Step #1: Plan for the Unexpected Big Bill
The first involves bad debts taken on from a one-time large expense. For example, something that is too large to be paid for with just your monthly paycheck, or by "cutting back" for a few months.
The most common example of this expense is the purchase of a home. Most people are not able to save enough money to purchase their home outright with cash, or pay for their entire home out of a few paychecks. We use a mortgage to pay for the home after-the-fact, and to enjoy the home while paying it off. Another example of the "big bill" is your investment in education. Many people cannot afford to pay for college tuition, so they take out student loans, planning on the fact that future income will enable them to pay for the education after it is complete.
The worst type of one time, unexpected large expense is the expense that is not planned. The emergency, unplanned for bill such as, extreme medical bills, disability, failure of a business, a lawsuit judgment, or long term unemployment. These bills can put a family down for the count, forcing them to either sell their assets, move out of their home, or even declare bankruptcy. Usually, the debt is so big that they will never be able to pay off the debt with just their income.
The best way to combat this danger is to set aside at least 3-6 months of your living expenses in a special savings account called an emergency fund. This fund can be utilized for the emergency, unexpected, and large big bill. This money should be treated as sacred, which means only to be used for a family emergency. The emergency fund will save your family from potential tragedy and help you create a more secure future.
Action Step #1: Open a special savings account to be your emergency fund. Set aside some money each paycheck or month to fund this account. Start with whatever you can afford.
Step #2: Think Out of the Budget Box
Instead of focusing on your budget each month, flip your focus to the cash flow problem - your income.
You know when you have a debt problem. Usually, you stop opening the bills and stop answering the phone for creditors. You may even try to create a budget, reduce your expenses, cancel your cable, and try to stop the financial bleeding.
But most of the time, overspending is not the problem. The true problem is underearning.
You may just not earn enough to afford the life you desire. I'm not talking about living an extravagant lifestyle, but the basic necessities of life including housing, automobile, phone, insurance, groceries, gas, clothing, may add up to too much money each, given your current income. This is an especially common occurrence in expensive places to live, like Silicon Valley for example.
The first step in dealing with this problem is to stop feeling guilty about it. If your problem is income related, you are not a bad person. You do not spend irresponsibly. You are simply someone who needs to acknowledge the problem and create a plan. You need, want, and deserve more income in your life.
Instead of being frozen in guilt, start taking action to create more income. You may not even need to do something radical.
For exampl, put together a proposal for your boss, describing how the company would be better off if you got a raise. Create a new product to generate income for your business. Search your basement for items you can auction on eBay. Teach a local class on scrapbooking or changing the oil in your car. Have a garage sale to generate some quick cash and reduce the clutter in your home.
Whatever you do, the important idea is to start right now, today.
Action Step #2: Brainstorm 5 ways you can earn more income now, such as asking for a raise, looking for a new job, starting a small business, selling a new product, auctioning old items on eBay, renting out an extra room, teaching a skill, or having a garage sale.
Step #3: Plan for Big Purchases
This step is all about planning for the bad debts that sneak up on us in life. You may be able to pay for your bills and regular expenses each month without issue, but what happens if the car breaks down? How do you handle the property tax bill when it arrives? Christmas? Baby shower? Wedding? The family or high school reunion? The big family vacation you all deserve this year?
Are you able to pay for those non-monthly expenses out of your paycheck? Or, do those items always go on a credit card each year?
Automobile repair, gifts, taxes, and travel expenses are all examples of expenses that are non-monthly, but should be completely expected. We know they are coming each year without fail, but may not necessarily know when, or how much it will cost. These expenses should never be going on a credit card - you should save for them ahead of time so you have the money set aside.
Go through your all your bills, receipts, and credit cards for the last year, and figure out how much you spent on each of these items on average. If you don't have those records, make a realistic estimate. Divide that annual amount by 12. That's how much you should set aside each month for your irregular expenses.
Action Step #3: Open a separate savings account for your irregular expenses. Contribute money each month into that savings account, so when the bills are due, you already have the money for them.
Step #4: Plug The Bad Debt Hole
Step four is all about how to prevent your family from going back into debt by planning for your expenses ahead of time. In this step, we talk about the most common problem, and the most difficult to conquer - overspending.
Do you know where your money goes each month? How much are all of your bills? How much are you spending on Eating Out? Gas? Target & Costco? Clothes? Personal care (i.e., massage, pedicures)? Recreation expenses - movies, golf, Netflix? Toys (both for the kids, and for yourself)? Do you know?
Do you spend your money in accordance to your values and priorities?
Commonly, we see this in clothes, toys for kids, recreation, high-tech gadgets, and dining out. It is easy for relatively small expenditures, made eevery day or week, to add up to hundreds, if not thousands, of dollars each month. Spending without thinking about it will derail you from ever being able to achieve your most important life goals.
Instead of being aloof, do something about it. Look over your spending habits for the last few months, and pick the most obvious problem area. Do you buy DVDs? Shop online all the time? Get a new pair of shoes? Start in just one category, and create good habits and rules for yourself in that area. Then, carry those personal rules over to the rest of your expenses one by one each month.
Action Step #4: Create a cash account for your most problem category. Withdraw your budgeted monthly amount from your account in cash on the first day of the month, and place the cash in an envelope. When the envelope is empty, you're money is done for the month!