The Stages of Personal Finance

When you say you want to be better at handling your money, what does that mean? The answer to this question depends on the person. It could mean early retirement, higher income, more savings, and a variety of other things. But is financial improvement merely a numbers  game? What do you aim for if you’re unclear about how a certain lifestyle will cost? Surely there must be other ways to measure improvement.

Because of this, I prefer to think of financial growth in stages. It doesn’t include a specific net worth amount, nor a minimum income level. After all, there’s no such thing as “one size fits all” when it comes to personal finance. What exists instead are different psychological and emotional stages, and the numbers corresponding to them vary from person to person. What I’m measuring in this case is one’s sense of comfort, freedom, and security which, frankly, is more telling than the numbers themselves.

So what are the different stages of personal finance?

Stage Zero: Ignorance

Why start with zero and not the number 1? Well, because zero is what’s going on here. The idea of handling money hardly makes a blip on your radar. Not to sound too harsh, but stage zero is the stage where you are ignorant about money. That’s okay, everyone starts here.

While you may know about saving or investing, you’re not really doing them. You feel like you should save or at least do something about your money, but this thought soon disappears as you go back to your daily life. You don’t know how much your monthly expenses are, either. If you’re unlucky, you’re already in financial trouble but are vaguely aware of it. If you’re lucky enough to avoid trouble, this is mostly because of chance. Any minor event such as a toothache or “therapeutic shopping”  is bound to rock your financial boat.

Stage One: Awareness and Action

Finally, you’ve realized that it’s time to take control of your finances! You start asking around, reading books, and learning all you can about how to do things right. Then, you actually do something with this new information.

If you have debt, you’re creating plans to reduce or eliminate it. At this point you are also forming new habits such as getting your spending under control and managing your money. If a lot of damage has already been done, you may be far from financial stability - but at least you’re taking steps towards it.

Stage Two: Stability

By this time your actions have paid off and you’re taking consistent measures to keep it that way. You have no debt, or if you do, it’s completely under your control. You have an emergency fund that is suited to your needs, and you’re on track when saving or investing for retirement. Your income is also consistent and you spend less than you earn. You may even be sleeping easier.

Stage Three: Freedom

In this stage, you’re earning passive income that’s equal to or greater than your living expenses. You don’t have to rely on your job to live. Where are you getting this passive income? It could be from a business that you’ve invested in but don’t personally run, stock dividends, or the sale of information products (such as ebooks). The only downside is that because of the high level of knowledge, time, or capital needed for this stage, not everyone ends up here.

What stage of personal finance are you in right now? What stage do you hope to be in by the end of the year?

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My Personal Financial Goals for 2010

Although I’ve privately noted my 2010 financial goals in detail, I’d like to share some of them here. The main reason I’m doing this is for accountability, but I wouldn’t be surprised if readers wondered about my finances from time to time. After all, everyone has their own financial problems, challenges, and aspirations. As usual, I won’t be giving out actual numbers here for privacy reasons.

Without further ado, here are my financial goals for 2010:

Emergency Fund. In yesterday’s update I talked about how all I have left is a 4-month emergency fund because of the many financial emergencies I experienced last year. My goal for 2010 is to save up for a 7-month emergency fund (meaning have 7 months’ worth of living expenses tucked away). My “big” goal is to get it up to a year’s worth, but it’s not as necessary anymore since I’ll have less dependents this year.

Retirement Fund. Basically add PXX,XXX to it over this year. After that, I’ll be making an effort to move it to investment vehicles with better returns.

Insurance. I need medical insurance, so does my partner. This year I’ll make sure that we both have it so we can minimize medical expenses.

Legal paperwork. I need to finalize my last will and testament, as well as a power of attorney for my partner. This may sound morbid, but anyone with assets should do this, no matter how young you are. This is especially true if you want your assets to go to other people apart from the default legal choice (your children, spouse, or parents).

Launch graphic design studio. I’ve been planning and organizing a graphic design/illustration studio with some friends for almost two years now and it’s time to jumpstart it from months of stagnation.

Improve returns from passive income stream. This basically means to spend a few hours for testing and research. Doesn’t sound exactly passive, I know, but if it means better returns then hopefully it’ll be worth it.

If time and opportunity permits it, launch another passive income stream. Not a must-do, but if I find the time and don’t have other unexpected projects, I’d love to do this. I have a few options right now but I’ll need more information/research.

Looking at these goals, I see a unifying theme: I’m laying the foundations. It looks like I’ll be spending this year ensuring stability for me and my family. I’m putting safety nets in place (bigger emergency fund, retirement fund,legal paperwork) while setting up systems that will allow me to protect myself and earn more income (insurance, additional income streams).

How about you, what are your financial goals for 2010? How do you hope to achieve them?

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Personal Financial Review: How Did I Do in 2009?

At the start of 2009, I wrote a post describing my financial goals for the year. I know that’s I’m already a few days late, but I’d like to take this opportunity to review whether I’ve accomplished those goals.

1) My Income Goal

I didn’t disclose the figure, but I wasn’t able to meet my income goal consistently. I earned more in 2009 if I compare it with the previous year, so it’s not necessarily a bad thing. Also, it’s been taking me much longer to launch my other income streams, so it’s taking a while for my additional income to make a difference.

2) Emergency Fund

My goal for my emergency fund was to save up for 1 year’s worth of living expenses. Sadly, I wasn’t able to reach this goal. So many emergencies happened this year - someone close to me needed an operation, I got sick a few times, etc. Even with my discipline to save and my existing emergency fund, I couldn’t really keep up with those emergency expenses. I still have 4 months worth of an emergency fund, but that’s less than what I started with in 2009.

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