Effective money management establishes long-term wealth through growth, while minimizing the risks of financial loss. Financial responsibility begins with cash and debt management, alongside adequate insurance coverage. Beyond these foundations, your financial plan transitions into putting together an investment portfolio that is in line with your life goals. Be advised that all financial transactions carry distinct risks.
Financial responsibility is primarily concerned with budgeting. Preserving strong cash flow is critical to provide for day-to-day expenses and to build savings. You will do so by living beneath your means—where personal expenses are far less than your income. Beyond paying bills, responsible money management includes contingency—with savings and insurance. Build six months worth of your living expenses in cash reserves to make large purchases and provide financial relief amidst emergency. Additionally, health and life insurance coverage are critical to protect your family’s earnings power—in the event of sickness and premature death.
Debt and Credit
Cash management and insurance strategies are also associated with establishing good credit. Failure to preserve stable cash flow through proper budgeting, alongside the lack of adequate insurance coverage, may force your to rely on credit to make purchases. Large credit balances lead to increased interest expenses and adversely affect your bottom line. Manage debt responsibly by keeping bad debt to a minimum. Bad debt is associated with high-interest credit cards and consumption spending. Conversely, good debt, such as low interest mortgages and student loans, may be leveraged to build wealth. Work to pay all debts on time, because lenders evaluate credit reports to determine whether applicants are responsible consumers, prior to extending credit.
Responsible money management demands that you balance potential risks against rewards when making financial decisions. In general, you should expect higher potential returns for taking on more risks. The Standard and Poor’s Equity Index 500 (S&P 500) is a benchmark for United States stocks that illustrates this risk-return relationship. The S&P 500 Index has averaged eleven percent annual returns, since its 1957 inception. These average returns, however, include 38 percent gains in 1995, alongside 37 percent losses in 2008. Money market deposit accounts do not offer the potential gains associated with stocks, but they are also far less volatile investments.
Responsible money management calls for diversification—in order to profit across various economic scenarios. For example, stocks general perform well amidst times of economic growth, and lose significant value heading into recession. Bonds however, provide stable investment returns and interest payments throughout the economic cycle. Savers should increasingly add bonds to their investment mix as they approach and enter retirement—to reduce financial risk. Young investors in their 20s and 30s, however, are best served with the growth potential that comes with heavy stock market exposure.
All financial decisions are exposed to systematic risks, or financial system collapse. Systematic risks are associated with stock market crashes, job losses, investor panic, and credit crises. During these times, the government may propose tax cuts and bailout packages to guard against further financial damage.