One way to avoid debt and to avoid the strain of living month to month is to start living below your means. Basically, spend less than you make. If you always spend every pound you have, you’ll never have anything left over to invest.

Credit cards give you a skewed perception of how much money you actually have, which is why so many people up end deep in credit card debt. The money you are spending isn’t actually yours. Look at your income and find ways to reduce your sending so that you can save at least 10 percent each month.

A simple trick to living below your means: automatically deposit a certain amount from your checks each month. Withdraw it in cash and store it under your mattress or transfer it to a separate account that’s more difficult to access. Pay yourself first.

Invest wisely:

Once you have eliminated your debt, work on a budget and spend less than you make, you can begin making investment options. Investments make your money work for you. Because investments can be tricky, and even a little scary, it’s usually best to work with a professional advisor who can help you create the right investment portfolio. 

A simple rule to remember: diversify. You’ll still earn money on your investments but with a much lower risk. Essentially, don’t put all your eggs in one basket.

Should I Try to Save While I'm Still in Debt?

There are two schools of thought on this subject. I am largely in the camp that believes debt should be retired before beginning a serious investment strategy. There are three exceptions and I will begin by addressing these.

Exception 1—Your Mortgage

The typical mortgage has at least a ten-year term and often a twenty-year or thirty-year term. I do not believe it is practical to wait that long to begin investing. 

Exception 2—Employer Matching 401k

If you are fortunate enough to work for an employer that offers matching contributions to a 401k plan, I cannot recommend that you wait to an investment in that plan. You would be leaving free money on the table and that makes no fiscal sense whatsoever.

Exception 3—Small Business Owners

If you are a small business owner, you should invest in growing your business. After all, it is be the wellspring of your present and future income.

These exceptions noted ...

I believe in the time value of money and by extension the value, indeed the necessity, of eliminating the interest expense associated with most if not all debt.

The Time Value of Money

The time value of money is the most persuasive argument available for retiring debt and for investing. You see, saving differs from investing. If you have a piggy bank and save ten dollars, you empty out the piggy bank in ten years and guess what—you still have but ten dollars. Conversely, if you invest ten dollars, in ten years you will have more than ten dollars because whatever you invested in (stock, bonds, certificate of deposit etc.) will have grown in value.

Debt also exemplifies the time value of money. However, with debt, the value accrues to the lender not to you, the borrower. Think about it … instead of you earning money on an investment, the lender is earning money from you. Why? Because you have debt and the interest expense that is a result of that debt finds its way into the corporate coffers.

Sample Scenario

In this example, imagine you have a credit card debt of $5000 with an annual rate of 10%. You would have to pay $126.81 every year for four years to pay this debt in full. That means for $5000 you will pay a total of $6086.88 over a four year period. Obviously, you are paying the credit card company $1086.88 for the privilege of using their money. The time value of money is working for the credit card company, not for you.

Now, I want you to consider this. If you elect to invest before retiring this credit card obligation, what investment can you make that will provide you a safe return exceeding the 10 percent rate you are paying the credit card company? Can you think of even one? I can’t!

If you are lucky and find a reasonably safe investment that pays even 5 percent, this is only half of what you are paying out in interest to the credit card company! This is not a rational course of action.

Conclusion

Apart from the exceptions noted above, it is clearly counterproductive to invest before you have retired your debt.

For you small business owners, the principle applies equally with respect to business debt. Look to your accounts receivable for cash flow and/or debt relief. Take advantage of free invoice factoring calculator to see if your accounts receivable can help you retire business debt early.

About Author:Andrew Cravenho is the CEO of CBAC LLC, an innovative invoice financing exchange. As a serial entrepreneur, Andrew focuses on helping both small and medium sized businesses take control of their cash flow. Prior to CBAC, Andrew founded an annuity financing company relieving tort victims of financial hardship.