Editor's note: This article ran originally on Five Cent Nickel. It has been reprinted here with permission.
Sustainability has become a key concept in environmental and resource-management circles. It’s also a good goal for your personal financial practices.
I’m sure it once seemed as if the world contained an endless reservoir of oil; but by the end of the 20th century it was clear that when people draw on a resource faster than it can be replenished, eventually shortages will occur. Similarly, there are some common financial practices that may seem harmless from week to week, but which will back you into a troublesome corner over the long haul.
The test, then, for your personal finances is whether or not your habits are sustainable — if you project those habits out into the future, do they result in your building wealth or facing bankruptcy? The following are several ways in which you should consider the sustainability of your personal finances:
- Is your debt level rising or falling? Controlling debt isn’t simply a matter of meeting minimum monthly payments or not having maxed out your credit limits. If your debt is rising month to month, it is only a matter of time before it becomes unaffordable and/or no one will extend you any more credit. There are times when it is necessary to take on debt; but for the most part, a fundamental goal of personal financial management should be to pay off any debt that isn’t backed by an asset of equal or greater value.
- What will happen to your monthly payments if interest rates increase? A common complaint of people with credit problems is that their credit card rates increased, making their debts unaffordable. Although the Credit Card Act limited the ability of credit card companies to raise rates on existing debts, if you depend on credit to make ends meet, an increase in rates will squeeze your budget by making subsequent purchases more expensive. Remember, the deeper in debt you get, the more likely it is that credit card companies will increase your rates.
- Have you stabilized your housing costs? Credit card rates aren’t the only form of interest that can rise. From 2007 to 2012, mortgage rates dropped by more than 3 percent before starting to rise again in 2013. They could be headed back to where they were; so if you haven’t locked into a fixed-rate mortgage by now, you should do it soon. Also, if you face a balloon mortgage payment, do you have a realistic plan for meeting it? Finally, renters should realize that they also face the risk of fast-rising housing costs, which should be a factor in any rent-vs.-own decision.
- What kind of shape is your car in? Cars are not only expensive, but for many people they are indispensable. If yours is somewhat the worse for wear and tear, you had better start planning on how you will afford a replacement.
- How secure is your job? The economy in recent years hasn’t just been generally weak, it has been especially disruptive in wiping out large parts of the workforce in many industries which once paid well. Never take your job for granted — always keep tabs on what is happening in your industry, and make sure you keep your skills marketable.
- How close to the edge is your budget? Between spreadsheets and budgeting tools, people can plan their budgets with a great degree of precision, which has the unfortunate effect of leading them to believe it’s an exact science. It isn’t. A variety of unexpected setbacks can await, so a good budget isn’t one that is planned down to the last cent. A good budget is one that leaves plenty of cushion for the unexpected.
- What will happen to your income when you retire? Retirement isn’t some sort of finish line for personal financial planning. In fact, it is the phase when sustainability becomes most important because your future earning ability is limited. Retirement planning should include figuring out what kind of income you’ll need to meet inflation-adjusted expenses and how long you can expect to sustain that income.
- Are you burning up your assets? One common risk in retirement also sometimes occurs at other times in people’s lives: the risk of burning through their assets to meet short-term expenses. If you are relying on past savings or any sort of windfall to meet regular expenses, you need to figure out how long you can continue at your current burn rate. This can be subtle; for example, people who take a home-equity loan to make ends meet have just diminished an asset to meet expenses that very well may outlast that asset.
As with energy and environmental policies, sustainability in financial habits can be tough to attain after years of damaging practices. However, the starting point is to put yourself on a course leading to sustainability, because if you are not heading in that direction, you are heading for trouble.
Richard Barrington is a personal finance expert for MoneyRates.com. He has earned the CFA designation and is a 20-year veteran of the financial industry.
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