What does it mean to build a strong financial foundation?
Like many others first starting out in life, I had little knowledge of personal finance concepts when I was in my 20s. While out in the real world for the first time on my own, I fumbled my way through being a responsible adult through trial and error.
One of those errors was reliance on debt rather than saving for things that I wanted to buy in advance. The concept is straightforward – there’s a cost for borrowing money and especially over time those costs can really add up to a lot – but it simply was something I don’t believe I was ever taught growing up.
The alternative to debt – having cash reserves saved up – is a foundational component to my finances today. Most people can relate to savings as something you wish to have in an emergency. If your car breaks down or your refrigerator needs repairs, savings in an emergency fund can help you out. Those savings serve as a financial safety net to lessen the blow. Before I understood the cost of carrying a balance, I thought the available credit on my credit card could serve this purpose. But there’s a big difference – one provides relief when you need it most and the other just postpones the issue perhaps making matters worse and more stressful in the end.
But a strong financial foundation is more than just an emergency fund. Another component is awareness of your spending. Knowing how much money you have coming in each month and how much you spend – referred to as your cash flow – is also important. When you have more going out than you have coming in, it means that you’re either spending down your savings or you are borrowing (accumulating debt) to make up the difference.
A useful tool that I often share is the CFPB Spending Tracker you can use to document where your money goes each month.
Breaking the paycheck-to-paycheck cycle when you spend more than you make each month can be solved by either cutting your expenses or making more income. If you receive any extra money like a tax refund, a third paycheck in a 5-week month, or something similar, that can be a good opportunity to break the cycle. One example of putting that extra money to good use is by paying off a debt which can help by decreasing your monthly bills. Sometimes rightsizing your budget could require more significant changes. On the income side these could be things like trying to get a promotion, seeking a new job altogether, or getting a second job. For expense cuts, more extreme but productive changes could include things like buying a cheaper car, taking on a roommate, or budgeting how much you spend on food, shopping, travel, or entertainment.
What are some steps you’ve taken to strengthen your financial foundation?