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Take Control of Your Finances By Luke Landes
This series explorers the concrete steps anyone can follow to take control of your finances. Many years ago, I felt like I was a victim of circumstances. Bad things, like job losses, apartment losses, and debt — even my girlfriend leaving me — were other people’s fault, a result of the world around me.
I came to realize after self-reflection that I had the ability to control these outcomes. I applied the theory of control to my personal finances. I was able to dig myself out of debt, and now I’m doing quite well financially.
Here are the keys.
Part 1-A: Become aware. Compare this to the scene in The Matrix where Neo sees the world around him for what it is. Every journey starts at an awakening.
Who are you?
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For any one human being, the number of answers to this question approaches infinity. There are many aspects that are included in the definition of self. The most common response is to answer with the collection of sounds used to nominally identify yourself: “I am Joe.”
Our names, generally given to us by our parents, influence our identity to some extent. In a world with billions of practically identical members of the same species, names help us identify each other quickly.
You might also answer with your occupation: “I am a plumber.” Many adults spend most of their lives training for a certain job or career and exchanging their time and effort within that career for compensation in the form of money.
This trade is permission to survive, and in some cases, prosper. It is not surprising that a person would choose to identify herself by the activity that consumes her life and provides the opportunity to continue living.
If you do not have an occupation, you may answer with the way you are considered by the people most important to you: “I am a father.”
This only scratches the surface of who you are. There is more beyond this top layer. How do you view the world? What is important to you? What topping do you like on your pancakes?
I want to focus on “What is important to you.” The details of your finances probably aren’t that important to you. You live, work, and pay your bills. You may be in a comfortable situation financially, or you may not be. Is there a need to fix something that isn’t “broken?”
Most likely you only pay attention if your finances start impeding your life. In other cases, you might keep denying bad situations until you hit a point at which no further decline is possible — rock bottom.
At rock bottom, there’s a good chance that the accumulation of poor circumstances or choices force you to suddenly become aware.
In terms of finances, it’s much less damaging if you become fully aware of your money and everything that is tied to money in your life before the worst occurs. Whether you call it Enlightenment, kensho, epiphany, or a revelation, it pays to move towards awareness than let it happen to you.
The first part of becoming aware is understanding your role in the greater economy.
Assuming you are not a slave or independently wealthy, you trade your time and effort for money.
You trade the money you earn for food, shelter, and possibly some extras.
If you are lucky enough to earn more money than you need to survive, some of your money will be diverted to programs that help society in general.
Companies make money by convincing you that their products are worth spending the remainder of the money you earn, and in general, companies are smarter than you.
I don’t mean to insult anyone with the last point. Successful companies spend a large amount of money to understand the way people think and behave in a consumer society.
If you watch television, the commercials you see are targeted specifically to people just like you. These commercials are tested, and only the most successful ones make it to the airwaves.
Companies spend money on advertising because they know they will regain that money through new customers as a direct result of that advertising. Advertisers are getting smarter and are adapting to new consumer behaviors, like time-shifting television programs and skipping commercials.
It is very hard to outsmart advertising experts who rely on scientific studies of financial behavior. Understanding your role as the consumer in this relationship is the first step to being able to control your finances.
What are some of the creative ways companies try to convince you with your money?
Now that you’re aware of your role, you can begin to quantify your financial identity and place it in context. The next step in taking control of your finances is to expand the definition of yourself by discovering your financial identity.
- See more at: http://www.consumerismcommentary.com/take-control-of-your-finances-become-aware/#sthash.FmUAnhWY.dpuf
Part 1-B: Take an inventory. You can’t determine where you are going without knowing where you’ve been and where you are.
An acquaintance of mine formerly owned a store that sells “country” products like hand-crafted wood furniture, candles, and decor inspired by rural living. Twice a year, she recruited family members and friends to help take an inventory of the entire store.
This process involved many hours of walking throughout the building and counting items on shelves and in storage. Even though the computer sales system tracked the quantities of items so at any time she could identify the number of wool welcome rugs with a turkey design, someone would count the rugs on the shelves to ensure the computer was correct.
Like a store, your awareness isn’t complete until you do your own financial inventory. Just like your name or your occupation identifies yourself quickly to other people, your net worth — the sum of the values of all your financial accounts — is a nominal description of your financial identity.
The complete calculation of a net worth can be convoluted because there are some important items to include that aren’t easily valued, so we can start with the most important aspects. For our purposes, we will look at the simplest way to determine your net worth.
Everything we need to consider fits within these six categories:
Bank accounts: where are they and what are the balances?
Investments: Do you have any? If so, what is the current estimated value of what you own?
Property: Do you own a house? How much did you buy it for or how much do you think it’s worth now?
Mortgage: Are you paying off your house? How much left do you owe?
Other loans: Are there any other loans that require your attention?
Credit cards: If you have credit cards and don’t pay the balances in full each month, what are the balances?
If you enjoy working on the computer, list all of your accounts in each category into a spreadsheet program like Excel, Google Docs, or the free OpenOffice.org. Spreadsheet software isn’t difficult to use for the purpose of creating these lists, but if you would prefer to work with paper and a calculator, that is a valid choice.
Each row should represent an account or item. For each item, the first column should include the location or type of account and the second column should contain the amount or value. For accounts in categories one through three, enter the values as positive numbers. For accounts in categories four through six, use negative numbers to represent the values.
Add up the numbers in the second column and enter the total beneath. This total, for the purpose of this early stage of financial development, is your “net worth.”
Your net worth is just a calculation of what you own subtracted by what you owe at any one point in time. Just like your name or your occupation identifies you, your net worth describes your identity in financial terms.
If you are married or share finances with another individual, you may want to consider the financial accounts belonging to everyone within the household rather than just your own. Whether to do so is a personal choice.
Here is an example net worth calculation in its most basic form. The red numbers in parentheses are negative numbers, representing amounts you owe to other people or companies.
While your bottom line is a very personal number, don’t take it too personally if you feel unsatisfied. There are often quoted guidelines that describe what your net worth “should” be for your age, but that type of comparison neglects to consider situations which might be unique to your situation.
For example, if you’ve spent more time earning undergraduate and graduate degrees before entering the workforce, your net worth may be lower than average once you begin working full-time, but may increase faster if your degrees provided you with opportunities for higher-earning jobs. (Please note that I wrote “higher-earning,” not “better.”)
Resist the temptation to compare your net worth with those of others. Although websites like NetworthIQ exist to make interesting comparisons within and across demographic groups, focusing on other people’s numbers is distracting when all you want to do is control your own finances.
Use this number, your net worth, to understand your current position and determine whether it is where you would like to be.
Now that you know where you are financially, you need to look at some more numbers to get a quick feel for how fast your net worth is likely to increase (or decrease). The next part of taking control of your finances is making an accurate prediction based on your income and expenses.
- See more at: http://www.consumerismcommentary.com/take-control-of-your-finances-take-an-inventory/#sthash.3KmJ3oMk.dpuf
Part 1-C: Make accurate predictions. With an inventory in hand, you only have part of the story. Your income and expenses are key to determining your future.
Now that you’ve taken an inventory of your finances and determined your net worth, I can tell you that the number is meaningless. Well, there is a point to your net worth, but it’s not the most important number to your finances. Your net worth tells a very small part of the story that defines who you are.
Let’s say my net worth is $100,000. Am I in good financial shape, poised well for the future? It’s impossible to say because we don’t have enough information. $100,000 means different things to different people.
For example, starting retirement with $100,000 in the middle of Kentucky will go farther if you relocate to Kentucky or Argentina than if you move to New York City or London.
But more importantly, your net worth is nothing more than a snapshot at some particular time. If you’ve recently climbed out of credit card debt, $100,000 is good. If you have hospital bills to pay without insurance, $100,000 might not be enough to last the next year.
When you view your net worth in combination with your income and expenses, you will be able to better define your finances. You’ll have an idea of where your money is going.
In today’s society, almost everyone needs income. Most people acquire money by trading their time and effort. I give eight hours of my day, five days each week, as well as a portion of my brain power during that period, to an employer. The employer is (usually) grateful and provides me with money in return.
It’s kind of a strange system, but it works. Chances are you do something similar, but perhaps you receive income from investments or a pension.
With one source, it’s easy to calculate income. On a monthly basis, how much money do you receive? Some incomes are steadier than others. I receive a predictable paycheck from my employer each week. But I also earn money from a side business. The side business is highly unpredictable, so I don’t rely on counting that income each month.
The reason we trade of time and effort for money is often because we need to use money to trade for items that allow us to survive, like food, water, and shelter. If we’re lucky, we’ll have some money left over after paying for necessities to spend on luxuries like furniture, internet access, and hot air balloon rides, or to save for the future.
Your expenses should be less than your income. Put another way, spend less than you earn, or live within your means. If you do, your financial situation will gradually improve. If you do not; that is, if you spend more money than you have each month, then you will dig yourself a hole that gets more treacherous each month.
Determine about how much you spend each month in a number of categories to determine whether you’re sinking, treading water, or winning a gold medal in breast stroke. For now, until you actually track every financial transaction you make, these numbers can be estimates.
These are expenses you have to pay, the necessities for living. I use these categories but you may have some others you’d like to include. Like the net worth calculation, create a two-column list. The first column contains the category and the second column contains the monthly amount you spend in each category.
Automobile/Transportation: This includes parking, tolls, and train tickets.
Food and Groceries: If you have a family to feed, this could be very high.
Healthcare: How much do you pay each month for doctor’s visits and prescription drugs?
Household: Some household expenses are non-discretionary. I include clothing in this category.
Interest and Fees: If you have loans, credit cards, or any service that charges a fee, then include the amount you spend in this category.
Insurance: Health, car, and life insurance should be placed in this category.
Rent: I rent an apartment, but you may not.
Utilities: You pay for power to your home. Perhaps you would include cable television here, but I would consider that discretionary.
Tax: It’s almost impossible to avoid paying tax.
Debt payments: Each month you must make at least the minimum payments on all your debt.
Everything else is a discretionary expense. You don’t have to spend this money every month. Dining out, gifts, charity, and your vacation are discretionary expenses.
The goal is to be able to start with your monthly income, subtract your non-discretionary and discretionary expenses, and still have some money left over.
The goal is to be able to start with your monthly income, subtract your non-discretionary and discretionary expenses, and still have some money left over.
This calculation is your “net income” if it is positive; if the number is negative, you can call it a “net loss.” Net income can be saved, invested, or used to pay off your debt faster.
Here’s what your income and expense report might look like. Note that income is positive while expenses are negative.
Example Income and Expense Report
This person is in bad shape. With a monthly income of $2,000, he has only $175 after non-discretionary expenses.
During this time period, including all expenses, he spent a total of $2,175 while earning only $2,000.
If this is a pattern, he is probably increasing his debt load every month, and the non-discretionary debt payments expense will grow.
If this is you, this should be the first sign that it may be time to change your behavior. This individual has some flexibility, but everyone’s situation is different. Assuming that the month observed here is typical of other months, we can predict fairly accurately that net worth, if not buoyed by investments, will decrease every month.
This is the opposite of anyone’s financial goal. It’s time to take action.
- See more at: http://www.consumerismcommentary.com/take-control-of-your-finances-part-1-c-make-accurate-predictions/#sthash.09OfNNLr.dpuf
Part 1-D: Decide to take action. Although you can see what the future might look like, events are not fixed. You can change your path if you don’t like what you see.
After viewing yesterday’s income and expense report for an imaginary person, Dan observed astutely:
… The one area that I don’t see is for a persons IRA, 401K, or ESPP. When is that money taken out or where/how is it assigned? It isn’t like you can say that you had a net income so you placed the net income in these funds because those IRA, 401K, or ESPP plans are taken out as if it was money flowing out.
Let’s call the imaginary person “Roger.” Here is a view of Roger’s income and expense report again.
After paying all non-discretionary (required) expenses, only $175 of the income remains.
Roger could take this excess money and save it, invest ir, or spend it. Beneath the non-discretionary expenses, Roger also has discretionary expenses.
This second category of expenses adds up to $350. Before Roger can think about saving and investing, Roger spends more than the $175 he has left.
Rather than having an extra $175 at the end of each month, Roger has a $175 deficit. In order to cover all his expenses, Roger has to come up with an additional $175.
This will come from savings or a form of debt, like a credit card or a loan. Either way, Roger is cash flow negative and his financial health will get worse every month until expenses decrease or income increases.
If this month is typical for Roger, he will reduce his savings or increase his debt by $1,500 each year. And this is a conservative estimate, because he may need a new car someday or he may want move to a new house. Most likely, he will have large expenses not covered by his income.
If Roger has savings to cover the monthly shortfall, eventually they will be depleted. He is not able to save or invest for retirement or any other future goals. Roger will be required to work to afford to survive until he can live no longer.
' title=This should be a wake-up call. In this first part of this series, I wrote about financial enlightenment, the moment when you realize where you stand and your future outlook.
I described how to take an inventory of your finances to determine your current position and how to use your income and expenses to predict your improvement or deterioration over time.
In many cases, people don’t reach a turning point in their financial lives until they hit “rock bottom.” That is something that people should avoid as much as possible. It’s not uncommon to just ignore a problem until it gets in the way of normal human functioning.
You can live with a broken heater until winter, and you can continue to accumulate debt for a long time. Eventually, you’re going to want to be warm when the temperature drops and you’re going to want to keep your house when you start receiving foreclosure notices.
Now that he has reviewed his finances, Roger should have a good understanding of his condition. So far, I’ve written about self-evaluation, but now it is time for people whose situation is similar to Roger’s to take action. Starting with Part 2, I will share some ideas for moving in the right direction.
- See more at: http://www.consumerismcommentary.com/take-control-of-your-finances-part-1-d-decide-to-take-action/#sthash.oSNNnod5.dpuf
Part 2: Track your money. All you need to get on the right path is a pencil and paper — but these tools will help, too. Tracking your finances closely immerses you to build a better understanding.
After deciding that it’s time to get a handle on your finances, find a way to accurately track the way you handle everything involving money. Before deciding to take action, you may have estimated your income and expenses, but now the details matter. Here is how to get to the details.
Every cent is important at this point. That will change later on; as you grow as a master or mistress of your money, you can ease the pinch on the penny.
But in the beginning of this journey, you should record everything. From the $5 check from your grandmother on your birthday to your $75,000 annual performance bonus, and from the $1.99 music download to the $28,150 car, you must write it all down in some form.
There is a purpose to this madness. By tracking every detail of your money, you get a real picture of how much you’re spending. Many people don’t know off the top of the head how much they spend on lunches with coworkers every month or how much they spend on cigarettes or coffee.
This process can be very enlightening, and in some cases, it might provide motivation in itself. By tracking your finances accurately, you’ll be poised to make better decisions about where to spend your money.
You don’t need to start with fancy software. Sometimes, low tech can be most effective, especially when starting out. Pads and pencils are portable as well, and they are great tools for keeping track of your cash spending while you’re on the move. The first step is to choose the method that will work best for you.
Intuit Quicken is the king of financial tracking software. Unfortunately, the software is not cheap. Quicken 2009 Deluxe, the most basic version available this year, costs $45 through Consumerism Commentary.
You can connect to banks to download your deposits and withdrawals and credit card companies to download your charges and payments.
Microsoft Money Plus is another option offering similar features. Both of these programs cost money to use.
For those who don’t use Windows-based computers, MoneyDance is a good choice, but this software is not free, either.
If you’re looking for software that is free to use, take a look at GnuCash. GnuCash also has a portable edition which allows you to take your financial data with you and access the program anywhere you can jump on a computer. (Thanks to Dave Stinner who reminded me about Gnu Cash.)
Quicken Online Edition is now free. Here’s a review of the service. Mint (reviewed here), Geezeo, and Wesabe offer similar features to help you track your money.
While web software offers seamless integration with online access to your banks, it has some limitations. These web applications are not designed to keep track of your cash spending, which may be the most important requirements for accurately tracking your expenses.
Keeping track of the money you spend while you’re out is a challenge, at least for me. It helps to ask for receipts for all transactions so you can collect them and record the amounts at night when you’re home.
I’m experimenting with software for mobile phones that allows you to keep track of your spending. SplashMoney works with my BlackBerry as well as iPhones.
For Quicken users who enter transactions while away from the computer and sync them to desktop Quicken later, Pocket Quicken may be a good option. This software runs on Palm and Windows Mobile devices.
For people who prefer old-fashioned methods and have unlimited filing space, paper accounting is an option. Download this ledger paper and print a few pages. Use a separate page for each account, and keep track of your transactions just like you would with software. If you don’t like my ledger paper, try these templates, available for free.
Tips for accurate accounting
Collect receipts for all transactions, including the purchases using cash. “Cash” should be an account in your software or on paper. Your starting balance is amount of money you have in your wallet on the day you begin tracking.
If possible, keep notes about your expenses while you’re away from your computer or desk. Carry a small pad or use mobile software like those listed above.
Every month, or more often if you have online access or automatic transaction downloads, compare what you record with the activity your bank has recorded in their systems. This “reconciliation” ensures you have accurate records for your bank accounts, investments, and credit cards.
The web software listed above usually download your bank activity automatically. In some cases, the application will try to categorize your spending based on the vendor name or similar transactions by other users of the software. This “artificial intelligence” will make errors, so review every transaction to categorize the expenses and income properly.
ATM withdrawals should be recorded as a transfer between your savings account and your cash account, not an expense. Cash deposits should be transfers as well.
As time goes on and you become more familiar with your finances, you can afford to be less aggressive about recording every cent. I suggest following the above suggestions and keeping track of everything for at least several months to get an informative view of your money.
- See more at: http://www.consumerismcommentary.com/take-control-of-your-finances-part-2-track-your-money/#sthash.rco8HOQM.dpuf
PART 2 OF FIRST PART