It may sound like a simple equation, but executing the task is more difficult than people realize: Spend less than you make, and you’ll be debt-free sooner, have a comfortable savings account and a more secure financial future.
Steven B. Smith, president and chief executive of Finicity, an online money-management company, says when people are struggling to get out of debt and pay their bills, using two financial principles – envelope budgeting and debt roll-down – can help pave the way to financial health.
“Periodic spending is usually what gets people in trouble,” Smith says. Paying for unexpected car repairs, or even birthday presents or summer vacations, is made easier when the two financial principles shape a family’s savings and spending plan, he says.
Problems arise, he says, when people don’t have money set aside to pay for expenses, so they instead put it on a credit card. Mvelopes, a budgeting software program created by Finicity, allows users to place their money in envelopes so they can have a visual image of what amount is coming into the household and how it is being used.
To help improve their financial future, says Smith, families (businesses can also use these methods) should consistently spend less than they make. In addition, they should create a balanced spending plan based on their income and spending needs.
“Once you’ve done that, fund your envelopes accordingly and focus on living within your envelope balances, and therefore within your balanced spending plan,” he says.
Smith advises families to stop accumulating debt. If they focus on spending only the amount allotted within specific envelopes, no new debt will be incurred. The method enhances the opportunity of families to live within their means.
Saving for periodic expenses is another key to reducing debt, says the Utah business owner.
“Setting aside money for these expenses in smaller increments throughout the year is easier to manage than trying to come up with it all at once.” The same theory applies to financing emergencies.
Smith says building up a 90-day emergency fund is critical in case a family experiences a loss in income or an unexpected health emergency. Having cash on hand now stems reliance on credit-card debt in the future.
The final step, says the CEO, is using money from discretionary categories to increase savings or further reduce debt.
“At the end of the month, if there is money left in your monthly discretionary envelopes (i.e. groceries, dining out, fuel, etc.) why not use that money to reduce your debt more quickly or increase your savings?” he asks. “Transfer that money from your discretionary envelopes into your credit-card-repayment envelopes or into savings and reach your goals more quickly.”
Families should also consider using the debt roll-down principle to eliminate debt more quickly. Users first create a list of debt obligations and prioritize them in order of highest interest rate. Money is then allocated for monthly payments in the balanced spending plan. Once the first-priority debt is eliminated, that first payment amount is rolled over into payment of the second-priority debt.
Finicity is a privately held company founded in 1999. For more information, visit www.finicity.com.