Happy New Financial Year

It’s the new financial year. This is often the time when we sit down to make grand plans for the future.

But how do you make them stick, especially when your finances need an overhaul?

We’ve all made financial resolutions. We will spend less and save more, redo the budget and cut up at least one of our credit cards. We will pay our bills on time. We will stop buying lunch and instead make and take our own.

Unfortunately when resolutions are not backed up with a decent plan they tend to fall in a heap. The trick is to approach money resolutions step by step rather than expecting miraculous, overnight changes just because you’ve ushered in a new financial year.

Trying to do too much all at once also sets you up for a fall.

So be realistic, be flexible and give yourself a real shot at gaining financial control over the next 12 months.

Here are four financial resolutions to get your house in order. Each change flows naturally to the next.

1. Manage your debt

The first and most important resolution is learning to manage your debt. In the past decade, Australian household debt levels have risen dramatically. While the credit crunch has forced people to rein in spending and pay down debt, people should aim for low debt levels in good times as well as bad.

Start by separating your debt into good and bad debt. Good debt includes the family home, investments and money borrowed to invest in your education, skills or development.

Bad debt means liabilities that bring nothing (financially) in return. Bad debt includes credit-card and store-card debt, personal and car loans.

It can be very confronting facing your debt for the first time but if you have a lot of bad debt, you need to eliminate that before you can do anything else. Pay off the debt with the highest interest rate or penalties first. Pay the minimum plus something extra - as much as you can afford. In the meantime, you should be paying the minimum monthly amount on the other bad debts.

Once the first debt is paid off, start paying off the debt with the second-highest interest rate. Continue paying the minimum on that plus the whole amount you were paying on the first debt. Over time this will snowball so you are paying off bigger amounts each month and paying the debt much more quickly than at first.

2. Protect your wealth

Resolution number two is to protect your wealth. “What wealth?” people often ask, especially if they are single and yet to accumulate assets. It is important to recognise that your earning ability is an asset, and therefore your ability to work and make an income needs protecting.

Too often, insurances are put in the “I’ll do it later” basket. People rebel at the idea of paying for something they may never need. Of course that may be true, but what happens if you do get sick or have an accident and wind up with no means of financial support? Many people also put off insuring themselves or their income because they think it will add a lot to their weekly expenses. While this can happen, it doesn’t have to be the case.

Take the time to consider the type of insurance you might need. If you’re young and don’t have dependants, maybe life insurance isn’t necessary - but you may get peace of mind knowing you have income protection or trauma cover. This means if you are in an accident and can’t work, you will be covered when the sick pay runs out.

If you are older and have a family and a mortgage you should consider life insurance for you and your partner, as well as income protection.

The costs can add up, so look at ways to reduce the effect on your cash flow.

Some superannuation firms offer life insurance and you can take out extra cover with payments coming out of your super. You may not want to chip away at your nest egg but if cash flow is tight, it makes more sense to do it this way than not at all.

Your super fund may also offer limited income protection, say two years. You can then get extra cover elsewhere with a waiting period of two years, which will reduce the cost.

3. Taking financial control

The third resolution requires you to focus on where you are and where you want to be. It’s called taking financial control.

You need to get a full overview of your finances. That means what you earn, what you spend, where it goes and on what. You can then begin setting up a roadmap for where you want to be.

This can be a scary step. Many people don’t want to know how much they spend on dinners, dresses or little extras like a coffee in the afternoon. They also worry that if they look at where their money is going, they’ll be forced to give up things they want. But this is less about deprivation and more about directing how you spend your money.

Any good budget should have flexibility, but you do need to be realistic. If it’s important to you to have dinner out once a week, then include it in your budget but recognise something else may need to go to pay for the cost. Or make small changes. You can still go out every Friday but aim to spend less.

At this stage it’s also important to create goals. There’s no use in having a budget if the money you save is not going towards a genuine goal. What are your financial goals for the next 12 months, the next five years and long-term? Sit down by yourself or as a family or couple and list as many as you can. When you are done, prioritise and separate the needs from the wants- putting the needs first, of course.

It’s important to write these down. This helps makes your goals concrete, forces you to focus on what is important and helps you to get what you want. How much will it cost? How much do you need to save to get it? Suddenly those pie-in-the-sky dreams are possible and only require reworking your budget to achieve them.

Make sure to keep your budget for the month - and the year- where you can see it. Keep it achievable and make sure you factor in money for debt repayment, emergency situations and your insurances.

4. Building wealth

The final resolution is about building wealth. For most people you can’t make your fortune overnight, but you can get there through diligent saving and sound investment.

Here is a “three-bucket” savings plan:

1. one for short term (12 months to two years);
2. one for medium term (three to 10 years); and
3. one for long-term savings (more than 10 years).

The first two tend to be about funding your lifestyle such as a holiday, a renovation, or school education for the kids. The long-term saving is primarily for retirement.

Then work out your risk profile: whether you are inclined towards higher – or lower- risk investment. There’s no point investing in riskier stocks if it will keep you awake at night. You are better being comfortable and going for longer term, safer shares.

What you plan to do with the money will also determine where you put it while you save, such as a high-interest internet account, a cash-management account, managed funds, direct shares, or maybe property. Always direct some savings into your super, no matter what your age.

Finally, remember to always diversify your savings and investments. Put it all in one spot and you risk losses. Spread it out and you spread the risk.