Does money make the world go round? Or is it the root of all evil? Either way, we can’t live without money, and yet so many people seem to switch off when it comes to taking care of their finances.
The world is changing, what with the information economy, credit crunch, ageing population… Let Personal Money Management show you the financial facts of life.
Having money doesn’t necessarily mean material extravagance. In fact many seriously wealthy folk live modestly. But what money does equate to is freedom.
If you have money you can spend your time how you choose rather than busting a gut just to pay the bills. Wealth allows you to do the work you love, and support the causes you believe in.
Budgeting – Take Control
A significant proportion of households these days owe more in debt than they own in assets. This is a problem rapidly becoming a crisis. But all that is needed to avoid joining this unfortunate group is a little self-discipline and the realization that spending foregone today will yield significantly more spending potential in future on an ongoing basis.
The aim of financial planning is to take you further along a pathway of building assets that will either grow in value, or produce a regular and growing income, or both.
The first steps along this path come from taking control of your day-to-day finances. Produce detailed inventories of both income and outgoings, and do this on a regular basis, no less than monthly, and preferably weekly.
Once you have quantified income and expenditure you can take steps to maximize your available investment capital (and hence your future financial security).
“A penny saved is a penny earned” runs the old saying. And it is very true. If you can reduce expenditure, even if your income remains flat, you have increased your investment capital. Itemize your typical weekly expenditure. Look for ways to reduce the cost.
Perhaps you can walk somewhere you usually drive or use the subway for? Maybe swapping a named brand for the supermarket’s own? Or getting a take-out (or cooking yourself) instead of eating in a restaurant. How about reading the newspaper online? Having less beer or a beer-free day each week?
Carefully review your insurances. Loan protection plans are notorious for being mis-sold. If you have one, make sure that it would actually cover you in the event of losing your job – if you’re a freelance/contract worker, it may not. If you really feel you need such cover be sure to shop around to get teh best deal (provided your lender permits this).
Another “scam” is extended warranty cover on electrical goods. Most such goods are covered by a legal warranty period of a year or so. In most cases if a fault develops it will do so within this timeframe. If it doesn’t the product wil most likely go on working for many years.
If you’re paying extended warranty insurance, consider cancelling it and putting the funds in a high interest savings account instead. You’ll soon have enough to cover the cost of any necessary repairs, and if none arise you can spend the money how you please.
Check also for memberships and subscriptions that you’re not using – and cancel them! It’s easy to sign up for things you think are good, but neglect to cancel them should they prove less useful than imagined.
The best things in life are free; taking a walk, visiting a museum, re-joining the public library, spending more time with family/friends… Your circumstances are personal to you, but I’m sure we could all find some extra savings with only a little sacrifice.
However, don’t go overboard in the pursuit of economy. Without a few pleasures life would be terribly dull. Allow yourself some expenditure on luxuries. This will make your other budgetary measures much more bearable.
Identify Your Goals For Your Money
Every journey starts with knowing where you want to go. Your financial journey is no different. This article will help you identify your and plan the route most likely to achieve them.
Everyone is different. We all have different present circumstances, different goals and priorities, and different attitudes to issues like risk. Just as we are all different to one another, so our circumstances, goals and priorities continue to change throughout our lives.
Financial planning, therefore, isn’t something that we can do once and file away. We need to keep reviewing our financial position and goals on a regular basis.
The first stage of financial planning is to take an inventory of where you are now. What is your income? What are your assets? Your debts? What is your expenditure? Consider also your prospects? How stable is your income?
Does it remain constant, or is it dependent on factors beyond your control? And what about prospects, are you in an occupation where you can reasonably expect your income to increase year on year?
The next step is to identify your goals. These will depend upon your age, circumstances and individual tastes. For example, the young will probably be concerned with purchasing their first home, the early middle-aged with paying their kids college fees, and the late middle-aged with providing sufficient retirement income.
Goals exist within different timeframes. A short-term goal might be to save enough for next year’s vacation. A medium term one may be to pay off your mortgage.
And the longest term one may be building a decent pension fund. Work out how much you have, and need, to fulfil each timeframe’s goals and allocate your available funds accordingly.
In itemizing our goals we most likely come up with a lengthy wish list. It is necessary to prioritize these goals, eg into essentials, desirables, and luxuries. Don’t be afraid to add “blue sky” goals, so long as you recognize them as such. You never know, some day you may pick the winning lottery numbers!
In investing, reward is invariably linked to risk. Our capacity to accept risk is highly individual, and should be a matter for much reflection before making financial decisions. The risk of an investment is the degree to which returns may be expected to fluctuate, or to put it another way, the degree of uncertainty in predicting returns.
Generally risk decreases with the length of time frame under consideration. For example it is quite possible to lose on a stock market investment of one year. But over just about any 20-year period stocks have shown a healthy return. Thus someone saving for next year’s vacation would expect to exercise greater caution than a 20-year old just starting to build a pension fund.
A useful exercise before entering any investment is to visualize yourself and how you would feel in the event of the best, worst and most likely outcomes for the investment. A simple rule of thumb is that if an investment is going to make you lose sleep, don’t do it!
How to Conduct a Financial Review
What is a financial review? A financial review is an attempt to bring your financial arrangements in line with your personal circumstances and objectives, and external conditions.
A financial review consists of the following steps:
- On the basis of your present circumstances and objectives, and prevailing economic conditions, sketch out the optimal configuration of your finances.
- Detail your actual current financial situation.
- Make any necessary changes.
I’d strongly recommend you do 1) before 2) so your current position doesn’t influence the theoretical ideal.
Income vs. Assets
Our financial situation consists of two components – income (the money received per unit time) and assets (the stock of money and other valuables we possess). What follows is primarily concerned with assets, although a similar process can and should be conducted for income and expenditure; ie ascertain your income, work out how it would best be spent, how it is currently being spent, and implement any necessary changes.
How Often?
Conducting a financial review too often can lead to excessive tinkering and/or anxiety. Failing to do so often enough may fuel financial inefficiency. For most people carrying out this procedure once or twice a year is appropriate.
In the current economic difficulties, it’s advisable to keep a closer watch on deposit interest rates. It’s common for institutions to offer high introductory rates, which are soon reduced to derisory levels once sufficient customers have been attracted.
Financial Review Tools
It’s perfectly possible to carry out a financial review with pencil, paper and (maybe) a calculator. However, numerous computer packages can ease the task ranging from a standard spreadsheet, to specialist free and commercial software such GnuCash and Quicken respectively.
Constructing the Optimum Mix
Start by setting aside your “rainy day” money. Ideally this should be between 3-6 months living costs with the exact amount determined by your confidence about the future. This money is to tide you over should disaster strike and should be kept readily available, preferably in an interest-bearing instant access deposit account.
Next consider your insurance and pension provisions. At this stage forget what you actually have and consider only what you need. Insurance comes in many varieties, the most obvious being life, house, car, healthcare.
But you can also insure against losing your job, critical illness, accident, pets… Insurance is essentially a bet on something you hope never happens, but if it does at least your finances will be taken care of.
The amount of pension cover you need depends on i) the income you hope to have in retirement, ii) the time before you retire, and iii) the expected returns on your fund. Obviously iii) is the most difficult to estimate.
The temptation with pension planning is to delay it in favor of more immediate demands, however the golden rule is the sooner you start, the more likely you are to enjoy an agreeable standard of retirement.
Finally, having taken care of the bare essentials, consider the allocation of what remains. These funds can be distributed between cash, bonds, stocks and other asset classes such as real estate (including your home!).
You may arrive at a “tiered” solution, as an example first $10,000 split 50:50 cash: stocks, next $25,000 60:40, and the remainder 80:20 -Â you’d set the the thresholds and proportions to suit you.
There is no unique solution. The right mix for you depends on:
- your financial goals (retirement, buying a house, putting the kids through college…)
- your attitude toward risk
- your age (generally the older you are the more conservative you should be towards risk)
- personal preferences (you may be inclined to investing in a certain stock/sector)
Within broad categories such as stocks and bonds consider more specifically how your funds should be spread. For most people it probably makes sense to keep the bulk of their stock investments in trackers such as ETFs, but you might want to use some money for specific stocks.
For more information see Asset Allocation – Your Most Important Investment Decision
Assessing the Current Situation
In this stage you need to work out your actual financial position. This is the result of various “informed” decisions taken at various times, and “circumstances”, eg unexpected windfalls and expenses.
Check the balance on all your deposit accounts, and the capital value of bond and stock holdings. Note the type and value of all insurances held and the current worth of your pension fund. Make a realistic valuation of your real estate holdings – based on sold (rather than asking) prices.
Make Necessary Changes
Ideally you should now have two figures against each category – the ideal and the actual. Your actual situation and the theoretical ideal are constantly changing. It’s impossible to keep both exactly aligned. The key task is to identify areas of greatest discrepancy and consider making changes to equalize them.
Consider also the timing of any changes, eg you may want to increase your stock holdings but consider the market expensive at this time. In such case, earmark the money you want to increase your holding by, keep it on fast access deposit, and watch and wait until market conditions improve. (NB It may be thatprices don’t quickly improve, such is the nature of markets!)
Before making changes, consider the costs of the proposed change alongside its benefits. Change only where the benefits clearly exceed the costs.
In addition to making changes between broad categories, consider also the use of funds within categories. For example, as mentioned above savings rates are frequently changing, so be sure your cash is earning the highest possible rate.
Conducting regular financial reviews won’t in itself bring great riches. But it will at least ensure your hard earned money is employed in the best way possible given your particular circumstances.
Solving Debt Problems
Causes of Debt
The root cause of debt is living beyond your means. The Dickens character Mr Micawber sums it up nicely in David Copperfield: “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” It’s surely no coincidence that Dickens’ father was imprisoned for debt.
Pre-credit crunch lending institutions were falling over themselves to offer credit to all and sundry with little regard to their ability to repay. Unfortunately the glossy offers of vast spending power soon turned to misery once borrowers realized the difficulties they are in.
If matters go too far bankruptcy is often the only escape, but this can have a devastating effect on the prospects of the bankrupt for years to come as well as pushing interest rates even higher for those borrowers who do make their repayments on time.
The trouble is that the world is so full of slick advertising and smooth-talking salesmen offering us paradise on easy monthly terms it’s all too easy to become trapped in the spider’ web of debt.
Good Debt, Bad Debt
Of course there are “good”, even unavoidable, debts. For example, few of us could afford a home without the benefit of a mortgage. Similarly, few businesses are able to get started and/or expand without loan finance. Such debts are justifiable, but one should carefully question one’s motives before incurring debt for luxuries such as a new car, latest widescreen TV, or a few days holiday in the sun.
Debt Free Living
The golden rule for luxury purchases is to live within your means. If you can’t afford the latest hi-tech wizardry, then go without until you can. After all you’ve managed to get through life thus far without it, so surely you can manage a bit longer.
Living within your means requires careful money management. Be aware of how much you have coming in, and how much you are spending. How often you do this is up to you. Once a week is ideal, any less frequent than once a month could be asking for trouble.
Hopefully you will find that your income exceeds your outgoings, if so, congratulations! Now look for a home for your surplus funds. This will depend on your financial goals and your attitude towards risk. A copious amount of advice is available on this site and elsewhere.
But what if you find your outgoings exceed our income. Once again congratulations! It’s a problem, but at least you’ve discovered it and can take steps to do something about it.
Start by carefully examining the outgoings side of the equation. Are there areas that you could cut back? Some typical examples might be making a sandwich in the mornings instead of buying lunch outside, canceling non-essential subscriptions, making sure that, where there’s choice over things like utilities and telephone service, that you’re getting the best deal.
How about the income side? Do you have an opportunity to make part-time earnings? Perhaps you could turn a hobby into a valuable income source, or maybe there’s an opportunity for overtime in your existing employment.
Debt – Finding the Best Deal
So, you’ve carefully considered the pros and cons, and you’re personal balance sheet, and concluded you can justify taking on a debt. Your task now is to find the best deal. The good thing is that there are numerous lenders falling over themselves to lend you money. Though this can be a minefield for the unwary, this places the savvy borrower in the driving seat.
Always compare the APR (annual percentage rate) in comparing deals. Lenders have all manner of clever ways of calculating rates to make them seem more attractive. APR places everything on a level playing field.