5 Steps to Financial Control
A word to the wise:
A lot of financial authors will tell you to stop buying daily coffees or that you should start investing in real estate and one day you will be a millionaire like them. Well that’s great, but what if I like coffee? And what if I am not in the position to put $100,000 into real-estate today? For the financial beginner, it is more important to gain control of their finances before starting their journey to personal wealth. Find out your net worth, optimize your accounts, start putting money where it needs to be, pay off debts and begin saving for your future.
When I originally finished college, I had approximately $15,000 in debt. Considering that the average student debt in Canada is approx. $26,000 and in the USA $39,400, I didn’t think that my debt was too bad at the time! After that, I decided I would spend a year abroad in Ireland for an additional year of school. I was able to save up $10,000 dollars in 9 months (while living with my parents), but that only covered my tuition. Because I wanted to make the most of my once in a lifetime experience, I took out two student loans for $10,000 each, so that I could pay for my living expenses and enjoy myself as much as possible while I was there.
When looking back, I believe if I had been more aware of the consequences of debt I would have been able to avoid the initial $15,000 debt. I would have also preferred to save more before living in Ireland, but I don’t regret my decision at all. It was and is one of the greatest experiences of my life!
But now what? I had $35,000 worth of student debt and no real plan to deal with it. Luckily, I was able to come back and start working at my previous workplace right away. The problem was the consequences of my debt hit me!
The books I was reading about finance were not helping. They were inspiring, but only gave me a vague description of how you should always be prepared to jump on a financial opportunity like investing in property or buying the perfect stocks. Others would provide a graph showing how buying coffees each day is taking away from my potential retirement fund. Let’s be honest, none of this information was helpful to me. I was living paycheck to paycheck, barely able to pay my minimums and not saving anything.
At a certain point I realized that I needed to get control of my finances. All my research into personal finance was helpful for learning concepts and gaining an understanding of how I could become rich, if I had the resources to start. It just wasn’t right for my situation, so I took it upon myself to create 5 steps to getting control of my finances.
College Word to the Wise’s 5 steps to financial control:
- Finding out your net worth.
- Optimizing your accounts.
- Putting money where it needs to be.
- Pay off debts.
- Start savings.
Before taking these steps, I found my financial situation to be overwhelming and out of my control. All I was doing was working my hardest to feed my money into an account that instantly emptied itself. It was a helpless feeling. After taking the time to following these steps, I was able to feel more in control of my finances after only 2 months. Rather than being worried about insufficient funds, I knew the money was where it needed to me. By no means am I filthy rich from this plan, but I am no longer struggling. I have paid back almost $20,000 in two years, started an emergency fund, taken a solo trip to Europe for 10-days, have begun to grow my wealth and now feel confident in my ability to maintain control of my finances for the future.
Step 1) Finding your net worth:
This is ground zero for financial basics. There is no way to build a financial plan if you don’t know what you are working with!
To find your net worth you will need to look at two categories; assets and liabilities.
Assets can include, but not limited to:
- Money! Any money that you have in your chequing’s account, savings accounts, investments or cash. This does not include your credit line.
- Your house market price.
- Rental real estate.
- A car that is fully paid off.
- A profitable business
Liabilities can include, but not limited to:
- Monthly bills.
- credit card balances.
- mortgage payments.
- car loan.
- Student debt.
- loan debt.
Add up all of your assets and subtract any liabilities you have. For example, if my assets total is $4,000 dollars and my liabilities total is $20,000, my net worth would be -$16,000. On the flip side, if my assets total is $20,000 and my liabilities total is $4,000, my net worth would be $16,000!
Be honest with yourself when considering both your assets and liabilities. If you buy a new car it is not an asset. The second the dealership puts the keys in your hand, the loan payments start and the value of your new car drops significantly. However, if you have paid off your car completely, it is potentially an asset (assuming you are willing to sell it).
Step 2) Optimizing your accounts:
Do you pay for online services you don’t need, such as premium phone companies, cable, high interest credit cards, or a membership to a gym you don’t use? All of these things can quickly add up. Figuring out what is important and what isn’t, is essential. Take a moment to actually read through your credit card statement. You might be surprised what you are paying for each month.
Spending more than we can actually afford:
It’s a tough thing to accept that we want more than we can afford.
- We want the newest smart phone the second it comes out, not caring that it adds $15-25 dollars per month to our phone bill for the next 3 years.
- We stick with the most expensive phone company because we’ve always been with them. Or perhaps you are thinking “only reason they are so expensive is they must be the best”, when in reality a discount phone service provider would be perfectly suitable.
- We buy a fancy car to impress our friends and family, even though it cost $200 a month more than the car you can actually afford.
- We sign up for an online monthly subscription that we forget about shortly after. Only when we notice it a year later do we realize it has automatically renewed itself and we are still paying for it!
- Paying for a premium gym membership when there is a gym with the same equipment next door for only $10.99.
Everything is so easy to buy that people often get caught up in flash deals and things “they have to have!”. Before you know it, you have a credit card balance that you just can’t seem to pay off.
Ask yourself why are you with the bank you currently use? Is it because you researched all the best options and found a low interest credit card, no-fee chequing’s account and high interest saving? Or did you parents set you up with a bank account when you were a kid, that you just held onto forever?
Monthly bank fee’s can add up quickly. You can use websites such as ratehub.ca to find the best rates. For example, I discovered a no-fee bank account called Tangerine which I now use for my daily banking, savings and investing. If you do not live in Canada, simply type in “best chequing’s account” in your preferred search engine and you should quickly find some results.
If you are just starting to invest or already have some money in a mutual fund, consider switching to an Index Fund. They are proven to out perform mutual funds on a regular basis. They even have the additional bonus of having less fee’s!
Just like debit cards, credit cards also have a lot of good options. Make sure your card has a low interest rate and consider switching to a card that provides benefits such as travel points or cash-back cards. Keep in mind that you should not have a credit card limit higher than you can afford to pay back. Having a huge limit can be an unwanted temptation.
Step 3) Putting money where it needs to be:
One big issue I had was spending money before putting it where it needed to be. This would lead to fees for insufficient funds or being left with no money until my next pay cheque. By putting money where it needed to be first, or “paying myself first”, I was able to avoid these mistakes and have money left over without spending to much time budgeting.
1 – Find where the money is coming from. This could be a monthly subscription on your credit card or your rent payment coming out of your chequing’s account.
2 – Put the money where it needs to be ahead of time! For example, if you know that all the monthly subscriptions and memberships on your credit card add up to $85/month, you should set up an automatic money transfer from your chequing’s account. This will ensure that you will never accidentally miss paying off your card on time, resulting in a fee!
3 – If you are worried about having money in your chequing’s account for automatic payments such as rent or car payments, make sure to request that the payments be made a day or two after your regular paycheck. This will help you avoid spending to much prior to the payment being withdrawn from your account.
Step 4) Paying off debts:
A lot of experts will tell you to pay off your debt first. And I totally agree with them! However, I believe that it is important to follow steps 1,2 and 3 right away so that your debt payments don’t leave you feeling overwhelmed each month. Debt is already stressful enough without the added stress of being unprepared.
There are two main methods of paying off debt:
Snowball – Paying the minimum on all debts and putting any extra money on the smallest debt. Once that debt is paid off, continue to pay the minimums on all debts while putting any extra money towards your next smallest debt.
Avalanche – Paying the minimum on all debts and putting any extra money on the debt with the highest interest. Once the high interest debt is paid off, continue to pay the minimums on all debts while putting any extra money towards your next highest interest debt.
There is a benefit to either option, however, I personally think that the best option is to simply pick one and start.
When I started paying off my debt I went with the Snowball method. Paying off that first smaller debt gave me a huge emotional boast. I felt amazing calling up the Bank and happily requesting that they close that line of credit now that it was paid off. Whenever I looked at my bank after that it felt good knowing one of the debts was gone for good! Once that small debt was paid off I than had 2 loans of the same amount. I then switched to the avalanche method and picked the one with the highest interest and began focusing my efforts on that debt.
Step 5) Start Saving:
Paying off debt is priority #1. Savings should come after debt payments are made. Having the proper savings can take away stress, set you up for future success, and actually save you money!
When thinking about saving money, one of the biggest questions a lot of people have is “do I start saving and invest before I finish paying off all my debt?”. That’s a difficult question to answer and will require a future post to go into more detail. But here is a short run down on what I have done:
Step 1 – Pay off any high interest debt first. (credit card or high interest loan)
Step 2 – While paying off lower interest debt, start to save a “buffer” in your chequing’s account. Running out of money is extremely stressful. Try to save up a few hundred dollars in your daily banking account. This will ensure that you don’t accidentally spend to much, resulting in fees from your bank or send yourself into overdraft.
Step 3 – Save up an emergency fund. The goal is to have at least 3 months worth of expenses saved in an emergency fund, this will save you from taking money from any retirement fund you have or force you to use a credit card (which will put you further into debt!). 3 months is considered a bare minimum. Most financial advisers will suggest 6 months expenses to start and gradually save up to a year’s worth of expenses! This will be important if you ever lose your job. I started this savings account for myself a few months ago and saved 1 month’s expenses at this point. It’s a slow process, however, it saved my butt when I had to pay $600 dollars for new tires on my car! Without the emergency fund, I would have been in a much worse position.
Step 4 – You have now paid off all high interest debt, saved up some extra cash in your daily banking account and started an emergency fund. At this point you are probably sick of paying off debt and starting to get excited about being able to invest. This is the tricky part and should be well thought out.
If you have a low interest loan that is lower than what you would make from investing, it may be worth it to start investing. However, if your loans interest rate is higher than the potential yield of a safe investment, than it may not be a good choice. The reason I say ‘safe investment’ is because if you are still in debt and considering investing, it should be in something such as an Index fund which will follow the market and likely increase your investments. Investing in the stock market on your own can be risky at the best of times and should not be done while you are still in debt.