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Personal Finance

5 Steps to Take Control of Your Finances

Woman saving in jars

Managing your finances can be intimidating, particularly when you’re first getting started. Only about half of U.S. states mandate personal financial literacy courses before graduating from high school, so many people are left to figure it out on their own. Education doesn’t end with school, though, and learning personal finance as an adult can be liberating.

Navigating your finances might seem impossible at first—maybe you’re facing student loan debt, low income, expensive housing costs or all of the above. But taking a few key steps, like setting financial goals, paying off debt and starting your retirement savings, can help you feel more in control.

Read on to learn more about how to get started.

1. Take Inventory—and Set Goals

The first step toward managing your finances is to assess your current financial state. To gain a better sense of your financial condition and create a realistic spending plan, ask yourself these questions:

  • What are you earning (after taxes)?
  • What are your expenses? Is there anything unnecessary in those expenses?
  • How do your expenses compare to how much money you make every month?

Assessing your finances will help you determine your priorities and establish goals. Setting goals can help you stay focused on saving and gives meaning to the dollars you put away (or to the luxuries you skip) to make your goals a reality.

Some goals will take longer to achieve than others, which is why it’s good to set some short-term goals. Saving only for events far in the future might feel overwhelming. Your short-term goals can help you stay motivated and on track.

2. Understand Compound Interest

Compound interest, essentially the interest earned upon interest, can work in your favor or work against you. You can earn interest in savings accounts or on other investments, and you can owe interest on any sort of debt you carry. That interest becomes compound interest when it’s added to your balance and included in future interest calculations.

Say you have $1,000 in a savings account earning 3 percent interest annually (the equivalent of 0.25 percent interest monthly). In month one, you’d earn $2.50 in interest on the $1,000. But in month two, you’d earn interest on $1,002.50, which means you’d earn $2.51 in interest that month. This small difference can really add up over time. If you didn't touch that account for 10 years—no additional funds deposited or taken out—and the interest rate stayed constant, you’d end up with $1,343 without lifting a finger.

Unfortunately, compound interest also applies to debt like student loans, mortgages and credit cards, which generally have significantly higher interest rates than savings accounts. That means unpaid credit card balances can quickly spiral out of control, and making only the minimum payments isn’t enough to keep balances from climbing.

Let’s say you have a $1,000 balance on a credit card with an 18 percent annual percentage rate (APR) and minimum monthly payments of $25. If you pay only the minimum each month, you’ll accrue $538 in interest and take more than five years to pay off the balance.

3. Pay Off Debt and Create An Emergency Fund

A prime example of a short-term goal is paying off a large loan balance or high-interest debt to mitigate the effects of compound interest. Make sure you’re making regular, sustainable payments every month to alleviate your debt over time, paying extra when you can afford to do so.

Along with paying down debt, you’ll want to start establishing a financial cushion in case of emergencies. There will always be large, unexpected expenses in life—medical bills, a flat tire, a flight home for a family emergency or something else. An emergency fund prepares you for that inevitability and enables you to tackle the challenge without resorting to your credit card.

Ideally, an emergency fund should be big enough to cover three to six months' worth of expenses, but you can start small—even a few hundred dollars can help give you a buffer.

4. Set Up Your 401(k) or Individual Retirement Account (IRA)

Saving for retirement is a significant long-term goal. While it might not seem like a priority when you’re young, a sufficient retirement fund takes decades to achieve. The key is to start early so compound interest will help supplement your savings.

Many employers offer a 401(k), which is a great way to get started without having to do too much heavy lifting. Employer-sponsored plans often let you invest as little as 1 percent of your pay each pay period. Try to increase this amount each year, especially when you experience an increase in income.

Additionally, many employers match an employee's 401(k) contributions up to a certain percent of salary. If you contribute at or beyond that threshold, you take full advantage of the benefit. If you contribute less than your employer is willing to match, though, you might be passing up free money. 

Investing in a retirement account can also provide tax advantages in the present. Every dollar you contribute to a traditional 401(k) will reduce your current taxable income by the same amount, which means you’ll owe less in income taxes for the year. Traditional IRAs might also provide tax deferral benefits, depending on your income and other retirement investments.

5. Start Building Your Investment Profile

A common misconception is that investing is only for rich people, but investing is for everyone. And early in your career is a very good time to learn how. The goal of investing is to grow your money faster than you typically could in a bank account, so contributing regularly, even in small amounts, can help you save for the future.

In a FINRA Foundation study with the CFA Institute, Generation Z adults ages 18 – 25 who said they hadn’t started investing cited a lack of sufficient savings (65 percent) and a lack of sufficient income (64 percent) as the main barriers. If you’re focused on immediate goals like paying down debt or saving up to move into your own place, you might think you can’t afford to invest yet. Yet investing with a small amount of money is easier than ever, with digital technology making investing increasingly accessible. According to the FINRA Foundation study, 56 percent of Gen Z adults already own some kind of investment, and ease of access was cited as a key contributor.

Many financial apps are available, but you should understand how online trading works before investing through any of these platforms. And when you’re ready to make an investment, it’s important to understand how it fits with your goals, how it could make or lose money, and how you’ll manage the risk.

Financial management isn’t one size fits all; what works for a friend might not be applicable to you. But educating yourself and making well-informed financial decisions will help you greatly in the long run.

Learn more about investing basics.