Personal finance is something not taught in schools. Most people learn it through experience, parents, mentors, seminars, books, videos and podcasts. However, not a lot of people are lucky to discover these (or has the patience to go over these materials) and some have been brought up in an environment that was not efficient in handling finances.
If you are currently in debt, it is best that you get to know the basic principles of personal finance. For this blog post, we will feature this chart “Personal Income Spending Flowchart (How to Prioritize Your Spending)” created by Reformed Adviser. This chart will be a very helpful guide for those who are confused with how to handle their finances.
To start off, here is the flowchart, just click the image and save. Please note that the chart below is a general guide. Feel free to adjust according to your current needs and financial situation.
Also, after this is a brief explanation of the chart and what you can get out of it. (Click to enlarge)
7 Steps of How to Prioritize Your Spending
Step 1: Create a budget and reduce expenses. Set realistic goals.
Creating a budget will give you a bird’s eye view of where your money goes. Here’s an in-depth guide on how to create a budget [insert link].
Focus on the essentials first before other items like entertainment. The suggested priorities are as follows:
- Rent/Mortgage (including insurance)
- Essential items like utilities and toiletries
- Income earning expenses (transportation, internet, those you need to work)
- Taxes (if you are self-employed, set aside 30% of net income. If employed, your employer will do this for you)
- Minimum payments on all debts
Step 2: Build an Emergency Fund
Set aside a small amount for emergencies, target to have at least $500 or one month of your total expenses
If you have non-essential bills like the internet, phone, and cable, pay them in full.
Step 3: Consider employer contribution matching and government super incentives
Maximize the benefit offered by your employer. If your employer doesn’t have this and you have high-interest debt, proceed to step 4.
Step 4: Pay down high/moderate interest debts
High rates are debts with 10% interest like credit cards and student loans. Moderate rates are those with 4-5% interest rate. Consider which of these payment methods, “Avalanche” or “Snowball” you should use.
If you don’t have any of these debts, increase your contribution to the emergency fund.
Step 5: Save for large and discretionary expenses (i.e car or home loan)
If you are expecting large expenses in the future, like buying a house, car or maternity, now is the best time to set aside funds. This account should be separated from your emergency fund account.
If you currently have a mortgage loan, analyze if you can make extra repayments, depending on your current financial situation.
If you are not expecting any large future payments, proceed to Step 6.
Step 6: Increase superannuation contributions
This is where you utilise your government co-contribution, spouse contribution or salary sacrifice with the context of your own financial situation
Step 7: Save for other goals and investing
This is where you need to contemplate your short-term and long-term goals.
For 3-5 year goal:
Increase your superannuation, invest on paper assets, stocks or real estate. For example, use the savings for goals within 3-5 years, a conservative mix of shares or bonds for goals more than 3-5 years
For 7 year goal:
The idea is to have a more assertive mix of shares or bonds for goals of more than 7 years. This depends on your risk appetite. Ideally, have a mix of investments, i.e does not put all your eggs in one basket.
So there’s the summary of how to prioritize your spending. This may not be applicable to all, but at least you have an idea on how to plan your financial life.
If you have large debts, Credit Counsellors Australia can offer you a hand. Contact us to get started!