Personal Finances


Eventually, if you want to get ahead in this world the importance of personal finances becomes obvious or your financial situation needs to be addressed. This is all about understanding the importance of personal finance in creating the life you want. Managing your money need not be scary, difficult or complex. In fact, everything I am going to present to you in this section is very straightforward and easily understood.

I will cover off some basics around debt management, budgeting and investing in this section as well and no - I am not a financial planner so what I am relating to you is approaches I have learned about and applied very successfully myself. Please note - if you are looking for an easy, get rich quick scheme of some sort - you will NOT find it here!

Now to keep things simple, I am going to talk about two key measures of your financial success. The first of these is: Net Worth and the second is: Cash Flow. To simplify this even further, I am going to state that the only real measure of your financial success (and progress) is the growth of your personal Net Worth over time. Your Cash Flow situation is basically going to help (or hinder) that from happening.

The foundation of personal finances starts with determining your Net Worth.

Personal Finances and Net Worth

As I mentioned earlier, your Net Worth is really the only true measure of how you are doing financially over time. In short, your net worth is the sum of all your assets less the sum of all your liabilities.

Assets are things you own of value. In its most simple form, this is cash in the bank, stocks, bonds or other investments and it also can include things like property (the house you own), recreation property, vehicles and rare collections.

So the first step in calculating your Net Worth is to add up all of your assets and their current value. This is simple in concept but a bit more difficult in practical terms. For example, your bank accounts and investments will have a "market value" that you can get from your bank or financial institution. This is pretty straight forward.

Things get a bit more complicated when you want to assess the value of your house. One approach is to have three Realtors come in and give you an appraisal and then take the average of the closest two. However, few of us want to go through that hassle every year or so and choose instead just to use the assessed property value from your property tax. This is usually a bit conservative (i.e. a little lower than you might get by selling your house) but in this game, being a bit conservative is not a bad thing.

Other principal assets such as cars, boats, trailers etc., are even more problematic in terms of assessing a market value. One of the best places to go to get an idea of the market value of these assets is on line by searching used car or trailer listings for example. If you can find very comparable products in comparable condition then averaging these "list prices" and subtracting 15% is usually a pretty good measure.

The final item that is even more difficult to get your hands on is the value of any pensions you might have from work. Now not all organizations offer pensions but for those that do, it is worthwhile asking your human resources person for a pension statement that indicates its current "commuted value". This is especially important if you are middle aged or older or if you have been with the same organization for a long time.

If you do not have a pension from work, you may be contributing to a 501(K) in the USA or to an RRSP in Canada. These are also assets so be sure to include whatever their value is in your calculation.

With all this data in hand - you add up the values and thus have a reasonable estimate of your assets. Note that after you do this process once, it gets a bit easier.

Now we need to subtract from your assets the value of your liabilities or your debts. Of this will include things such as:

  • Credit card balances
  • Car loans
  • House Mortgage
  • Student Loans
  • Line of Credit balance
  • Other loans or debts outstanding

Adding all these up will give you a total of your liabilities and subtracting these liabilities from your assets will give you your Net Worth!

Tracking Your Net Worth

Now - it is my hope that your net worth is positive but this is not always going to be the case, especially if you are just starting out.

Remember, the important part of this is to move your Net Worth in a positive direction year over year until it is not only in the positive territory but is heading for whatever financial goal you have set for yourself!

The benefit of tracking your Net Worth is that it gives you an honest assessment of where you are and where you are heading.

If your Net Worth is negative and/or continuing to decline year over year then we need to do something about that and so let's look at Cash Flow.

Managing Cash Flow

Okay, so as promised we are going to keep this very simple. In short, cash flow is basically all about understanding what money you have coming in, e.g. from employment, investments, gifts, tips etc. relative to the money you have going out to pay your rent, mortgage, phone bills and grocery bills.

Money Coming In:
Employment Income + Investment Income + Bonus + Tips + Gifts + Whatever = Total Cash In

Money Going Out:
Rent/Mortgage Payment + Car Payment + Food + Clothes + Phone + Cable + Insurance + Gas + Entertainment + Charity + etc = Total Cash Out

Money In - Money Out = Money left over for growing your Net Worth

Clearly, if you regularly have more money going out that coming in, not only do you have nothing left over for adding to your savings and thus increasing your Net Worth, this "more out than in scenario" is unsustainable in the long term and eventually you will go bankrupt! Ugh!

Now to make sure this doesn't happen, a lot of people turn to the tried and true idea of budgeting. For me there is nothing tried and true about budgeting because to be brutally honest, budgets usually fail! Why? Because they are just like diets and diets usually fail as well! Who wants to go through life focusing on all the stuff you can't have or can't eat? Hardly the path to a fun and fulfilling life, right?

Another huge drain on cash flow is debt repayment. Now there is all kinds of debt in this world, some good, some bad and some just terrible. Often when people get in "over their head", it is because they take on too much debt by buying a house that is too big for them or a car that is too expensive. Some people even maintain a running balance on their credit cards which makes it nearly impossible to get ahead financially!

The real bottom line on cash flow is that you must have more coming in than going out and there is no magic that will change this brutal truth.

Simple Investing to Increase Your Net Worth

Once you have started to realize positive cash flow or in other words, you have more money coming in each month than going out, then it is time to consider what to do with that money.

There are many options including paying down your mortgage sooner which can result in a huge savings in interest payments. The thing I like about this scenario is that it provides for a guaranteed after tax return on your money. Again, I don't want to fill this page with all sorts of financial gobbledegook but consider the following benefits of paying down your mortgage.

  • you will be paying money off the principal and so lowering the amount of money you owe, e.g. reducing your liabilities.
  • you will save the interest payments on the money you are paying down which may be anywhere from 4% to 12% depending on your mortgage (where else can you get a guaranteed return on your money at that rate? Nowhere!)
  • in Canada, you pay your mortgage with after tax dollars so by avoiding those interest costs, you are actually getting an even higher "return" by paying off your mortgage sooner. In the USA, a lot of mortgage interest can be written off so it won't have the same impact.

The bottom line is that paying off your mortgage early is a great investment and often you can get a secured line of credit against the equity in your property so that you still have emergency access to the money if you need it.

Still - there are other options for investing that are simple and make great economic sense for people who are not interested in playing the market or studying stocks and bonds.

The Big Questions

The two big questions that people often have when it comes to money are:

  1. How much should I save and how much should I spend now?
  2. Will I have enough money to be "okay" in the future or when I retire?

By following the "unbudget" approach to budgeting you have already answered the first question, so enjoy what money you have left over!

By following the unbudget and investing according to the approach here, you will be doing better than most people and will quite likely have enough to live out your old age in peace and enjoyment.

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