What does it mean to be financially responsible? It's a complex question with a complex answer, but at its core is a simple truth: to be financially responsible, you need to live within your means. And to live within your means, you must spend less than you make!
Credit Cards and Debt
Sorry – if you're really looking to be financially responsible, just being able to make your credit card payment doesn't cut it. In fact, the fact that you have a credit card payment at all and aren't able to pay your balance in full shows that you already spend more than you earn. Responsible use of a credit means paying the balance on your account in full each month.
And (this part will hurt) credit cards should be used for convenience, not to make ends meet. Credit cards are handy because they eliminate the need to carry cash – you can even generate reward points. And credit cards can be very helpful in an emergency. That said, if an emergency does force you to carry a balance on your card, living in a financially responsible manner means curbing your spending until that balance is paid off.
The same logic applies to all recurring payments that involve paying interest. Think about: paying interest on anything means that you are spending more for that item than the purchase price. Does that sound like the most responsible choice, or just the most convenient? When the interest payments are factored in to the purchase price, you are spending more to obtain the item than even the item's manufacturer thought it was worth. As such, avoiding paying interest on anything should be a major objective. Of course, when it comes to the cost of housing and transportation, avoiding interest is almost impossible for most of us. In such situations, minimizing the amount you spend in interest each month is the most responsible action.
Acting in Your Own Best Interest
For many people, cutting down on interest and borrowing is easier said than done, but in practice, it really comes down to knowing the difference between necessities and luxuries. For example, you might need a car, but you don't need a luxury sedan and, unless you can afford to pay for it in cash, you shouldn't be driving one. Likewise, you might need a place to live, but you don't need a mansion. And, although most of us must have a mortgage in order to afford a home, purchasing a home in a financially responsible manner means that you should purchase one that won't break the bank. In financial terms, this means it shouldn't cost more than two or 2.5- times your yearly income. Another healthy estimate is that your monthly mortgage payment should not cost more than 30% of your monthly take-home pay.
In addition to avoiding overspending on your home purchase, you should make a down payment that is large enough to eliminate the requirement of having to pay for private mortgage insurance (PMI). If you can't afford to meet these purchasing guidelines, rent until you can afford to buy.
Paying Yourself First
Spending every dime that you earn is simply irresponsible unless you have a massive trust fund that is so flush with cash that you will never outlive the earnings. For most people, especially those of us hoping to retire someday, saving is an activity that must be taken seriously. A great way to do this is when you get your paycheck – and before you pay your bills – pay yourself first. A good goal to save is 10%.
When it comes to saving, investing in the stock market might be the most profitable choice available. Sure, investing involves risk, but taking calculated risks is sometimes a necessity. The responsible way to go about it is to have a plan.
Start by examining asset allocation strategies to learn how to choose the right mix of securities for your investing strategy. From there, contribute to your employer-sponsored savings plan if such a plan is available. Most plans offer to match your contributions up to a certain percentage, so by contributing at least enough to get the match, you earn a guaranteed return on your investment. If your finances permit, maximize your tax-deferred savings opportunities by contributing the full amount that the plan allows. After you've started investing, monitor the progress that you are making toward your goals and rebalance you portfolio as necessary to remain on track.
Financial responsibility means being prepared for the unexpected. Most experts agree that you need to be able to support yourself financially for at least six months without an income. If you are married and used to living on dual incomes, this means being able to pay the necessary bills such as the mortgage, food and utilities on one income – or even neither income! If a missed paycheck would ruin you financially, it's time to create a financial escape hatch to prevent this.
Don't Worry About the Neighbors
Financial responsibly means doing what you have to do to take care of your needs and the needs of your family. To make this happen, your focus should be internal. The neighbors aren't paying your bills, so their spending habits shouldn't dictate yours or set the bar for your standard of living.
Having a budget is one of the core pillars of financial responsibility. You should know where your money is going. Business owners know the importance of understanding their cash flows and balance sheets; as a result, no successful business exists without a budget. Neither should you.
A Very Personal Definition
Does being financially responsible mean that you have to scrimp and save? Maybe, but only if that is what it takes to live within your means. On the other hand, if you are the Sultan of Brunei, you may easily be able to afford a jet, a mega-yacht, a mansion in the South of France and a few palaces. Although those of us with lesser means might frown on this extravagance, it shouldn't be confused with a lack of financial responsibility. After all, there's nothing irresponsible about buying things you can afford to pay for.
Arriving at "Responsible"
Ultimately, financial responsibility means living within your means, regardless of the level of those means. So take a close look at your financial situation, evaluate you earning and spending habits, and make the necessary adjustments to put yourself on responsible financial footing.