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Eye on the 'Fiscal Cliff' Part I: Four Ways to Prevent Going Over Your Own Cliff


[Editor’s note: The following is a cross post by David Bakke, a contributing writer for Money Crashers Personal Finance, a website dedicated to helping readers improve their "financial fitness" by getting out of debt and building long-term wealth]:

The looming economic crisis, aka the fiscal cliff, has been years in the making. To stop runaway government spending, Congress got serious in 2011 and enacted the Budget Control Act. Not unlike a ticking time bomb, it was enacted to ensure that the country would make necessary changes to get itself financially on-track by the end of this year. However, sufficient changes haven't yet been made, and the country is about to suffer serious consequences. Higher taxes, more unemployment, and another recession are all likely unless we act fast.

In addition to shoring up your finances for a potential economic disaster, take the opportunity to see if you're headed toward your own fiscal cliff. Have you spent years accumulating debt? Do you have a hard time making sacrifices today to prepare for tomorrow?

If so, it's time to act fast to keep yourself from going over the edge.

Organize Your Finances

The first step to see where you're at and where you're headed financially is to become organized. If you don't have a good filing system for bills, receipts, bank statements, and income statements, get one in place. To be more streamlined, sign up for e-billing and electronic statements, and file these on your hard drive. Scan paper statements and shred hard copies to reduce clutter and prevent identity theft, and make sure your computer is password-protected. To keep yourself on track, schedule one or two days per month to pay bills and update your filing system.

Establish a Budget

Once you're organized, the next step is to create a personal budget. If you don't know where your money is going or how much you're spending, finding ways to cut back can be extremely difficult. Use your monthly statements to itemize and categorize your monthly expenses. If you regularly withdraw and spend cash, start saving your receipts and make it a habit to record them in a spreadsheet on a weekly basis.

Itemizing expenses by category shows you where you spend the most money and helps you to identify hidden areas of expense. You should classify each individual expense as a "want" or a "need." Then, review your wants and challenge yourself to eliminate as many as possible. Once you've established a target amount to spend in each category, hold yourself accountable with a budgeting app (such as Mint), or implement an envelope budgeting system. Also, use your budget to identify better uses for your funds, such as paying down debt, adding to your retirement fund, and growing your emergency fund.

Prioritize Retirement

The majority of Americans are vastly under-saved for retirement, which presents an interesting parallel to the country's fiscal cliff scenario: Thinking too much about the short-term and not enough about the long-term is what led the Federal Government to its current impasse. If you aren't yet facing retirement, you still have the opportunity to avoid a similar perilous fate. Therefore, you must prioritize your budget. What are you able to give up today in order to secure a better tomorrow? How can you reduce expenses or services that you don't really need?

For example, lowering a bill by $10 per month may not seem like much, but it adds up over the course of a year - especially if you can find 5 or 10 additional ways to save another $10 per month. Contribute these savings to your 401k plan, especially if your employer matches your contributions. Or, if you qualify, save your money in a Roth IRA, which does not penalize you for withdrawing contributions before you turn 59 1/2 years old.

Prepare for Emergencies

In addition to saving for retirement, saving for emergencies is crucial. Emergency funds should be stored in a regular savings account, money market, or even in a laddered CD - but however you save this money, you need the funds to be easily accessible. The idea behind an emergency fund is not only to avoid racking up high-interest credit card debt in the event of an emergency, but to protect yourself in case you lose your stream of income. At the minimum, you should have at least six months' worth of living expenses in your fund. However, if your income fluctuates, or if you live in a one-earner household, you should likely save even more.

Final Thoughts: Many people are facing their own fiscal cliffs, as they too have been affected by the predominant American ideology: Live for today. This may be a good sentiment, but in order to live well every day, it's necessary to exercise restraint and save for tomorrow.

The world has changed and will continue to change. Relied-upon standards such as Social Security (already a shadow of its former self) and Medicare will not be remotely adequate to secure your retirement, and debt isn't so easy to escape anymore. If you haven't already, it's time to get serious about your finances to survive any economic downturn.

What are you doing to prevent going over a personal fiscal cliff?


Click here for Part II of our “Eye on the Fiscal Cliff” series

©2012 Money Crashers, David Bakke. All photos courtesy Getty Images.

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