The Money Diet
Have you been on a diet? I have. A million times. And it never works. Well, it works for a while, then I go back to my old weight and then some.
Diets are a lot like budgets. It's hard to follow a budget. Why? Budgets, like diets, at least the way we do them, often restrict us. And usually, whatever's prohibitive, we do. We like eating fatty food and junk food in the same way we like eating out and watching movies. Or buying clothes. Or drinking a capuccino everyday. So once we deprive ourselves, we end up frustrated and then give up.
That's why I'd rather call a budget a "spending plan". You can say "a rose by any other name...", but you have to start thinking of a spending plan as a "plan for spending". Duh, right?
Think of it this way. We think of a budget as a restriction on what we cannot spend. But that never works. People find it hard to process negative things. But once restated in a positive way, then it can work. So if you start thinking of what you can spend on, not what you can't spend on, then there's a greater chance of succeeding.
It's the same with diets. Diets that focus on what you can eat and what you can do to lose weight tend to work better than those that tell you what you cannot eat.
For instance, we began an allowance system. My wife and I allocated a certain amount each week for our lunches and other daily expenses. That's all we have in our wallets. Instead of withdrawing anytime from the ATM machine, we live with our allowance. And our focus becomes: With this much, I can eat this and that...
The other thing is that a spending plan must be realistic. Too often, budgets are so out of touch with reality that they're doomed to fail. No budget for clothes? Of course not. No budget for coffee? Impossible.
Of course, you need to cut back, but don't cut back entirely unless absolutely necessary. One trick is to cut a little across all expenses. A little of this, a little of that. Work on a plan you can live with. And don't wallow in self-loathing if you go over it. Just make certain adjustments, say skip the movie this week and rent a DVD, until everything balances out.
Replace bad habits with good habits, just like when dieting. It's a bit hard at first, until you get used to it. Instead of buying a book, maybe you can spend some time browsing at the bookstore. Instead of buying a new magazine, buy cheaper back issues. Or check the magazine's website. You can be as creative as you want -- there's much to enjoy in life without overspending. Once you get into the groove of things, you can go on auto-pilot without groaning or whining.
Always go back to your financial goals, if you need a boost in motivation. And remember, your spending plan is not cast in stone. Once your income increases, you can make adjustments. When you pay off your debt, then you can allocate more to savings.
Dude, Where's My Cash?
How often does this happen? You withdrew cash from the ATM this morning. This afternoon, it's gone. Or you received your bonus (lucky you) yesterday. By the weekend, it's gone.
Time flies, and so does money. And you'd think, there's never enough to go around.
Last issue, you (hopefully) calculated your net worth. Now, you will come up with your cash flow statement. In short, how much cash comes in and how much cash goes out.
Before you draw up your strategy in achieving your financial goals, you need to know exactly where you stand in terms of cash flow. Net worth is important, but for some, cash flow is king.
Remember I wrote that net worth is the measure of financial wealth? Well, for some, it's not net worth, but cash flow. How rich are you really? You can look at it this way: If you stop working right now, how long will you able to sustain your lifestyle?
If your assets can support you for twenty years, then that's how rich you are. If you can live off your assets for five years, that's how rich you are. If it will take only three months before you run out of cash, then that's how rich you are. If you live paycheck to paycheck...you get my drift.
Some people are living on interest, or what people call "LOI". People who have inherited tons of money or have worked their way to wealth. But I'm getting ahead of myself. Before we all get depressed, we need to do a reality check and know exactly how we're doing in the cash flow department. Because this will determine what actions to take.
Again, I'm uploading a Personal Cash Flow Statement worksheet for your use. You can call it a personal income statement or spending record, whatever. The whole idea is, you need to know how much income goes in and how much expenses go out.
INCOME
On the Income side, list down all your sources of regular income. If you're employed, that includes your salary, allowance, commission, etc. That's "earned income".
If you're self-employed or own a business, put in the income you generate from the business that you use for personal expenses. That's "business income".
If you have investments or paper assets that generate dividends, interest, and the like, plug it in. That's "portfolio income".
If you have rental property or have equity in a limited partnership or business but not actively engaged in it, put it in. That's "passive income."
You can either plug in gross amounts then subtract taxes and other deductions to get the net amounts or you can just input net figures for simplicity.
If your income does not come regularly, such as commissions, you can add up what you earned last year and divide it by twelve months to get the average. It's tempting to include bonuses, but since you don't receive them on a monthly basis, take the conservative path and exclude them.
EXPENSES
Now, on the expenses side. Okay, this will be bloody. You need to know how much you spend every month. These are your regular monthly expenses, which includes household expenses like utilities, rent, or your mortgage. Then you have groceries, food, entertainment, and the like.
The best way to find out how much you spend and what you spend on is to track your expenses for a week, at least for this exercise. Then, adjust the amounts by tracking them for a month, and another month, and another, until you get a good idea of your average expenses per month.
Of course, you need to categorize these expenses. It's up to you what categories to use, but I suggest you keep the list short. Break down each category into more detailed accounts, such as Dining Out and Movies under Entertainment. Just make sure they're related.
That's not all. You just listed your "regular" expenses. Yes, you spend a lot more than you think. It's really the "irregular" expenses that can prove burdensome. These are expenses that you pay quarterly, every six months, or once a year, such as insurance, clothing (unless, of course, you make it a point to buy clothes every month), and annual fees. And those that you did not plan for, like emergency car repairs or dental work (ouch!).
You need to estimate how much you spend every year on these irregular expenses. And be realistic. Don't exclude clothing expenses just because the last piece of clothing you bought were those leather red pants three years ago.
For each of these irregular expenses, estimate how much you spend every year. Then divide by 12 months. That's how much you effectively spend every month.
NET INCOME
Now, subtract your total expenses from your total income and you get your net income. That is what's available for savings and investments. Well and good. Most likely though, you'll get a negative amount. That means, my friend, if you're a business entity, you're in the red.
Don't fret. At least now, you know where your cash is. It's in the pockets of your credit card company, your bank, your utility company, your cell phone company, your landlord, your friendly neighborhood mall, your local Starbucks, etc.
Next week, I'll show you how to make a spending plan that will free up cash to finance your goals.
How Much Are You Worth?
When people refer to, say, Microsoft as a "$30 billion company", what exactly do they mean? Some would say it's in terms of total revenues, others total assets or market value.
But when they refer to Bill Gates as being "worth $100 billion", you know what it means -- net worth, i.e. assets minus liabilities.
When it comes to the definition of wealth for individuals, most agree it's net worth. Not their annual income. Nor their total assets. There's another definition I learned from a recent seminar that's even more to the point. But I'll share that next issue (yes, I am tricky!).
You now know where you want to go. This time, you need to know where you are. And the starting point is knowing how much you are worth (financially, that is...remember, your self-worth has nothing to do with your net worth).
For that, you need to come up with your personal balance sheet. I'm sure you know what it is. Some call it a statement of assets and liabilities. Elected government officials (mis) declare it.
So that's what you have to do right now: declare your assets (what you own) and liabilities (what you owe), and the difference is your net worth (what's left over).
Use a spreadsheet for this. Or just use pen and paper (a notebook that you can keep confidential). But since I'm really nice, I made a worksheet just for you (see Toolbox at the top left).
Assets
List all your "liquid" and "appreciating" assets. That means cash (or cash equivalent), investments, real estate, and business equity. Beside each, enter the amount.
For cash (cash on hand, savings deposits, checking accounts) and cash equivalents such as CDs (nope, not your Celine Dion Greatest Hits CD...I mean certificates of deposit) and other money market accounts (like time deposits and T-bills), check with your bank. If you have foreign currency deposits, get the equivalent peso value. If you own a whole life insurance policy or an endowment plan, find out what the accumulated cash value is.
For investments and real estate, find out the current market value. Log on the Internet or make the necessary calls for stock prices and net asset values (NAV). Your paper's business and classifieds section can also help (for prices of stocks, NAV of mutual funds, and average selling price of similar houses in your area or other real estate property you own).
You may want to include preneed plans you have, like an educational plan. They're not appreciating assets, rather they are prepaid expenses, which in business accounting counts as an asset until used. They are, after all, funds you saved for future use. If you own a business, include what your business is worth (or compute your equivalent share in the business).
Now, notice I didn't include most personal property like cars, furniture, electronics, clothing, and your Celion Dion CD collection. Why? These are "depreciating" assets, i.e. they go down in value. Sure, you can still sell them, but they represent an expense for you, not assets that go up in value (unless your Celion Dion CDs become rare collectibles 50 years from now).
A few personal finance experts would even exclude from your net worth calculation some appreciating items like jewelry and art work, and even your house. Mainly because they don't provide liquidity for you to live off them. So if you want to be conservative with your calculations, exclude them. But I recommend at least including the value of your house.
Liabilities
Next, list all your debt. This includes both secured (loans with collateral) and unsecured debt.
Secured debt includes the mortgage on your house (and other real estate investments), your home equity loan, and auto loans.
Unsecured debt includes your credit card balances, personal loans, salary loans, and SSS and PAGIBIG loans.
Net worth
Finally, deduct your total liabilities from your total assets and you have your net worth. Tada!
Do you feel rich? Maybe you just found out you're a millionaire, even if it's just on paper (especially if you listed your house as an asset). Congratulations! Or perhaps you discovered you're not worth much financially, even if you're a high income earner. Well, we'll get to that next week.
At least now, you know where you are in your financial life. Compare where you are (personal balance sheet) with where you want to go (financial goals).
Do you want to own a house in 10 years? An educational fund for your toddler? Money to travel to Europe by yearend? Retire at 50? A Range Rover next year? A home theater system this year?
Check your assets. Can your assets finance these goals? No? Not enough appreciating assets? Maybe your assets are not liquid enough. Maybe now realize you spent too much on depreciating assets. Or your debt is too high that it eats up part of your investments.
Most likely, you'll see a gap between what you have right now and what you want to have. Maybe a huge gap. Depressed? Go on, wallow in self-pity. When you recover (and I hope it should be right about now), remember you want to gain control over your financial life. And this is what's financial planning is all about.
Next issue, we'll do your personal income statement, or to be precise, your personal cash flow statement. This will be another eye-opener. Reality bites? You betcha.
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