5 Finance Basics

I get a LOT of questions about people who are nervous they aren’t doing the right thing, but more often than not.. you instinctively are!

Trust yourselves.

I know we in the PF blogosphere use a lot of terms like “snowball”, and if you were like me, you were wondering what the hell they were talking about.

So here are my 10 basic financial tips, tricks, hacks, calculations, whatever you want to call it for people who are just starting to take charge of their finances.

1. Know not only your debts, but how much interest you pay on all of your debts

The first part is simple but very hard.

Gather up those credit card statements stuffed in your dog’s basket in the hope that he’d eat them and not only save you some money in dog food, but in having to deal with your debt reality.

Tally up what you owe, write it down on a blank white sheet of paper, the amount you owe, the interest % you are paying and the minimum payments requested of you each month.

After you see it in black and white, down a Scotch and figure out how much of what you are paying each month is towards the interest and the principle.

(The principle is the original balance you owe).

I know it seems dead easy to all of us who have dealt with numbers and feel comfortable in Excel, but I know many of you aren’t comfortable with basic math, which is totally fine.

When I started clearing my debt, I had to re-learn a lot of math from my younger days.

So if you are anything like the me 2 years ago, I have a feeling y’all are a little scared of math, so I am going to tell you how to (easily) calculate how much interest you pay each year, assuming annual compounding.

Example:

You owe money on 2 credit cards and they’re roughly the same amounts but with different interest rates, one at 15% and the other at 25%.

Take the balance you owe, and multiply it by the interest, in numerical format, like so:

CARD #1

$2000 Balance

15% = 0.15

$2000 x 0.15 = $300/year in interest

CARD #2

$2000 Balance

25% = 0.25

$2000 x 0.25 = $500/year in interest

Pretty easy huh?

Now that you can see absolute numbers, which one do you think you should be clearing first?

If you want to get more advanced with compounding interest and all that, read my post on how Simple and Complex Compounding Interest Formulas works, as well as de-mystifying why compounding daily, monthly or yearly makes a difference in the final effective interest rate.

You can also check out my Retirement Sheet.

2. Always put your money towards the balance with the highest interest rate, then if all things are equal, the lowest balance

If you don’t want to know (or care) how much interest you pay, then my rule of thumb is to always pay the balance with the highest interest rate.

If the debts are exactly the same interest rates then:

A) Consolidate it all onto one credit card or debt if you can
B) Pay the balance with the smallest amount first so you can snowball the payments later

So if you have 2 credit cards at 15% interest, and $500 on one card and $2000 on the other, pay the $500 credit card off first then snowball the rest of the payments.

3. Snowballing your debt payments and what Snowflaking means

This is something we talk about a lot that I am sure has a lot of coverage on other PF blogs, but I may as well explain what it means as it’s very simple and effective.

Snowballing is basically the act of focusing on one debt at a time, clearing it completely, and taking that amount plus the interest you paid on that debt, and applying it to the next debt on your list.

Example:

Credit Card = $500

Line of Credit = $2000

If you have $300 a month to put towards the debt you would do the following:

1. Pay the $100 minimum on the $2000 Line of Credit.

2. Take the rest of the $200 you have and put it towards the $500 Credit Card.

3. Once the Credit Card is cleared and snowball the payments by putting the full $300 towards your Line of Credit.

Very easy.

Snowflaking, is kind of like snowballing, except it’s putting small amounts of extra left over money towards your debt when you have it.

Example: When you budget $50 for a coat, and end up only spending $30. You take the remaining $20 left over, and instead of spending it on something else, you put it towards your debt instead.

I used to do this a LOT with my debt. I would even put $1 or $0.50 towards my debt.

Every single penny counted, no matter how small the amount.

4. Tracking your expenses helps

I harp on this a lot, but it’s true. If you don’t know how much you eat on average a month, how can you expect to budget accordingly or cut back?

You need to track your expenses. Point blank.

Just try it for a month, up to 6 months to get a good range of numbers of what you normally spend eating out, on groceries, whatever, and get REALISTIC numbers to work with.

See, if you THINK you spend $100 on groceries each month but really spend $300, sticking to a $100 will be initially very difficult for you, you are going to feel frustrated, drained and like a failure.

Don’t fool yourself and play with unrealistic numbers.

5. …and you need to budget accordingly

So now that you have realistic numbers of what you eat and spend your money on, and you’ve gotten over the initial shock, you need to figure out how to make a budget.

And you have to make a budget on what you earn, NET each month.

I am not talking about gross salaries here. Don’t take your gross salary of $30,000 and divide it by 12 months. That’s not accurate.

Gross means you are paid $30,000 a year as a salary, but it it hasn’t accounted for the deductions for taxes, unemployment insurance and so on, or in PF speak: “Your gross salary is not net of the deductions”.

Net means what you actually have in your pocket each pay day after deductions and so on.

Now that you know that you don’t bring home $2500 a month ($30,000 divided by 12 months) but $2000 a month on a $30,000 salary, you need to make a budget for $2000.

The basic idea, is to put in your fixed expenses like rent, telephone, and utilities. Then your variable which is groceries, etc. Fixed means you can’t change the amount each month. Variable means you can.

Here’s a longer post explaining how to do a budget.

That’s it.

That’s all you need to know for now if, and believe me, what I wrote up there is a lot of work if you are just starting out.

You can get into fancier things, but these are the 5 basic things you need to know and get crackin’ on.

OTHER RESOURCES

Need a budgeting and expense tracking tool?

FB Budgeting Sheet

Still in college?

Read my post on tips for college students.

Do you rent and feel like a loser? (or worse, others make you feel like one?)

Don’t. The path to wealth is not necessarily always in real estate, contrary to popular belief. Read my post on why renting may be better than owning.

Want to know your credit score but don’t know how to get it?

Read how to get your FREE Credit Report just by filling out a couple of forms.

Want to survive on $12k/year?

I couldn’t. But this woman does it, and says she’s thriving on $12k a year.