In the previous article, I discussed how to overcome a personal debt crisis. In this article, I want to discuss how to avoid it in the first place (or prevent it from reoccurring). The best way to overcome a personal debt crisis is to never have one. With some forethought, discipline, and planning you can avoid the stress and other negative effects of a debt crisis. You will sleep better at night, maintain focus on other areas of life more easily, and not be bankrupted by minor financial hiccups.
Three Ways to Avoid Debt Problems
There are three specific strategies you can use to avoid running into debt issues.
Spend Less Than You Earn
You will never make any financial progress if you consistently spend more money than you earn. It’s basic math.
Just ask Charles Dickens:
Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.
David Copperfield, 1849
To successfully spend less than you earn you need to know two things:
- your consistent monthly income
- your expenses
I like to underestimate my monthly income and overestimate my expenses. Building a cushion in to your calculations will increase your odds of not having to take on debt during any given month. And avoiding debt is one of the best things you can do to building a secure financial future.
Utilize and Stick to Your Budget
In my opinion you can never go into enough detail in your budget. Your monthly budget is your blueprint for how a particular month is going to progress. In turn, the twelve monthly budgets throughout the year comprise how your financial year is going to play out.
You need to plan for things like utilities, groceries, and gas for your car. But you would also be well served to break up annual and semi-annual expenses like life and car insurance into monthly “payments” to yourself.
Getting your budget setup can seem like a daunting task, but it should only take you an hour or two. Once it is setup you just have to maintain the financial discipline to stick within the bounds of the budget. Building in an overage category with $25 or $50 set aside each month can help deal with any unexpected overages. Again, you want to plan for as much as possible in advance.
Plan for the Worst
No matter how well you stick to your budget you will run into emergencies. You’ll get a flat tire, the refrigerator will die, or the roof will leak. And these things will happen all at the most unfortunate times.
But, you know emergencies are coming. You don’t know when. You don’t know how. You don’t know how much. But you do know they are coming, so you can take steps today to prepare for them.
When most people speak of emergency funds they are talking about one big pile of money that is set aside for anything bad that happens. The general rules for this type of emergency fund is 6 to 12 months of your expenses saved up and set aside.
That’s a good start, but I like to think more critically about our emergency funds.
When you pile all of your emergency money together it doesn’t have a specific purpose. It’s there to help you cover income loss through being unemployed, or to help pay for a new furnace. There are a multitude of uses for the cash.
We prefer to have funds built up to cover specific emergencies:
- an income loss emergency fund
- a home repair emergency fund
- a car repair emergency fund
…and so on.
It takes a lot more saving, but the results should help you sleep at night. With these three emergency funds set up you can now handle three serious emergencies all at the same time. You can adjust and add more funds as your home appliances and cars age, or decrease the amounts if you upgrade to newer items.
If you can accomplish the three major tasks above — spending less than you earn, sticking to your budget, and planning for emergencies — you will have made giant strides in giving you and your family a stable life.
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He’s building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, and many others.