Chapter 1
Your Financial Snapshot
In This Chapter
Taking stock of your net worth
Evaluating your spending habits
Recognizing your money personality
Whether you’re in Montreal, Medicine Hat, or Mozambique, just about every map you come across will likely have a “You Are Here” arrow. Why? Because you can’t get to where you want to be if you don’t know where you are. Your financial snapshot is a tool to help you map out and reach your financial goals, and it’s useless unless you know where you are now and where you want to go. Determine your current financial situation by taking a thorough survey of your financial status. This chapter shows you how.
This chapter also helps you understand why considering your financial future is important. In both Canada and the United States, survey after survey shows the importance of getting a financial snapshot of your current situation as a starting point to mapping out and achieving your financial goals.
The growing focus on financial planning for Canadians is mainly because more people are realizing that those who plan well tend to accumulate less personal debt and save more than those who fail to plan their financial futures.
Recent surveys have also found that more Canadians are adjusting their financial plans than in earlier periods. Revisiting your financial plan is another key theme of this book. When your personal circumstances and goals change, your financial plans need to change accordingly to be effective.
The work we encourage you to do in this part of the book is just that — work. It involves calculators, research, phone calls, and coffee. But the end result will help you reach your personal goals by arming you with more financial resources and freedom. With finances firmly under control, you’re much better poised to meet your retirement objectives — complete access to health care, lots of travel, and time for leisure! Failing to map out your financial condition can lead to scenarios best left to your imagination.
Figuring Out What You’re Worth
When it comes to placing value in what you have, worth is much more than how much cash you have been able to stash away, whether in the form of salary, savings, chequing accounts, and so on. Determining your worth is an exercise that can include any number of decisions about any number of things that have value. Did you inherit a really ugly but valuable (to someone else!) vase from Uncle Ted? Save your memories, sell the vase, and factor the proceeds into your worth assessment.
Knowing your financial worth at any given point in time tells you where you stand relative to your goals. This information provides you with a reality check that may cause you to more fully turn on your income tap, and put a bigger plug in your expenses drain. If you have a large enough sink, you’ll have saved a lot of cash for your future goals.
This section discusses some of the most common financial elements to include when figuring out what you’re worth. Table 1-1 later in this section gives you a chance to do a quick calculation of your own net worth.
Determining your income
How much money do you take home after federal, provincial, and municipal taxes? The answer to that question depends on how you earn income.
The usual suspect: Your paycheque
How much is deducted from your paycheque for pension, income taxes, employment insurance, and health benefits? That net pay figure doesn’t reflect your worth; rather, it gives you an idea of the money you have coming in on a regular basis. From that pool of steady income, you can build on those items of value that reflect your worth, whether they’re material items such as a home or jewellery or investment items such as stocks or insurance policies.
Business income and the taxman
You can generate income from other sources as well. If you’re a full-time entrepreneur or if you operate a part-time moonlighting business, you know your business exists to try to make money. Even when it doesn’t succeed at first in generating positive cash flow, you can still get a bit of income from your business — with a little help from the taxman.
You can deduct reasonable business expenses for tax purposes. If those expenses happen to exceed your business income, voilà, you may generate some cash flow in the form of a tax refund. In fact, the Canada Revenue Agency (CRA) now has to go a bit easier on you in this regard, thanks to two landmark cases resolved by the Supreme Court of Canada.
The court ruled that the CRA should not look for a “reasonable expectation of profit (REOP),” but instead should look at whether your business activity is “undertaken in pursuit of profit.” In other words, the CRA has to consider whether you had an “intention to profit” from your business that is operated in a “sufficiently commercial manner.” This is an easier set of tests to pass than the old REOP test. The new intention-based rules give you more of a fighting chance to deduct business expenses and even to get a tax refund for your efforts. Here, the taxman may be able to pay you!
Income from property
Thousands of Canadians own real estate properties that they rent out for income. Even more Canadians own investment property such as stocks, mutual funds, and income trusts that generate dividend and distribution income. When determining your income for the purpose of helping you calculate your net worth, don’t forget to factor in the positive impact of income you get from your rental property, vacation property, or investments. Some of the most successful wealth-builders in Canada have used a multiple stream of income strategy to achieve financial independence. The majority of Canadian millionaires have an array of salary, rental, investment, and capital-gain income streams. Diversify your income if you can.
Unexpected windfalls
Don’t forget to include temporary, part-time, or seasonal income, which you may want to treat as “found money,” putting it directly into your savings or investment plan. With the benefits of a compound return, such investments may mean much to your future. You can read a detailed discussion of compounding (a return that is paid on a return already earned) in Chapter 1 of Book IV so you truly understand the benefits of forgoing small pleasures now for giant rewards.
Tracking your savings
How much money do you have in a bank, trust, or credit union savings account(s)? Do you have a money market account? Guaranteed investment certificates (GICs)? For the purposes of figuring out your financial worth, your savings list includes liquid assets, or assets you can readily turn into cash.
If you find you have too many accounts in too many places, try consolidating them into fewer accounts. By consolidating, you can save fees, make tracking your assets easier, and make more money with accounts that pay higher interest.
Factoring in other assets
Other assets refer to those items — material or otherwise — that are less liquid than the ready-cash-at-hand savings accounts you have. By evaluating these assets carefully, you may find you can make them serve your purposes better by liquidating them (converting them into cash) and transferring their value to a more liquid asset.
While far from conclusive, your other assets may include stocks; bonds; mutual funds; retirement funds; insurance; real estate; and other investments, such as vehicles (land, water, or air!), jewellery, cash value of insurance policies, and collectibles (such as stamps or antiques).
Table 1-1 Your Assets
Now that you have listed your total assets (all the pluses), to get your net worth you must subtract your total liabilities (all the minuses). Liabilities are your loans, credit card balances, mortgages, lines of credit, and anything else you can think of: gambling markers, hockey pool IOUs, or bar tabs.
Figuring Out What You Spend
In your financial life, you may spend (or pay bills) until you have no more money. Then you wait for your next paycheque and start the process all over again. That approach may have worked (although not all that well) back in the days when you were collecting an allowance from Mom and Dad. It may have worked even in university — at least you wouldn’t freeze. As time goes on, though, this “system” becomes less and less sound.
This section helps you figure out where you are currently spending your money so you can lay the groundwork for wiser, more informed decisions about your spending.
Keeping a spending diary
Keeping a spending diary helps you determine how you’re spending your money on a day-to-day basis. For your diary, use a small notebook that fits in your pocket or purse. Carry it everywhere. Attach a pen or pencil to it so you have no excuse for not writing down every purchase you make. Every day. Every cent. Keep your spending diary for at least a month. Take a month off and start again, doing a month in each season. Good luck!
On each new page, write the day and date. Record all your purchases, whether you spent cash, used a credit card, or added to a tab. At the end of each day, total your expenses. (To make this exercise even more useful and meaningful, divide your weekly after-tax income by seven, write that amount on each day’s page, and at the end of the day figure out whether you spent more than you made that day.)
Try one of these three ways to keep your diary:
Basic: Create just two columns — one for the amount and one for a description.
Detailed: Decide how many categories you want, and then draw and label your columns (you’ll probably want to use two facing pages). Categories may include groceries, restaurant meals, snacks, transportation, clothing, and telephone calls.
Obsessive: Draw fewer columns for wider categories, such as food, transportation, utilities, clothes, and miscellaneous. Write a key in the front or back of your notebook so you can keep track of the items within each category. For example, under food you could use G for groceries, R for restaurant meals, S for snacks, and so on, as shown in Table 1-2.
You, of course, will want to create your own key based on your lifestyle. In Table 1-2, for example, B may stand for bus fare, F for fuel, N for newspapers, and C for a very expensive cup of specialty coffee (or clothing, if you’re into that).
If your miscellaneous column adds up too fast, you probably need more categories. And if you find you’re altering your spending habits as you keep your diary, don’t write your totals until the end of the month.
Table 1-2 Sample Daily Spending Diary
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Food
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Transportation
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Miscellaneous
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R $10.50
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B $5.25
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N $2.75
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S $2.50
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F $39.48
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C $39.00
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G $33.88
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Using other tools to track your spending
Your bank and credit card statements can help you keep a handle on your spending. Rather than just checking to make sure the amounts are correct, use these records to find out how much money you spend in each category you use in your spending diary.
Using the information you’ve gathered, you can use pencil and paper to create a financial worksheet. Or, because financial software has become so inexpensive, portable, and easy to use, if you have a computer or handheld device like a BlackBerry or Treo, you may choose that way to keep track of your spending and saving habits.
The time you invest now to gather your information and understand your financial fingerprint pays off in easier tracking and decision making later. You’ve already made the decisions about your money; now you just have to apply them.
Reviewing your bank records
Every month, your bank, credit union, or other financial institution sends you a list of how much you put into your accounts and how much you spent out of them. Bank records are a good place to put your expenditures in categories using different-coloured highlighters: try green for savings and red for impulse purchases.
Your banking can be remarkably slick if you have Internet access and use online banking. All Canadian banks have systems where you can see current and even past records online. You can find out whether a specific cheque has cleared. You can check your current balance. You can check your records when it’s convenient for you rather than waiting for the post office to deliver your statement. In addition, you can make your financial tracking life easier by using your computer to set up automatic payments for such expenses as
Mortgage
Utilities
Telephone
Credit cards
Savings
Investments
The easier you make it to keep track of your finances, the more likely you are to do it.
Monitoring your credit card statements
Those handy reports — or devastating reminders of how much you’ve spent and how much you owe, depending on your perspective — you get every month recording your credit card activity also help you draw your financial map. Signing on the dotted line to make a purchase is so easy many people do so much more often than they should. Again, using highlighters, mark each purchase to be tallied in a specific category.
Using financial management software
Computers can do many things for you. Luckily, keeping track of your money is one of them! Programs such as Quicken and Microsoft Money are inexpensive yet flexible. These programs do the basics, such as keeping track of your cheque record and balancing your chequebook. But that’s just the beginning.
Like the paper worksheet in Table 1-3 later in this chapter, financial management software creates a budget for you according to your specifications. Even better than automatically calculating totals as you enter amounts, the software enables you to move items from category to category. (For example, you may want to move restaurant meals from a Food category to a Personal category — your choice.) This software enables you to be as specific or as imprecise as you want. You can create categories down to the nth degree, monitoring not only how much you spend in groceries but also how much of that you spend for meat, cereal, cookies, and ice cream — or whatever your idea of the four basic food groups may be.
Flexibility allows you to reorganize your budget so it gives you the information you want. When you’ve set up a budget, you aren’t stuck with it. And as your situation changes, you can customize your budget to reflect your new reality.
With your software package you can compare your forecast spending with your actual spending in any category, know when expenses are due with the use of a financial calendar, monitor your loan payments, manage your investments, and create reports and graphs to show how you’re progressing toward your goals.
Don’t put off budgeting because you don’t have a computer. Software is nice, but not necessary. On the other hand, don’t avoid using a computer or handheld device for budgeting simply because you’re intimidated by them. You likely have a friend or family member who is comfortable with computers. (And any number of For Dummies books can help you through most computer or handheld device issues you may have.)
Evaluating where your money goes
With your spending diary in hand, you have the information you need to set up your budget. Knowing where money goes can help you keep it from going!
Table 1-3 is a budgeting worksheet that shows you what your spending history looks like. Using the last six months of bank and credit card records, figure your expenses in each category. For items that fluctuate, such as food, add up your six-month total (SMT). Then double that amount to get your yearly cost. Divide your SMT by 2 for your quarterly cost for that item. Divide your SMT by 6 to determine your monthly cost. Divide your SMT by 26 to calculate your weekly cost. Prepare to be shocked at how much you’re spending in some categories.
Table 1-3 Budgeting Worksheet
With Table 1-3, you can know how much you’re spending in each category. After you create a budget based on what you want to spend in each category and adjust your spending habits accordingly, you’ll be able to tell when you overspend or underspend in a category. Neither situation is cause for despair or jubilation as long as your long-term expenditures stay within your personal range. If you consistently overspend, you may need to cut costs, or you may have underestimated your costs initially. On the other hand, if you consistently underspend your allowance in any category, you may be able to lower that budget item and reallocate the difference.
Identifying Your Money Personality
The best-laid plans are worthless if you can’t follow them. To find the best plans for you, and to help you stick to your budget, you need to understand how you feel about money and how you react to money matters. This section describes a few of the most common money personality types.
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You need to understand not only your own money personality, but that of your spouse or partner as well. (As you teach your children about budgeting and saving, you’ll need to identify their money personalities, too.) When you recognize your money personality type, you can identify what habits you need to keep or change to reach your financial goals.
Saving for a rainy day
If your money personality is closest to a saver, you have trouble spending money even when doing so is in your best interests.
You may think that a saver wouldn’t have any changes to make. But you can actually save to the point of hurting yourself. When going out of your way to save a few dollars or cents creates extra effort or inconvenience for you (or for your family or friends), you’ve likely “spent” where you could have “saved.” For example, if you hire a cube van to move a few heavy items, and rush to return it before a deadline so you can save a few dollars or get back a deposit, you may cause yourself and those who are helping you to have a few aches and pains (literal and figurative).
Spending like there’s no tomorrow
If you’re a spender, your immediate reaction to available cash (or even available credit) is to figure out what you can buy with it. Sometimes you spend because you can’t resist salespeople. Spenders use credit if they don’t have cash, with no concern for the long-term consequences of that debt.
A spender has more problems to overcome than the obvious. The attitude that any money available is available only to spend, rather than to put in savings, is its own problem. But it’s not unbeatable. If you learn to stop, evaluate, consider alternatives, and make a decision instead of reacting to the desire to spend (or giving in to a sales pitch), you’ll have a more secure financial future. Millions of aging North Americans are only now realizing their savings are inadequate relative to their future goals. The good news is that many of these people have also begun to quickly shift gears to spend less, save more, and retire well!
Spending on a whim
If you’re an impulse buyer, your spending habits are a little different from plain old spenders. When you see something you like, you buy it without evaluating the purchase in terms of your long-range goals. Impulse buyers react to one or two types of items (whereas spenders buy everything!).
An impulse buyer is similar to a spender. But an impulse buyer doesn’t even have to “find” money available for spending. Just seeing something to buy is enough to bring out the wallet or credit card. The desirable habit to cultivate is the same as that for a spender. If you figure how many hours of after-tax income would be needed to buy an item, you can stop much of your impulse buying in its tracks. If you have a working sound system, for example, is it really worth hundreds of work hours to replace it with a new one?
Taking your time on a purchase
The last category is the cautious buyer. If this is your money personality, you are a serious comparison shopper who may waste more time making a decision than the item is worth.
Cautious buyers may waste both time and money. But time is money. Not only may a cautious buyer spend too much time gathering information about various features and comparing prices, but there’s also the cost of phone calls and driving around. Even worse, a cautious buyer may not enjoy a purchase after making it if he or she sees the item on sale later. If you’re a cautious buyer, use those good comparison-buying skills, but learn when enough information is enough to make a decision, and ignore any information you gather after the purchase.
If you have a lot of trouble making a buying decision, you may not need to buy that item at all.
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Stay alert when you spot this icon: The information it showcases is offered to help you avoid particularly damaging money management decisions.
Don’t worry if you’re not too alert around this icon. The information you’ll find next to it is sure to be interesting or even entertaining, but it’s not likely to be essential or critical to your money management plans.