How to Build a Strong Financial Foundation in 5 Simple Steps
A recent LendingClub survey found that 60% of U.S. adults, including more than four in 10 high-income earners, are living paycheck to paycheck. While not entirely surprising given the economic volatility of the past few years, this still translates into a large segment of the population who are carrying a financial backlog into the foreseeable future and who may need some guidance and support. How can we all get to a place where we’re empowered with our money? Let’s first start with a definition.
What is a Financial Foundation?
Having a solid financial foundation means owning more than you owe (positive net worth) and having more money coming in than going out (positive cash flow). Building a solid financial foundation starts with taking care of your immediate needs in a way that also supports the financial goals you’ve set for your future. This means not only setting some basic financial goals, but also being responsible with your daily purchasing habits on top of long-term financial planning. At first, taking even the smallest of steps toward improving the way you manage money can help you make big strides in the direction you want to go.
5 Steps to a Strong Financial Foundation
Putting a strong financial foundation in place is surprisingly straightforward. To help you get started, give your confidence a boost and set yourself up for success using this five-step method to build a strong financial foundation.
1. Get organized
The first step is to know exactly where you are right now with your money. You’ll need to round up some documentation, but this one-time exercise can provide an invaluable baseline view into your financial health.
Start by building a personal balance sheet—a summary of your assets (what you own) and liabilities (what you owe). Your assets may include your bank and investment account balances, the market value of your home, vehicles, valued possessions, and more. Your liabilities are the debts that you owe, such as home and auto loans, personal loans, student loan, credit card debt, and so on. List out each asset and liability individually in a document. This is your personal balance sheet. Once you’ve assembled your personal balance sheet, add up all of your assets and subtract your liabilities to come up with your net worth.
Now let’s look at your weekly and monthly cash flow—your income minus your expenses over a set period of time. Use a cash flow budget template to see how much money is coming in and how much is going out. On some weeks you may see more expenses going out than income flowing in. Use this template to see how adjusting your weekly expenses could improve your cash flow.
Lastly, check in on your credit health by requesting a free copy of your credit report from each of the three major credit bureaus. Carefully review all three of your credit reports, identify any errors or inaccuracies and, if possible, contact each of the credit bureaus—TransUnion, Experian, Equifax—to have them corrected. If the same error appears on all three of your reports, you’ll need to contact each credit agency separately to make corrections.
2. Protect yourself.
Now that you know where you stand, it’s essential to set up a plan that will keep you financially safe along your journey.
If you don’t already have one, focus on this first. (Check out our emergency fund essential guide.) An emergency fund is a must-have for keeping you afloat financially (not dipping into debt) when faced with an unexpected expense, temporary loss of employment, or any other financial setback.
Check your insurance coverages—home or rental, auto, health, life and disability. Insurance policies could limit your out-of-pocket expenses when the unforeseen occurs such as surprise medical bills, a car accident, disability, or death of a wage-earner. If you already have coverage in place, review your policies to ensure they still meet your needs or warrant an update since you purchased the insurance. It’s smart to shop around and compare coverage across a few insurers every couple of years. You may be able to find a less expensive policy that provides the same or better coverage.
Create or update your estate plan, an action plan and legal document used to determine what happens to your assets while you’re alive and after you die. Estate plans may include naming your heirs, dividing up your assets, creating a living trust, and assigning guardians for minors. Laws vary by state, so you may want to consult with an estate planning attorney to help.
3. Prioritize reducing high interest rate debt.
While some debt may benefit your financial situation (such as a home loan), be mindful about over-extending yourself because paying interest on money you’ve borrowed can keep you from putting money toward your other important financial goals. If you have high interest revolving credit card debt, focusing on paying it down is a smart way to eventually free up cash to put toward savings, and building a strong financial foundation.
An accelerated debt repayment strategies like the debt snowball method or the debt avalanche method can help you get started. And to simplify your debt payments and possibly lower your interest rate, look into consolidating multiple loans or credit cards.
4. Define your most important financial goals.
Now that you’ve put the pieces in place to start building a strong financial foundation, let’s focus on what you want your future to look like. Now is the time to spell out the specific financial goals you want to work on in both the short- and long-term. Here are a few goals that are worth putting on your list:
Start or increase dollars held in an emergency fund. A good rule of thumb is to have at least three to six months of living expenses saved;
Start (or increase your contributions to) a retirement account or 401(k), especially if your employer offers a match;
Pay off high-interest credit card debt;
Save for a down payment on a home;
Pay all of your bills on time (and improve your credit score);
Learn how to invest with confidence;
Set up a vacation fund and budget (to avoid adding to your credit card balance);
Establish a second stream of income.
5. Put your plan into action.
Once you’ve got your balance sheet, cash flow, and financial goals set, start prioritizing the changes you want to make. For instance, identify what changes you can make to your spending that could help you reach your savings goals faster. Or perhaps you want to take advantage of higher interest rates by moving your emergency savings from a regular checking account into a high-yield savings account. Regardless of where you begin, building a strong financial foundation may at first feel like a big hill to climb. Just remember you don’t need to accomplish everything all at once. Here are a few more tips it may help you to keep in mind:
Get your budget in place.
Continuing to spend beyond your means and live paycheck to paycheck will not support building a strong financial foundation. Leverage your balance sheet, cash flow statement, and your financial goals as guides to create a realistic budget and plan that reflects your actual income and expenses.
Automate your savings and payments.
Make life easier by automating your savings and bill paying as much as possible. Setting up recurring money transfers from your paycheck into your savings accounts or automating your bill payments so you never miss a due date can help you remain disciplined and on track.
See your financial plan through.
No matter what your goals, sticking to the plan you’ve created and checking off your accomplishments one by one can help you stay motivated and on track.
The Bottom Line
Building a financial foundation takes some focus, planning, and effort. But when you have a step-by-step process to follow, you’ll start to see real results. Ultimately, this will provide you with the momentum and confidence you'll need to continue to believe in your ability to create greater financial wellbeing for yourself and your family.