Fundamental Financial Truths
Most of us just muddle along and learn how to manage our money as we go, befuddled by the plethora of options, decisions, and expertise that today's economic world encompasses Take heart. There really are a few fundamental financial truths that don't change over time. If you master them and keep informed of current trends, you can live well for less and save for a financially solvent future.
Calculate Your Net Worth
Let's start at the beginning: Before you do anything else, it's essential to figure out just how much you are worth. The easiest way to do it is to get a pad and pencil and make two lists -- one of your assets and one of your liabilities.
Your assets. Start by adding up the current value of everything that you own or have coming to you:
- Cash: Total of your checking and savings accounts, financial investments
- House: The market value of your home.
- Other things of value: This includes jewelry, automobiles, home furnishings, art, vacation home, and such.
- Insurance: Figure out the cash value of all your policies.
- Investments: The current value of stocks and bonds, any rental properties, real estate partnerships, oil and gas partnerships, gold and silver, company stock options, personal collections (stamps, coins, antiques, and such), notes receivable, and the book value of a business.
- Retirement savings: Pension and profit-sharing plans, any deferred compensation, and company savings plans (only count the money you could take if you left the company tomorrow).
Your liabilities. Now add up all your debts -- the amounts that you owe to others:
- Mortgage: Be sure to include home equity loans.
- Loans: Bank, car, and any other loans or notes.
- Credit card balances or any other outstanding debts.
Your net worth. Once you have your two lists and have totaled them up, subtract your total liabilities from your total assets. The result is your net worth. Write that figure down. Memorise it. That's the number that will tell you when you can retire and how far along you are toward reaching your financial goals. Chances are your net worth is more than you think; however, if you find out that you are worth less than you think, let it serve as a wake-up call to revise your budget fast.
Assets - Libabilities = Net Worth
Get With the Budget
Every household should have a written budget. Some people have the feeling that if they balance their checkbook regularly, that should suffice. But focusing only on your checkbook is not a realistic, safe, or forward-thinking way to approach your financial well-being. It is also crucial to be honest about your budget, even when you overspend. Again all you need is a pad and pencil.
Total income. Add up all the money that you can expect to receive during the year, these include:
- Regular paychecks and bonuses
- Part-time or freelance income
- Other income
Fixed expenses. Next add up all the payments that you make a regular basis during the year, these include:
Mortgage payment or rent
Electricity, gas, and water
Telephone: Home and cell phone
Cable or satellite dish
Variable expenses. Now add up all the payouts you make that vary more widely from month to month, these include:
Food and beverages
Home maintenance and improvement
Furnishings and appliances
Gifts and contributions
Health care not covered by insurance
The moment of truth. Subtract all your annual expenditures from your total annual income. If the total expenditures are less than the total income, you are living within your income; if the expenditures are more than the income, you need to go through your variable flexible expenditures -- and some of your fixed expenditures as well -- and reduce your spending.
Total Annual Income - Annual Expenditures = Cash Flow
Savings and Spending
When you are working out your budget, keep in mind that the recommended savings rate is 10 per cent of your take-home pay. If this isn't happening, you may be ill-prepared for retirement. Start by writing down everything you spend for about three months. This should give you a pretty good idea of how much you spend on food, gas, personal items, recreation, and all other variable expenditures. It's also a good idea to take out the past year of utility bills to get an idea of the seasonal rise and fall of expenditures there. Once you start seeing where your money is really going, you can look for ways to cut back and save more.
Think Small to Build Big
A lot of people only think in big terms for savings -- feeling that if they're not putting away $500 a month, then the effort is just not worth it. That kind of thinking is really destructive. If you're not used to putting away any money for savings, start small. Can you find $25 a month to go into a savings account? Most people can find that much just by cutting out a movie, a dinner out, or even a really lengthy long-distance phone call. If you can free up $25 per month to go to savings, you'll be $300 a year richer; if you can free up $25 a week for savings, you'll be $1,300 a year richer. Because the money you put aside will be earning interest, you'll be surprised at how fast even small amounts of savings will grow. Put it in perspective: If you save just $1 a day, by the end of the year you'll have $365. In an account with a four per cent interest rate, that would actually become $372 (you've made $7 by doing nothing). In ten years, you'll have saved $3,650 or, at the same interest rate, $4,487. As you can see, over time it all adds up.
Bonus Tip: Unexpected Income?
When you have a windfall -- bonus, gift, extra cash for extra work -- use the rule of thirds to determine how you'll use it
- One-third for the past. Use one third to pay down a debt.
- One-third for the present. Use a second third to make a home or personal improvement you want.
- One-third for the future. Put the final third immediately into some sort of savings or investment.
If you follow this rule, you'll see your debt shrink, your savings grow, and you won't feel deprived.
Another trick to help you save more (or pay down debt much faster) is to take an amount from a debt payment that has been paid off and continue paying it -- either into a savings account or into another debt. For example, let's say you have two car payments, one for $300 and one for $230. Once you pay off the lesser debt, just begin adding the $230 to the second debt and make new payments of $530. You'll be amazed how quickly you pay off the second debt (and save on the loan's interest as part of the bargain). Once that second debt is paid off, try tucking that payment into a money market savings account and watch your savings take off. Because you are already budgeting for the $530 to be unavailable to you each month, this strategy may be the most painless way to build up your savings.
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