If you follow the news, you've probably read a lot about the state of American finances.
But according to theU.S. Financial Diaries, that isn't the case. The Diaries—a research project conducted by New York University’s Financial Access Initiative, the Center for Financial Services Innovation and consulting firm Bankable Frontier Associates—tracks low and moderate-income families over the course of a year to get a detailed picture of how they handle their money.
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The families profiled in the Diaries—from the Bangladeshi immigrants whose impressive education credentials don't translate to the U.S. to the dual-income foster parents living in Mississippi—are doing the best they can, but there are lessons we can all learn from them about financial basics we could be doing better.
In reading about their experiences, you'll not only appreciate all you do have but glean tips for ways you could improve your own financial well-being.
Read on to find out which steps to financial security these Americans aren't taking—and many of us may not be, either.
1. Creating (and Sticking to) a Budget
The Adrians*, a Mississippi couple in their early thirties, have a wildly fluctuating income. It depends on whether they're currently acting in their role as foster parents: When they aren't, they rely on income from her part-time job in a preschool and his full-time hotel job, and when they are, they're given an average or $1,400 per month from the foster care system. That money isn't guaranteed, though—even when they get these checks, they're sometimes for less than $500. Consequently, although they're aware of what needs to be paid when, they often have trouble making payments—such as utility payments—on time and have to "catch up" when their bills are past due.
Operating without a consistent and comprehensive budget hardly makes this family unique. A 2012 LearnVest survey found that only about 40% of respondents had a monthly budget. Worse, less than half were aware of how much money they had available for monthly spending. Spending more than you earn is a problem that stretches across all incomes—in fact, a 2013 FINRA survey found that 19% of Americans regularly spend more than their income.
RELATED: How Normal Are Your Finances?
How to Do It Better: When most people hear the word “budget,” they equate it with a spending "diet." But a budget is simply a plan for where your money will go—not a restriction on how much you’re allowed to spend. Without a budget, it may be hard to anticipate your expenses and make sure there’s enough money allocated to cover them.
A budget is one of the very first steps toward financial security, says LearnVest Planning Services CFP ® Elizabeth Sklaver. “Without a budget, it’s really difficult to move on to things like paying off debt or saving for your financial goals. You should know how much you have coming in and where pretty much every dollar needs to go. Guesswork adds a lot of unnecessary financial stress.”
The first step in creating a budget is to monitor your spending and see where those dollars are going, which you can do automatically in the free LearnVest Money Center. If you’ve already done that, check out your next steps in our simple guide to budgeting. And if—like the Adrians—you have an irregular income, we have a guide for you too.
2. Making a Plan to Pay Off Debt
The Rodriguez family, a three-generation household in California, diverts 40% of their monthly spending to debt payments—30% of which are to debt held on seven credit cards. The family is hardly alone in this: The same LearnVest survey found that the average credit card debt of respondents was $5,000, and that more than half of people don't pay their monthly balance in full.
One big mistake the Rodriguez family is making: They pay an extra $50 per month toward their mortgage to chip away at the principal, instead of using that money for their highest-interest credit card debt, which means they may well end up shelling out more money in interest than they'd ever planned.
How to Do It Better: Debt is simply the money you owe, plus interest—the continual fee you pay for the privilege of borrowing in the first place. There are certain kinds of debt that are considered investments in your future, like student loan debt that could increase your earning potential, or mortgage debt that will eventually make you a homeowner. Specifically, it’s “bad debt” that’s a problem. These debts will yield no reward once they’re paid off and often carry high interest rates … for instance, credit card debt.
Sklaver says that she often sees clients overwhelmed by “bad debt.” “Debt can feel all-consuming,” she says, “but putting a plan in place to pay it off is a huge step in the right direction.” If you’re worried about your own debts, she recommends first that you stop accumulating debt as much as possible. “If you keep digging the hole, it will take much longer to fill in,” she explains. Then, it’s time to tally up your debts in the LearnVest Money Center and figure out exactly how much you owe, and even set an automatically tracked goal to pay it off. To continue making your own plan to pay off debt, use our free checklist.
3. Establishing an Emergency Fund
The Johnson family living in a suburb of Cincinnati has a pretty effective system in place to pay their bills. They allocate each incoming paycheck to a different bill, and when it isn't enough, they economize on spending categories like groceries. But, like most Americans, they've been walloped by unforeseen expenses from time to time, including gallbladder surgery for mom Sarah, and emergency room visits prompted by their son's severe allergies. That's how they wound up with $8,000 in outstanding medical bills ... and no emergency fund to speak of.
They're certainly not the only ones without a financial cushion: The 2012 LearnVest survey showed that less than half of respondents had an emergency fund, and that among those who did have one, the money saved was, on average, a little over $15,000.
RELATED: 7 Reasons You Need an Emergency Fund
How to Do It Better: An emergency fund should be three to nine months of net income depending on your life circumstances, stored in a savings account to be used in case of emergencies such as medical problems or job loss. The leading contributor to credit card debt in the United States is medical bills, but we can’t very well be expected to build “unexpected appendectomy” into our monthly budgets. That’s why emergency funds exist: To keep us safe and financially secure in the face of life’s most unexpected challenges.
Sklaver says that a healthy emergency fund is a top priority on the road to financial health. “There are so many people who have to live paycheck to paycheck, and an ill-timed expense, like the car they use to get to work breaking down, can send them into debt,” she explains. “That’s why planning ahead and storing away funds when things are going well is so important. It’s better to have it and not need it than not have it when the need arises.”
4. Using Credit Cards Responsibly
Mike Smith is somewhat unique. This single, Kentucky man in his fifties has a deep distrust of banks and uses cash almost exclusively, saving money by stashing it around his house. Overall, he's pretty financially secure. He holds no debts and is extremely thoughtful about his spending. There is one thing, though, that he could be doing better: using credit cards. While it hasn't caused him problems yet, he isn't taking advantage of the resources that could help him manage his money more smoothly.
Smith isn't alone in his aversion to banks and credit. LearnVest research from 2012 found that 40% of respondents think credit cards are "bad" and you should only spend what you earn. But abstaining from credit cards altogether isn't nearly as smart a move as it may seem.
How to Do It Better: When you’re in debt or trying to reduce your spending, temporarily switching to all-cash spending is one way to get things back under your control. But aside from the convenience of swiping and being able to see line-by-line spending in your statements, credit cards have an especially important function in your financial portfolio: they help you build credit.
“Credit” refers to two things: a history and a score. Your credit history, detailed in a credit report, is simply a record of the money you’ve borrowed (after all, using a credit card means you’re borrowing money from the bank). Your history contributes to your credit score, a three-digit number lenders use to evaluate your trustworthiness and determine whether you can borrow money—and how much interest you’ll pay—for something like a mortgage.
“If you don’t use a credit card, it can be harder to build credit,” says Sklaver. “If you’re worried about using a card, you can establish credit by buying only one thing on your card, like your Netflix subscription or even your monthly bus pass, and then paying off your monthly balance in full." She recommends setting up an automatic payment—and making sure you have enough money in your account to cover the fixed cost—to avoid missing due dates. "You don’t have to use a credit card every day to build credit," Sklaver adds, "but it is very helpful to have one if you can use it responsibly.”
5. Putting Our Own Financial Health First
Rita Douglas is a giver. The 62-year-old retiree in Cincinnati is living out her golden years on a pension, Social Security—and a very unique barter system she's arranged with friends and family. On any given night, she'll cook dinner and wash clothes; they'll buy her toiletries and cigarettes. The only problem comes in when Douglas also offers to lend them her credit card! Unfortunately, her generous tendencies mean, at an age when health expenditures tend to go up, she only has $105 saved in an emergency fund and regularly incurs late fees by overextending herself to others.
How to Do It Better: If you want to help out your friends and family financially, there’s really one question you need to ask yourself: Can you afford to?
“Being able to help out your loved ones is a wonderful thing,” says Sklaver, “but if it’s going to put you in a financially precarious position, you might want to reconsider. After all, you aren’t being so helpful in the long run if your loan means your loved ones will have to turn around and spot you funds in the future.”
RELATED: How to Stop Being the Family ATM
This is a delicate subject for families especially, because it can be so hard to refuse a request for money. “It’s easy to feel like you have extra cash,” explains Sklaver, “but is it still ‘extra’ when you’ve made your retirement contributions and shored up your emergency fund? Just because you don’t need your money today doesn’t mean you don’t need it.” Instead of giving money away, you may want to consider making a loan (in writing!) or giving time instead of money by volunteering to babysit or run errands.
*All names in the project were changed to protect families' privacy.
LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc. that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment advice. Please consult a financial adviser for advice specific to your financial situation. The people quoted in this piece are not clients of LearnVest Planning Services.