By Leo Babauta

For a few years, I went through tough financial times. I was getting further and further into debt, not paying some of my bills (which then went to collectors) and always behind, even on payday. It took me awhile to step back and realize that this situation was all of my own making, due to my own choices and financial habits, and that it was possible to change.

Today, things have gotten better, although I’m not out of the red yet. I have begun saving, I’ve paid off several small debts and am well on my way to paying off my credit card (which I’ve canceled), and hope to pay off my car by the end of the year. I plan to be debt free in a little over a year, with good prospects after that. I’m also planning for retirement, a little travel, and a simple house. My finances are much better off today than they were just a year and a half ago.

Kiplinger magazine just posted a good article entitled, “Stop Living From Paycheck to Paycheck” and I’d like to share my thoughts on the subject as well. Some of my advice will be similar to Kiplinger, but mine is more practical, I think. I’ve been there, and I am living this advice.

First things first
Kiplingers recommends starting by tracking all of your spending on a daily basis, which is a typical recommendation from financial advisors and blogs, and is good advice. But mine is attempting to be practical — I’ve been there, in the trenches, and I know that keeping track of daily spending can be difficult. I advise you to do it, but if you don’t, for whatever reason, don’t let that stop you from fixing your finances.

My recommendation is that, whether or not you track your spending (and you should), at least do the following:

1. Stop the bleeding. Stop using your credit and debit cards immediately. Cut them up, or put them in the freezer in a ziploc bag filled with water, effectively freezing your cards. Also stop taking other loans, either from banks or finance companies or friends or family. Stop getting into more debt.
2. Start saving now! The next most important step you can take, in the beginning, is to start a small savings account if you haven’t already. Begin depositing into it regularly, at least $100 per paycheck but more if you can. If you can’t find $100 then see the next step for how. Make it an automatic deposit, the first bill you pay each payday, because it is the most important! A savings account will help you smooth out your finances — when an emergency comes up, like your car breaking down or someone having to go to the hospital, you won’t be thrown back into debtedness or brokedness. You will have some cash to pay for that emergency, and you can use your regular paycheck for regular expenses.
3. Look at discretionary spending. If you can’t find $100-200 to save per paycheck, then you need to cut some things from your spending. This is where tracking your spending comes in handy, but even if you don’t, you know some of the extras you spend on — cigarettes, coffee, snacks, candy, desserts, eating out, magazines, shopping for clothes or gadgets or toys or shoes, books, going out … these are just a few of the examples. I’m not saying you need to cut everything out, but if you can cut a few of them, or maybe just one at a time, that can add up. Then, take the money you didn’t spend on those discretionary items, and put that amount into savings each payday. Increase this over time. (See How I Save Money.)
4. Start a debt snowball to begin getting out of debt. If you haven’t read about debt snowballs, they’re simple. List out your debts and arrange them in order from smallest balance at the top to largest at the bottom. Then focus on the debt at the top, putting as much as you can into it, even if it’s just $40-50 extra (more would be better). When that amount is paid off, celebrate! Then take the total amount you were paying (say $70 minimum payment plus the $50 extra for a total of $120) and add that to the minimum payment of the next largest debt. Continue this process, with your extra amount snowballing as you go along, until you pay off all your debts. This could take several years, but it’s a very rewarding process, and very necessary.

Now that you’re out of the ER
Those are the first, emergency steps to take. While you’re doing those steps, start on these:

1. Make a budget. I know, it’s a dreaded word for most of us. But it’s not that hard, and if you set it up right, it’s fairly simple. I recommend using a simple spreadsheet. List all your regular expenses (rent, car, utilities, internet, etc.) and their amounts, and then your variable expenses (groceries, gas, eating out, etc.), and then your irregular expenses (things like car maintenance or medical that might not come up every month, but break them into estimated monthly expenses — if you spend $600 a year on car maintenance, budget a $50 monthly expense). Now match that up against your income. The expenses should be less.
2. Automate your bills. As much as possible, try to get your bills to be paid through automatic deduction. For those that can’t, use your bank’s online check system to make regular automatic payments. This way, all of your regular expenses in your budget are taken care of. Make sure that your savings is done the same way – automatic deduction.
3. Save for your irregular expenses. Some call it a Freedom Account, but the key to ensuring that you have smooth finances and that you stick to your budget is to take into account all your irregular expenses, such as insurance, car maintenance or repairs, gifts (think Christmas!), medical and other such things. List them out, estimate your annual spending, and begin saving for them each month. Again, if you spend $600 on car repairs, budget $50 a month for that expense, and put that amount in savings. You could set up different accounts for each expense in an online bank such as ING or Emigrant, or put it all in one account and use Money or Quicken or a spreadsheet to keep track of each. Then, and here’s the key, when these expenses come up, use that money for those expenses! That way, you can use your regular budget for the stuff it’s meant for, not for these “unexpected” expenses.
4. Use the envelope system for your variable expenses such as food and gas. This is optional, but it’s a good tip. I’ve been using it myself, and it works like a charm. Let’s say you set aside three amounts in your budget each payday — one for gas, one for groceries, one for eating out. Withdraw those amounts on payday, and put them in three separate envelopes. That way, you can easily track how much you have left for each of these expenses, and when you run out of money, you know it immediately. You don’t overspend in these categories. If you regularly run out too fast, you may need to rethink your budget.
5. Start thinking about your goals, and planning for them. When do you want to retire? How often do you want to travel? When do you want to buy that dream house? Do you want to save for your kids’ college education? Think about what you want in life, and start planning to save for them, especially once you’ve done all the above.

Once you’ve gotten beyond these steps, you should be past the paycheck-to-paycheck syndrome. Now there’s a whole world of personal finance options available to you, including investing your money for your goals. But getting past these first stages is important.