The term financially sound is thrown around a lot these days. But in all honesty, it’s a pretty ambiguous phrase. And in my experience, ambiguity and personal finance don’t mesh well. So, in an effort to clear things up, I went on a mission to answer the question, what does financially sound mean?
Financially sound is a term used to portray either a state of financial well-being, or a favorable financial decision. Additionally, anyone, or any decision, described as financially sound exhibits strength in three financial areas: stability, security, and progress toward a goal.
For example, when you save an emergency fund, you are making a financially sound decision. Why? Because you are improving your financial stability by protecting your assets with a financial buffer. You are strengthening your financial security by preparing for an emergency. And, by saving money, you are making progress toward your ultimate financial goals.
In contrast, when you finance a car, you are decreasing your financial stability by adding monthly payments to your cash flow. You are placing yourself in a situation where you owe somebody else money, which hurts your financial security. And finally, you are paying interest on a depreciating asset, which is the opposite of financial progress. This is why financing a car is not a financially sound decision.
10 Tips To Become Financially Sound
On the most basic level, your financial life is just the result of the financial decisions you make, good or bad. So truthfully, if you want to become financially sound, you need to learn how to make smarter financial decisions.
You also need to have an open-mind, and a willingness to change the way you think about money, entirely. So, if you are ready to commit to all of that, here are 10 tips to become financially sound.
#1 – Create A Plan
If you want to improve your financial life, you need to start somewhere. And the best place to start, is a financial plan. I mean, if you don’t know where you’re going, how are you supposed to get there? Here are a few quick tips for creating your first financial plan.
The best way to develop a financial plan is to begin with the end in mind. So, start by setting some clearly defined goals. What do you want to achieve with your finances? What are your ultimate dreams for your financial life? Where do you want to be 5 years from now; 10 years; 30 years?
Really dig deep into the goals you want to achieve in your financial life, and write them down.
Develop A Process To Reach Your Goals
Is your goal to become a millionaire in the next 10 years? That’s great! But the real question is, how are you going to achieve it? If you want to create a strong financial plan, you need to break your goals into small, bite-sized pieces.
Personally, I like to set monthly goals, but you might prefer weekly goals, or even daily goals. Just figure out what works for you and stick to it. Your step-by-step plan will make sure you stay on track.
#2 – Prepare For Emergencies
The only thing predictable about life, is that it is unpredictable. So, if you want to build a sound financial foundation, you need to prepare for emergencies.
Consider this, if you were to lose your job tomorrow, would you be able to support yourself and your family for a few months while you look for another job? If not, you need to start building an emergency fund.
How much should you save for emergencies?
You should save up enough money to carry you through six months of living expenses should you ever need it. I know that many people will tell you three months is enough, but coming from a family that has had its fair share of medical expenses, I can tell you it’s better to save for six.
Remember, emergencies will happen. Whether it’s a medical emergency, a broken down car, an unplanned trip to see a struggling family member, or a lost job, there’s no excuse for being financially unprepared. Cut some expenses, and save an emergency fund, before it’s too late.
According to bankrate.com:
“just 18 percent of Americans say they could live off their savings for at least six months.”
#3 – Get Out Of Debt
If making sound financial decisions is a priority in your life, then you should avoid debt at all costs. Think of it this way, when you calculate your net worth, you subtract your liabilities from you assets. And debt — no matter what kind — is a liability.
In other words, the amount of money you owe, is subtracted from your net worth. So, if making sound financial decisions means improving your financial stability and security, as well as taking steps towards your financial goals, debt is right out.
#4 – Live Within Your Means
This might be the hardest tip of all, but if you want to live a financially sound lifestyle, you need to spend less than you make. That means no credit card debt, no car loans, no more purchasing things on payment plans, and no more wasteful spending. Rather, you should pay for everything outright, and it should fit within a well-defined budget.
And speaking of budgets, you are going to need one if you plan to live within your means. At the bare minimum, you at least need to know how much money you make, how much money you plan to give, save and invest, and how much money you need to pay for the rest of your living expenses.
#5 – Invest Consistently
Saving money is a good thing when it comes to your emergency fund and paying for normal life expenses, but it will not make you rich. In fact, most savings accounts earn less interest than inflation, so often times, the money will actually lose value.
If you want to build a strong financial future, you need to invest your money. Utilizing the power of compound interest is one of the most important aspects of living a financially sound lifestyle.
But just to be clear, we’re not talking about high-risk investing for short term gain. That is anything but a sound financial choice. Instead, you need to invest consistently over time and let your money grow.
Eventually, if you invest long enough, the money you make from interest will far exceed the money you make at your day job.
#6 – Insure Yourself Properly
We have already talked a lot about financial security in this article, but if you want to build a sound financial situation for yourself, you need to properly protect yourself from catastrophes. And that’s what insurance is for.
Insurance might not be fun to pay on a monthly basis, but you will be extremely glad you have it if you ever need it. It’s a small price to pay in the long run to make sure you are protected if something terrible happens.
Life insurance is another critical component to the financial security of your loved ones. I know it might be a difficult subject to stomach, but it is one of the best ways you can protect them from financial struggle if something were to happen to you..
So, make a sound financial decision and purchase a term life insurance policy. It is one of the most loving and selfless steps you can take to protect your family.
#7 – Focus On Your Net Worth
With so many people worrying about their credit score these days, the subject of net worth has seemed to fade into the woodwork. And this is a giant mistake.
When you really look into it, improving your credit score is a losing game.
Think about it, your credit score is just a rating on how likely you are to pay off debt. But in order to build your credit score, you first have to take on debt. Then, as you pay off debt, your credit score increases. But if you don’t have any debt, your score decreases. Then, you have to go into debt to build it back up. It’s like a dog chasing its tail.
And meanwhile, while you are chasing the almighty credit score, you are sacrificing something much more important — your net worth. I mean, can you imagine if you were to just take all that money and invest it? Not only would you be earning interest instead of paying it, but your credit score would become less than useless. Why? Because you would have enough money to just buy whatever you want.
When you have money, there’s no reason for you to borrow any. And when you don’t ever borrow money, you won’t have any need for a credit score.
Focus on building your net worth, not your credit score.
#8 – Exercise Patience
Personal finance is a marathon, not a sprint. For instance, it takes time to get out of debt. It takes months to build an emergency fund. It takes years to start reaping the rewards of steady investing. And those kinds of timelines do not mix well with impatience.
The more you exercise patience in your financial life, the better off you will be.
Plus, I have found that patience leads to financial contentment, whereas impatience leads to financial stress.
#9 – Plan Your Financial Legacy
In addition to life insurance, it is important for you to plan your financial legacy. Yes, I’m talking about estate planning. Once again, this is a difficult subject to talk about, but do you really want all your hard work saving and investing to be squandered because you didn’t set this up?
Estate planning allows you to designate people you trust to make physical and financial decisions on your behalf should you ever need them to. Otherwise these decisions may be left up to the court. And what they decide to do, especially in regard to your money, likely will not align with your wishes.
Estate planning, though tough and sometimes pricey, is a sound investment of your time and money.
#10 – Study Personal Finance
When I was in school, we were required to take a certain number of math classes, english classes, science classes, and — well, you get the picture. And looking back on all of it, I often think, nobody I knew in high school grew up to be a scientist. Some people I knew ended up using math as engineers or architects. And some of them ended up majoring in english. But you know what all of those people have in common? They all make a paycheck.
Yet, I wasn’t required to take a single personal finance class. Funny, right? I mean, we all grow up to get jobs in different fields, and different locations, but the end goal for everyone is pretty much the same — make a paycheck.
But there’s a lot more to making a good living than just earning a paycheck. So, as an adult, it’s up to you to learn about personal finance.
I know it might not be the most exciting of subjects, but it’s worth it. Think of it this way, you work day in and day out at your job in order to make money. Don’t you think it’s worth your time to learn how to make the most of the money you earn?
Pick up a book on personal finance, or follow a personal finance blog (preferably Be The Budget). Just dedicate some time to studying the one subject they should have taught in school, but didn’t; personal finance.