Friday, September 30, 2022

What Does Financially Sound Mean?

The term financially sound describes a financial decision showing good judgment or a state of being reflecting good money management. A decision considered financially sound implies safety, stability, and financial benefit. Being financially sound means consistently making good financial decisions.

Woman making financially sound decision to budget her money.
What does financially sound mean and how can I become more financially sound?

Every day, we all face dozens of decisions that affect our personal finances.

They range from minor to life-changing. Deciding to stop for coffee and a muffin on the way to work doesn’t affect your finances or your life the way deciding to take a higher paying job in another state does. It’s the sum of these decisions, big and small, that usually determine your bank account balance, your financial stability, and your financial security.

Yes, some people are born into wealth. People do win the lottery. For the average person, whether you’re broke, rich, or somewhere in the middle largely depends on the quality of the financial decisions you make.

The more financially sound choices you make, the better off your finances will be. If you make more unsound financial decisions than sound ones, your financial life will likely be a struggle.

Why Is It Important to Be Financially Sound?

It is important to be financially sound because every area of your life is affected by the state of your finances. If you consistently make financially sound decisions, life becomes easier. You have more freedom, more stability, and more security. You’ll have less stress and a stronger marriage.

How Can I Be Financially Sound?

You can be financially sound by adopting good money habits like budgeting, setting goals, saving for the future, and living within your means. Other financially sound decisions include building an emergency fund, automating your finances, contributing to your 401k, and eliminating and avoiding debt.

How Can I Make More Financially Sound Decisions?

Making financially sound decisions and becoming financially sound is about understanding your current financial situation, being clear on your priorities, and acting accordingly. It’s not about “right” and “wrong.” Those distinctions won’t help you make a financially sound decision.

Is it “wrong” to quit your job and travel around Europe for six months? Is it “right” to max out your individual retirement account?

The answers depend on your financial circumstances. That’s where understanding your current financial situation comes in.

If you’re carrying heavy debts, can’t pay your utility bills on time, and can barely afford groceries, luxury vacations and putting the max into your IRA are unrealistic. You can’t ignore your reality when making a decision that impacts your finances.

If you’ve been saving up for your European adventure for years, have no debt, and have a plan for resuming your career when you return, then it might be the perfect time for traveling.

Instead of thinking in terms of right and wrong, try asking yourself “does this help me or does this hurt me?” As you think about your answer, consider the short-term and long-term impact of your decision.

You can also make a list of pros and cons. Grab a sheet of paper and a pen, draw a line down the middle, then list the pros on one side and cons on the other. It’s simple and it forces you into considering your decision from all angles.

Becoming a Financially Sound Person

People who make financially sound decisions have good money habits. They are financially stable, have several months of expenses in emergency savings, and have little if any non-housing debt. They pay their bills on time, save for the future, and have money left over.

If that description doesn’t fit you or you’re tired of struggling financially, here are some steps you can take to become a financially sound person:

Track Spending

You’ll have a tough time making financially sound decisions if you have no idea where your money goes. I spent years wasting my meager income and making bad financial decisions because I never bothered to track my spending. Despite working hard and having a steady income, I always felt broke.

If you’re not currently tracking your spending, start. Tracking your daily expenses for a month will open your eyes to any money wasting and bad money habits.

Create a Budget

Starting a budget ensures that you’re monitoring your income and your expenses. A budget is not meant to prevent you from enjoying life. It’s simply a road map for how you spend your money that reflects your priorities.

Identify and Eliminate Bad Money Habits

Once you start tracking your spending and creating your budget, you’ll probably spot some bad habits in need of addressing. Bad financial habits include impulse spending, being late on your bills, and overspending with credit cards. When you eliminate bad spending habits, you free up extra money to put toward your financial goals.

Live Within Your Means

Living within your means is one of the core principles of good money management. Regardless of your income, if your monthly spending exceeds your monthly income, you’re headed for trouble.

Living within your means is not about your income. You can live within your means on $15 an hour, $40,000 per year, or whatever you make. You can also make six figures, blow through it, and have nothing to show for it other than regret and credit card debt.

Living within your means is about spending less than you make. You don’t necessarily need to live a more frugal life, but addressing any bad habits and cutting expenses where possible helps. Budgeting and controlling impulse spending also help.

Review Your Budget Regularly

Income and living expenses fluctuate. Needs, goals, and plans change. Success with budgeting requires creating a realistic budget you can stick to and reviewing it from time to time.

When your financial situation changes, your budget can change with it. Set aside time every month for a budget review. A good time to do this is right before you set your budget for the upcoming month.

Compare what you planned to spend in the prior month with what you actually spent. Note any categories where you went over or expenses you underestimated.

Make any necessary adjustments. Devise a strategy for staying on or under budget for the next 30 days.

Set Financial Goals

Creating SMART financial goals is a good way to keep yourself motivated and on track. You might have short-term goals like saving for a down payment or your next vacation. Your longer-term goals might include starting a college savings plan for your kids or increasing your savings for retirement.

Break your short-term goals and your future goals down into action steps. That makes your goal more manageable. It also makes tracking your progress easier.

Use Cash for Daily Expenses

Use cash for your everyday normal living expenses. It’s too easy to rack up credit card debt or lose track of how much you’re spending when you use your debit card for everything. Handing over cash makes you much more aware of your spending habits and less likely to go overboard.

Prepare for Emergencies

Part of your financial plan should include being prepared for unexpected emergency expenses. You can’t know what tomorrow will bring, but you can bet life will throw you a few surprises. Those surprises often cost money.

Not having an emergency fund can lead to taking on heavy debts. You go from having an emergency to having an emergency and a financial burden on top of it.

Most financial experts recommend having 3 to 6 months of expenses set aside in an emergency fund. If your main source of income fluctuates, say you’re a contractor like I am or work on commission, then saving 8 to 12 months’ worth of expenses would be a financially sound decision.

Having several months of expenses stashed in emergency savings acts as a backup plan that doesn’t involve you going into debt. If you suffer a job loss, medical emergency, or your car or home needs a major repair, you can get through it without ruining your financial life when you have an emergency fund.

Secure Your Family’s Future

Beyond having an emergency fund, if you’re married or have dependents you should have a life insurance policy. Do this as soon as you can. You might be able to use the money you free up after identifying any expenses you can cut.

And don’t forget to create a will.

Eliminate and Avoid Debt

One reason many people struggle financially is credit card debt. Being saddled with high interest credit card debt makes it hard to make progress in other areas of your financial life.

It’s not just carrying high-interest credit card balances that get people in financial trouble. Any debt can lead to financial ruin, including mortgages, student loan debt, and other so-called “good debts.” That’s why retiring your debts and avoiding new debt is so important.

Make Savings a Priority

Savings should be one of your top priorities, especially if you haven’t established an emergency fund yet.

You might think you don’t make enough to save, but you can save money on a low income. Focus on what you can put aside, not what you can’t, even if it’s only $5 a week.

Establishing a savings habit is more important than the dollar amount. You can always save more aggressively when your financial situation improves.

Budget for savings just as you would for any other important financial obligation.

Automate Your Finances

We don’t always make wise decisions when given a choice. We know a salad is healthier, but often we go for the greasy cheeseburger instead. Automation can help you make better financial decisions by eliminating the limiting factor: you.

Set up transfers from your bank account for as many bills as you can. You can set them up to occur on or near your paydays so the money for bills goes toward your bills and not toward whims or the occasional spending spree.

Also set up automatic transfers from your bank account to savings accounts, investment accounts, or retirement accounts. That way, you pay yourself first without even thinking about it.

The process for setting up auto transfers and electronic bill pay varies by bank. It can usually be done online, though, and it’s easy. Service providers and credit card companies offer autopay options too.

When you set this up, you’ll see an immediate improvement. By removing yourself from the decision-making process, late fees, unpaid bills, and phone calls from creditors will be a thing of the past. You might also manage to save more than you thought possible.

Invest for Retirement

What are your plans for retirement? Unless your ultimate goal is working every day for the rest of your life, you need some sort of plan.

If you’re young, you probably don’t think about retirement often. But it’s never too early to start investing or retirement planning, especially if your company offers a 401k with employer matching.

Take advantage of employer matching if your company retirement plan offers it. Employer matching is free money and risk-free which makes it a sound investment.

Employers typically match a percentage of your retirement contributions up to a certain limit. Get the maximum employer match if you can.

Make Healthier Choices

One of the surest ways to go broke in America is by getting sick. Medical bills can ruin even the best financial plan.

Living a healthier lifestyle can save you money by preventing health issues. That might mean adopting new habits or getting rid of old ones.

Making lifestyle changes won’t be easy, but it is worth it. You’ll be there for your loved ones and you’ll enjoy the fruits of your labor.

Increase Your Income

You can be financially stable and make financially sound choices regardless of your income. Making more money will help you reach your goals faster, however. Having multiple income streams also offers you some protection in case of a job loss or pay cut.

You can try asking for a raise at work, finding a second part-time job, using your skills to freelance, starting a low-cost side hustle, or via gig economy websites and apps in your spare time.

Never Stop Learning

Personal finance isn’t taught in most schools, despite the fact that everyone could benefit from learning how to manage their money. That means learning about personal finance is up to you. Fortunately, there are plenty of resources available.

There are plenty of blogs and websites dedicated to personal finance. Grab a personal finance book from Amazon for learning the basics. If you prefer more structured learning, sign up for the free Kahn Academy Personal Finance Class.

Be Patient and Consistent

You can’t turn your financial life around instantly. You’ll have to make financially sound decisions every day for a long period of time to improve your financial life.

Establishing an emergency fund or reaching a savings goal takes time. Getting out of debt takes time. Compound interest, dividends, and retirement savings grow over time, not overnight.

The Case for Being Financially Sound

How much you earn doesn’t determine whether you live well or struggle. How much of your income you spend and how much you save are what separates success from misery.

Financially successful people make financially sound decisions. They don’t spend more than they earn. Their spending choices reflect their priorities, not their impulses.

Being financially sound gives you more options in life and assures you won’t lose any sleep over finances.

More From Kinda Frugal

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Featured Image Credit: Pexels

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