I am sure I am not the only one who, when looking at all the bank accounts and assets finds himself not being where they really want to be.
So, the only plan I have made to 2011 is to get where I want to be (and a few smaller things on the side as well, but this is the biggie).
In order to get there a plan was needed and here I am giving you an insight on how I plan on accomplishing this, maybe it will be useful to you as well.
1. Understand the Problem
Everything starts with an analysis. In this case you want to know where it is you actually spend the money.
For this I kept a log for a month, writing out any expenses that I have, so that included Rent (or Mortgage), Internet etc. all the fix costs are added up, then looked at. I found little I could cut, mainly because I already stripped my budget a few months ago.
I then looked at all the other expenses I had, that included food etc. But I was more interested in variable spending, that is, stuff I spent money on that wasn’t really all that useful. Seeing how much, for example, I had spent every month on eating out was a bit of an eye opener (though this is something I had already done earlier in the year as well and pared back accordingly).
Lastly, I set up a spreadsheet. In this spreadsheet I listed every single debt that I had. I brought out the whole amount, how much I paid off that month, and most importantly, how much I paid that month on interest.
So, any CC, Mortgage, LOC etc. that you have goes into this spreadsheet.
It tallies up the totals, how much outstanding debt (too much), how much I pay in interest every month (way too much) and then I added up how much I had paid off this month (not enough).
The reason for this is to show just how expensive debt is. I realized that over the last few months that only half of my payments went to serve the outstanding debt, the rest was interest payments. This number will go down as time progresses (and this part of the idea of keeping the spreadsheet) but for now it is a reminder just how stupid one can be by taking out a loan.
Also: Add up the amount of interest you pay and just imagine what you could be doing with all that money. Once the debt is gone, you will be able to use that money (interest alone!) to do nice things.
Motivated yet?
2. Make a Budget
Now that we have all of this sorted out and know how bad (or not so bad) we are off it’s time to make a budget and a plan.
The budget is rather easy, you take your fixed expenses, those you will not be able to par down much I would presume, though if you can, cut it down. Do you really still need Cable TV? I didn’t so it went out the window.
Make a budget for food, and also important, give yourself an entertainment budget. If you par it all down the odds are you will still be spending and then just be mad at yourself, plus, if you give yourself a budget and come in under you’re better of.
So my budget for entertainment beginning January is going to be $100 a mont. This does not include food, but it does include eating out.
Pay Cash
This is a biggie, and I am not the only one who had this idea: Stop paying with your Bank card or Credit Card. Why? Because it makes money less real. It’s just a number. Although you may see on your spreadsheet what you have just spent money, the reality is that it won’t sink in until later.
As such: give yourself a weekly money budget to spend, then carry this around as cash. Leave your CC and Bank Card at home and only take it with you when you know you need it (e.g. if you have to pay for a large item). Other than that, keep them in a drawer, the less temptation, the better.
Make a shopping list
If you sit down at home first, then write a list out of the things that you need you’re less likely to stray from it, this is also a cost control measure as you’re less likely to give in to impulse buys.
Make a payback plan
This is another biggie. I get paid once a month. The temptation is there to just make your debt payments right then and there. But, psychology, if you pay back more than once a month (say, every two weeks), you get a “benefit” out of it. you will see how your outstanding balance goes down twice and this is a very rewarding feeling.
I did put the spreadsheets etc. in place as of December, so I already had a “test run” and I can tell you to make the payment and then updating the spreadsheet is deeply satisfying. Pay back early, pay back often, see how you’re doing better.
Be Tax Smart
Oh, I am guilty of this. I never really bothered with writing stuff off. I spent the last month looking at all the things I could have written off but never did. Obviously you don’t want to do that yourself, you want to find yourself an accountant that can do the tax return for you. But in order to make this fast and less painful make sure you sort your invoices etc. I admit, I was very very bad at this too. I spent the last two months going through my “filing box” and shredded and filed a lot of paper. It was annoying and boring, there is a reason why I am not a bookkeeper or accountant, but if you want to take control of your finances you need to know where you are.
See the money you’re getting back from your tax return as a good way to pay back your debt even faster.
A good example of this is the MSP here in BC. I pay this myself and it is $57/month, which means I pay $684/year on the MSP. Rule of thumb is you get around 30% back on your tax return, so $205 just on that. Nice.
Likewise other things can be written off, get an accountant, talk with her or him and see what else you can write off.
This also means to try and max out any (income) tax shelter you may have, that is for example the RRSP here in Canada that you could and should max out if you can.
Savings
I admit it, I have a very very serious plan to be debt free, as such I have delayed / ignored any logic that would dictate to put money away. As I am single the risk is pretty slim but if you have family it may be a good idea to not be as aggressive on the payback as I am. For example, take your tax return and put it in a savings account, a Tax Free Savings account is a good idea (I will write about this a bit more in the next few days, but for now see it as this: As you already paid income tax on it, any profit you make in that account is yours to keep. While taking money out of the RRSP will incur income taxes (it is only deferred) anything you take out of the TFSA does not. So for a “rainy day” fund this is the better option.
Be aware though that there is a contribution limit of currently $5000/year, so you cannot save more than that in it, if you have more than a normal savings account will do as well.
Be Honest
This is the most important thing. Be honest to yourself about your financial situation. How much you own, how much you pay in interest and how long it would take you to pay it off at your current rate.
If you want to finance something new, calculate how much it is REALLY going to cost you, that is: How much will you pay on this item REALLY when you factor in all the interest you’re going to pay on it. This also leads into my final point:
Wants and Needs
This is probably the biggest. Advertising and peer pressure has turned many wants into needs. Learn the difference.
Crude example:
I NEED to eat and cloth and have Shelter.
I WANT that new iPhone / Computer / Game.
So, everything you currently spend money on is something you should examine based on this. Do you really need it? Or do you just want it? I mentioned above to make more than one debt repayment a month, the rational feeds straight into this. Reducing your debt has become a need, buying new stuff has become a want.
There is enough research that shows that if we go out and buy something we do get a “reward” in the brain, so a lot of the spending we are doing is based around this. Making these repayments is a way of getting the reward without causing any additional cost.
If you want, make debt payment every week, even if it is smaller amounts you pay back every time you will get the gratification of “buying” something and thus are less tempted to pay for other things that only get you deeper into debt.
Plan for the Future
Okay, it may take you a year or two to dig yourself out of that financial hole you’re in, but that should not prevent you from making plans for the future. This includes investments.
Do you have a pension at your job? If so, will it pay enough for you to live on? Where are your assets? (Note: If you have a Mortgage, you don’t own the house, so don’t count it as an asset it’s a liability until paid off, and even once it’s paid of you still have taxes and repairs to consider).
On how much could you survive? The rule of thumb is you should be paying no more than 1/3 of your income for shelter, how much will your house cost you once you’ve paid it off (taxes, repairs, utilities etc.). You get the idea.
Find yourself a good financial advisor once you’re done. Keep in mind: Diversification is the name of the game, don’t keep everything in one asset otherwise you’re badly exposed (this is also were the TFSA can come in).
Lastly a disclaimer: I am not a Financial Advisor, nor a Financial Professional. I have done a lot of reading about this over the last few years though and so far this plan works for me. I am also a single guy, I have no dependents and the only one I need to take into consideration when I make any financial decisions and the effects they have is me
Lastly, my longterm goal (two years out) is a simple one: I only want to need to have to work for six months out of the year, this does and has made an impact on how I live my life, but I am much more relaxed about this.
Life of course is unpredictable, so who knows what happens in the next twelve months, but the goal is that by the end of 2011 I will be in the situation that I am at the point where I only need to work nine months in 2012 if I so chose.
Your Turn.