20-year financial veteran Paul Murphy explains his system for building a realistic money management plan. If you’d like an expert to review your debt situation, you can contact your local 4 Pillars office here.
After working in the finance industry for 20 years, there’s one truth that seems to be proven again and again: people who are good with money tend to spend more time organizing, planning, and knowing exactly what’s going out—and what’s coming in.
Now, you might hate spreadsheets. Or dread actually looking at the math behind your income versus expenses. But it’s something that we all need to do every once in a while.
Today, take a few hours and complete the following 10 steps. By the end of this session, you’ll know:
- Where your money goes every month—and where you can cut expenses.
- A complete picture of your net worth, total debt, and financial health.
- Hidden places to cut fees, reduce unneeded expenses, and a realistic plan to pay down debt faster.
Step 1: Assess your situation, know your net worth
If you’re serious about improving your finances, you need to know your net worth. This is an exercise that is helpful to complete each year.
Your first task is to document every debt. You can use a spreadsheet. Or just a notepad, if you like.
First, list all of your debts.
Make a comprehensive list of all of your debts. Make sure to include debts such as:
- Car loan
- Credit cards
- Utilities you’re behind on
- Small loans (such as payday loans or in-store credit cards)
Next, break the list of debts down into secured and unsecured debts and list the interest rate by each one. If you don’t know the interest rate, you need to track down these numbers as this will be critical as we move through the plan.
This can be very daunting and scary. But you need to be completely honest and open when you do this.
What’s your total debt? Write it down as you’ll need it for the next section.
Make a list of your assets.
Next, complete a full review of all your assets and the estimated value of those assets. When valuing your assets look at reasonable fair market value.
Include assets such as:
- Your home
- Your car
- RRSPs or TFSA accounts
- Any stocks or investments
What’s your total asset value? Write it down.
Now, calculate your net worth. This is done with a simple formula: your total debts minus your total assets equals your net worth.
What’s your financial outlook for 2018?
You now have your net worth. It doesn’t matter if it is positive or negative. What’s more important is that you now know where you stand financially.
Don’t throw away this piece of paper or spreadsheet.
Save it on your computer or keep it somewhere safe as you are going to review it at the end of the year and see the progress you have made.
Every year, you will complete the same exercise and review against previous years.
Step 2: List all automated withdrawals
The next step is to figure out where the money goes every month.
List every single weekly, bi-weekly, monthly, quarterly, semi-annual and annual direct payment that comes out of your bank account.
This means going back on last year’s bank statements to ensure you don’t miss anything. It’s a bit of work. But think of all the time you spend at work earning this money—a few hours figuring out where it all goes can really help you improve your awareness of how to improve your finances.
Pay attention to the charges that come out less frequently as they are the easiest ones to miss. For example, your children’s annual Xbox membership.
Don’t forget to check your credit card statements. Include both the annual fee on your travel card for example and include any monthly bank fees.
How much money goes out in automatic withdrawals?
Write this number down. You can later look for purchases to cut. You’ll also be more likely to consider future purchases more carefully.
For example, when I did this exercise I found that I spent over $1,500 in unnecessary subscriptions and impulse purchases—an Amazon Prime account I didn’t really need, an Audible.com subscription I rarely used, a credit card with a hefty annual fee, tons of books I ordered, a subscription to accounting software I never used, and a host of small charges.
These charges seem small. But if you invested that $1,500 every year, you’d have $297,589 by the time you retire (a $1,500 annual contribution with a 10% return over a 30-year period).
Step 3: List all your income and deposits
Now do the same for your income and any deposits. List all sources of income you had throughout the year.
This includes everything that was deposited into your account including child tax credit, annual tax refunds, gifts from family and bonuses or overtime at work.
Review your bank statements and document every deposit.
Next, categorize it and add it up so you have a total received by category for the full year.
You can do this by manually reviewing your bank and credit card statements. Or you can download all of your transactions into a spreadsheet. You can also use a tool like Mint.com to help you automate the process.
Step 4: Review and prepare for 2018
For your income and deposits, you need to go through and make a list of what is guaranteed income for 2018.
For the outgoing direct deposits, go through each one and put them into two categories: ‘must have’ and ‘nice to have’.
‘Must have’ includes utilities, mortgage payments, car insurance, and ‘nice to have’ includes things like Netflix or the movie and sports channels you subscribe to above your standard TV package.
Now go through the ‘nice to have’ list and decide if you need the service and how much you used it last year. If you don’t get any value out of it, cancel it. You can always get it back anytime.
When going through the ‘nice to have’ list, be mindful of the value it may add to the family and or other savings it may offer. For example, if having the movie channel means you have family movie night at home versus going to the movie theater then it makes sense to keep it as it saves money in other areas.
Review bank fees and annual credit card fees closely and understand if they are worthwhile.
Lots of banks now offer free chequing accounts which could save you $30 a month on bank fees.
It can be a pain to change bank accounts, but as we said earlier, this is going to take time and effort. If it takes a couple of hours and saves you $360 a year, that’s a nice hourly rate you are paying yourself.
Look at the annual fee on a rewards credit card. For example, a travel credit card can have an annual fee of $120. If you used the card a lot and got more than $120 worth of travel benefits, then it’s worth keeping.
Step 5: Plan your payments and calculate what’s left
Now that you have a clear understanding of what’s guaranteed to come in next year and what is guaranteed to go out, you can start to create a plan. This makes your life and budgeting easier.
The first step is to make sure all your outgoings correspond with your incomings. If you are paid monthly, have all payments switched over to come out monthly shortly after you get paid.
If you are paid bi-weekly or semi-monthly, add up all the outgoing funds and divide by two. Then have 50% come out on your first pay period and the other 50% come out on your second pay period.
Try to balance the amounts coming out as closely as possible so one pay period isn’t much higher than the other. This will make budgeting for the non-discretionary expenses much easier.
Now calculate exactly what’s left over for each pay period.
Step 6: Create a budget
The earlier exercise allowed you to understand your fixed expenses and potentially cut out some of the non-essential fixed expenses.
Planning your spending for when you get paid is the most effective way to manage your money. However, for most people, tracking and planning the variable expenses is by far the hardest part of budgeting.
As you did with the fixed expenses, you need to try to plan variable expenses evenly over pay periods but this won’t be as easy given these expenses are variable.
In order to estimate the budget for each category look back on last year’s expenses for some categories like kids’ activities and sports, school fees, even clothing and gas.
To get an accurate understanding of categories such as groceries it will take a few months of diligent tracking of how you spend your money each month by keeping receipts for every purchase and putting them into the correct category.
Try to avoid using credit as this will hinder the debt repayment plan you are going to put in place and can also create a false and unrealistic budget.
If you do use credit, keep the receipts and transfer the funds immediately. Once you have completed a couple of months of tracking, you will then be able to create your budget and help ensure you are allocating money to the right places in-line with things that you value most.
Tracking spending is a discipline that needs to become part of your monthly routine. It’s not a process that stops you spending money in certain areas such as travel or eating out but helps you make informed decisions.
It’s often filled with moments of self-discovery and what previously seemed important can become an opportunity to reduce expenses and accelerate financial goals.
Step 7: Only use cash
Do you stick to your budget every month? Are you sticking to your debt repayment schedule?
If you answered yes, you can skip this tip. But if you’re having trouble, consider switching to only purchasing things with cash. Spending cash really works. It removes a lot of spur-of-the-moment spending.
Spending physical cash is emotionally harder than swiping a card. For example, spending $300 in Home Depot with a credit card is easy. Handing the clerk a stack of $20 bills makes the purchase more painful and memorable.
Use the envelope or jar method to allocate physical cash to each spending category during each pay period.
Step 8: Start a financial calendar
Whether getting caught off-guard by property taxes or missing your credit card bill (and getting hit with interest), it’s easy to forget to pay things on time.
Print out a calendar for your fridge. Or use Google reminders and Google Calendar to organize your financial life.
- Add a calendar date for bills that need to be paid. You can have these events automatically repeat every month.
- Schedule a trigger to review your budget every month.
- Add a calendar date to start saving for things such as annual vet appointments, car repairs, or property taxes.
Step 9: Tackle your unsecured debt
Secured debt is things like mortgages. They have a fixed monthly payment. And if you keep paying, you’ll eventually reach zero.
In contrast, credit cards or lines of credit can go on forever. You only need to pay the minimum payment. This can keep you in debt and balloon the cost of the initial loan over time.
In step one, you listed all your unsecured debts and the interest rates on each one. You now need to set yourself a goal of having the debt paid off and calculate what this will take.
Use this calculator to work out the required monthly payment for each debt to have it eliminated within the number of years you have set as your goal. You can find other helpful debt calculator tools here.
Now add them all up. Review the required monthly payments against the surplus income you have after all discretionary and estimated non-discretionary expenses and see if this is achievable.
Choose your debt repayment plan (Snowball and Avalanche):
List all the unsecured debts by smallest to largest by amount owed. Don’t worry about interest rates at this point. This method doesn’t include interest rates and is designed for people motivated by results.
Pay minimum payments on all the debts except the smallest one. Then, use all additional funds allocated to debt repayment each pay period to aggressively pay down the smallest debt.
Once it’s paid in full, take the money you were putting toward that debt and allocate those funds to the next debt on the list. Once that one is paid, take that combined payment and go to the next debt.
The point of the debt snowball is a psychological approach to debt repayment. In terms of pure dollars, it makes the most sense to pay down the debt with the highest interest first. But when you focus all your efforts on the small debt first, you see progress very quickly.
Soon the first debt is paid off completely and gives a huge sense of accomplishment and satisfaction. You will see that the plan is working and will commit to the plan and you may have a greater opportunity to succeed in your goal of becoming debt-free!
It makes more sense mathematically to target your debts in descending interest rates. But studies have shown that consumers who used the less rational snowball method were more likely to eliminate credit-card debt.
For the mathematicians out there, the avalanche technique may be the preferred method to create a debt repayment strategy.
The principle is the same: you’re maintaining minimum payments on all debts but one, and then allocating all available funds to that debt until it is paid off, then moving on to the next one. This is different from the snowball method technique because you are allocating all available funds to pay off the debt that has the highest interest rate first instead of the smallest balance.
This technique works best for those who are really disciplined and don’t need the motivation of quick wins in seeing the smaller debts paid off first.
It also works well for those motivated by understanding the math behind your debt, knowing that when you pay off the debt with the highest interest rate first, you will be paying less in the future as you will decrease the amount of interest that you would have paid on the high-interest loan.
Step 10: Get expert help
For some of you, the above steps will help you get a better sense of your finances.
Unfortunately for many Canadians, it won’t be that simple. After completing steps 1-8, you might realize that your debt is unmanageable.
And your calculations might show that no matter the changes you make, your income and budget will at best allow you to continue to make the minimum payments which will never repay the debt.
At worst, you might not even be able to make the minimum payments and you will soon fall behind on the payments.
Advice for families deep in debt
Many unexpected circumstances push us into financial corners we never expected to be in and this can be very difficult to deal with.
The thing to remember is unmanageable debt and financial crisis is only a short-term setback. There are many options available to deal with overwhelming debt, allowing you to restructure the payment arrangements, reduce the principal owed, and stop the interest.
Debt restructuring can help
Debt restructuring (also called debt consolidation) involves consolidating all of your debts. This reduces your overall debt and is a common strategy for dealing with large amounts of debt.
While effective for many people, there will be an impact on your credit rating. But when done right and carefully planned, debt restructuring will bring your long-term financial goals closer, not push them further away.
At 4 Pillars, we’ve helped thousands of Canadians successfully use debt restructuring. Our clients always agree—increased cash flow and removal of financial stress far outweighs the short-term impact on your credit rating.
A comprehensive debt restructuring plan will deal with your debt, get you into an affordable repayment plan, help you create a stable budget, and also reestablish your credit rating in 24-36 months.
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