What Is the First Foundation in Personal Finance?
Your introduction to personal finance usually starts with the basics: budgeting and tracking expenses. A budget is simply the way you distribute earnings, while spending is tracked to gain control over your cash flow.
In a lot of cases, debt repayment becomes the central theme of personal finances further down the line. However, it would be a mistake to head straight into solving this complex financial issue by yourself without having the proper foundation to do so.
The first and foremost foundation of personal finance that you always need to be mindful of is creating an emergency fund because regardless of whether you’re trying to save up for a car or pay off a debt, you should never be left without your rainy day money.
Creating an emergency fund
Don’t let the label “fund” intimidate you. If you are in high school, a lump sum of $500 in cash would suffice. For adults, it’s slightly different (usually higher), and the goal is to have an account that holds three months’ worth of household expenses.
Youngsters vs adults
Each of us has a specific starting point in our journey to financial freedom. While these variations depend on our life circumstances, i.e. the family you come from (and their spending habits), there are two groups, in particular, that have drastically different outlooks on finances: high school students and adults.
Debt is what separates life into before and after, so those of you who still haven’t accrued debt by getting a car loan or a student loan will, generally speaking, have better long-term prospects. That is, if you focus enough energy on building your foundation in personal finance.
Because of the differences in handling finances, we’ll first cover the first foundation for youngsters, and then go over what that means for adults. This doesn’t imply that adults should skip the first segment. Most of you have kids and nephews or nieces, so, from the next section, you can learn how to approach young people when you try to teach them about being responsible with money.
The first foundation in personal finance (for high school students)
High school is a great time to have a number of firsts. As a student, you start off with a clean slate, especially when it comes to handling money. Most of you probably haven’t really started to save yet, but that’s ok.
As we already mentioned, the first foundation is to save for an emergency. It’s recommended to have $500 in an emergency fund. You can save them in a bank account, or you can keep them in your socks. What is important is not to reach for them when friends call you to get pizza. You use your pocket money for that.
And note that this is a different stash of cash than the one you use to save up for a gaming console, concert tickets, or a spring break vacation. So, what can you spend your emergency fund on?
What is an emergency expense?
It’s very important to set clear rules about using these $500 from the emergency fund. They are to be used to cover unexpected expenses. Luckily, these unplanned incidents are quite harmless in your youth. We are talking about a flat tire, the sudden breakdown of your phone (we know that one is an emergency, right?), or surgery for your pet.
What is not an emergency expense?
In short, every regular expense. This covers going to the movies, tickets for football games or a concert, clothes, study supplies, sports team membership fees, or similar. It’s crucial to curb wasteful habits early on. Avoid ordering pizza delivered to your door too often, and try to find an alternative way to satisfy your cravings for snacks. These kinds of instances are definitely not an emergency. It’s one of the reasons advisers recommend putting away your $500 in a bank account. That way they are accessible, but you need to make an effort (and go to the bank) to use them.
Money saved for a specific purpose is also separate from the emergency fund. Adults call this a sinking fund. So, if you are saving for a car, an excursion, or a trip, don’t mix this money with the $500 in your emergency account.
Yes, you should have a savings account and an emergency fund. Let’s delve deeper into that.
The emergency fund and the other foundations in personal finance (for youngsters)
The other four foundations in personal finance (for young folks) are:
- get out of debt;
- pay cash for a car;
- pay cash for college;
- and grow your wealth.
In essence, it’s very similar to the foundation for adults, but the stakes for adults are higher.
Once you have set those $500 aside, you can focus on your other financial goals. Getting rid of debt is the second foundation in personal finance, so you can start working on that next. Remember, whenever you owe someone money – that’s debt. This applies to credit cards, but it also applies to any person having lent you money.
High school is prime time to start working a part-time job. There are a lot of opportunities: a server at a bar or restaurant, a babysitter, delivery driver, cashier, tutor, pet walker, a grocery store worker, etc. The income you earn from this job can be the basis of your budget.
The third and the fourth foundations – pay cash for a car and pay cash for college – follow the same philosophy. They are singled out as specific goals for two reasons. The first one is to keep you out of debt, while the second one is to give purpose to your saving efforts.
Having multiple accounts
Do your best to keep the money in separate accounts. As a youngster, having two accounts is potentially the best. One will hold the $500 emergency fund, and the other will hold the money you save. This will help you not to spend the emergency fund on a big purchase or for regular expenses.
If you were to use the $500 to buy your first car, and you suddenly have to meet unplanned expenses, then you will have to go into debt. This is the primary reason to keep these two accounts separate.
Of course, you can further divide the funds into your savings accounts with a ledger. For example, if you have $1050 in your savings account, you need to have a clear understanding that the $300 you took out to buy concert tickets are separate from the $750 you’ve saved up for your first car. Just have a clear understanding that the $300 you take out to buy concert tickets don’t stand in the way of the $750 you saved up for your first car.
Change your attitude towards money
Don’t let the fancy financial lingo intimidate you – taking control over your personal finance is an attainable goal. Keep in mind that the easiest time in life to achieve this is probably while you are a high school student, particularly if you lay the foundations to your financial freedom in a way that teaches you how to stay away from debt.
Essentially, you only need a change in your attitude toward money. You don’t need to change your income – your earnings from a part-time job are a great start. Just have a long-term goal in mind (it’s hard, we know, you are too young), but no one asks you to think about retirement – only to navigate through your young adulthood with as little debt as possible. And this also doesn’t mean you should miss out on the fun – you are young and you should enjoy life. Simply plan your financial future. The earlier you start, the better.
If you start saving at 19, compound interest will make money for you. This is when you get interest payments on the money in your savings account, and this interest is reinvested back to the same account to increase your savings. It supports the fifth foundation in personal finance – growing your wealth. You can be a student without a student loan, and you can use a debit card instead of a credit card. It just takes a little more effort.
The first foundation in personal finance (for adults)
Teaching the next generation not to get into debt allows us to be hopeful about the financial future of our youth. But what about the adults? What about those that have passed the threshold of debt through hefty student loans, credit card debt, and, not to mention, mortgages – can they ever live a debt-free life?
It’s challenging, but not impossible. And it all starts with the emergency fund.
The first foundation in personal finance is the same for both teenagers and adults – building an emergency fund. However, the size of emergency funds for adults is bigger, since they have more responsibilities, and sometimes they are the sole breadwinner in their household. It’s recommended to save money that accounts for 3 to 6 months worth of expenses in an emergency fund. Check out the type of emergencies below to understand why.
What is an emergency expense?
The greatest risk (in the financial sense) for an adult is to lose their job. Emergency funds are created to support the family if the regular income is out of the equation. Of course, this is a temporary fix that will ease the transition. Calculating the exact size of this emergency fund (beyond the 3-to-6 month rule) can stir an in-depth discussion that is beyond the purpose of this text.
Other types of emergencies for adults include unplanned expenses related to the house or car. For example, emergencies include fixing the roof, an unexpected car repair (that is not covered by auto insurance), any urgent trip, like if your teenager breaks a leg in the forests of Costa Rica and immediate transfer to the mainland is required.
What is not an emergency expense?
Using an emergency fund for a health crisis is not recommended, although sometimes that’s the only way to cover urgent and necessary medical expenses. Having any sort of health insurance (already set in place) is always better than using cash. Also, large purchases, like appliances or vacations, can be budgeted through a sinking fund (or savings with a specific purpose), not with money from the emergency fund. If the washing machine breaks and you need to replace it right away, then you can use some of the money in the emergency fund, but if you want to buy a trampoline for the yard – you’d better pay for this from a separate fund.
The emergency fund and the other foundations in personal finance (for adults)
Setting up an account for emergency expenses is pivotal for laying the groundwork towards financial freedom. The second foundation in personal finance is the same for adults as it is for youngsters – debt repayment. There is one critical difference, however: the sheer volume of the accumulated debt.
Adults are usually on the other side of debt. This means they have gone through college with a student loan, or they have abused their credit card and interest payments have put a heavy burden on the monthly budget. And now, they need to repay this debt, which is admittedly, quite a demanding task.
Also, regular expenses for adults are quite substantial. On top of the debt, they need to deal with big purchases like household appliances, farming or gardening equipment, recreational vehicles, etc. Additionally, they need to plan weddings and holidays, find grave sites and finance funerals, pay the lease on the car, and so on.
Break the debt cycle
One of the greatest mistakes an adult can make in pursuit of a debt-free life is to direct all their earnings into settling debts. It’s counterintuitive, but it’s true. When done right, personal finance helps you break the cycle of debt, not create more of it.
If all your income goes for debt repayment and you are suddenly faced with an unplanned expense (life happens), and you don’t have an emergency fund, what do you do? You will get into a fresh, new debt. Therefore, whatever you do, first establish your emergency fund and keep it far enough from your reach so you’re not tempted to dip into it in regular circumstances.
Financial goals change
There are other challenges to personal finances in your adult years that are beyond debt repayment (through debt consolidation or any other strategy) and big purchases. The financial goals in your thirties (and after) revolve around saving for retirement, and, hopefully, investing your earnings in order to create wealth. None of them are attainable without a reliable fallback position – something only an emergency fund can provide.
There is no such thing as an unexpected expense – we all know that, at some point, we will need extra money. So, plan ahead and build your financial freedom on solid foundations, and start with an emergency fund. Only then can you go after the other foundations like debt repayment, paying cash for big purchases, saving for retirement, and investing.
Everyone wants to get rid of debt. Even those that don’t engage in any financial planning are not keen on being a wage slave and would quit running on the hamster wheel if they believe it’s possible. The objective is legitimate and will enrich your life in the long run.
At the same time, the foundations in personal finance offer a road map to leading a debt-free life. Be mindful that the first and most important foundation is to have an emergency fund. This will not only allow you to repay your debts, but it can also allow you to achieve the other financial goals in your life.