This series of personal finance articles take a different perspective than what you would ordinarily find on blog and other sites related to the topic. The first article in this series [Personal Finance I, The Essential First Step To Investing] discussed the importance of personal finance, as the first step to investing. It discussed how a solid foundation (skills, knowledge, mindset, attitude, and other qualities) is important to becoming a successful investor, and is gained directly through the experiences of managing your personal finances. In the previous article [Personal Finance II, Getting Started] we explored how society and the media have misguided peoples’ mindset & attitude, to become financially counter-productive and actually harmful. We went through a list of mindset & attitude changes, along with their important relation to investing:
– Prioritizing Needs vs Wants.
– Self-Control & self-awareness.
– Discipline & Patience.
– Perceived worth (artificial or real?).
– Work Ethic (No excuses).
– Independent thinking.
– Self Improvement & Continual Learning.
– Procrastination & Motivation.
We also highlighted the fact that the task itself can seem huge, and that simple baby steps at first can be a good way to begin. This article will outline practical steps to getting started that will put the concepts into practice. As always, I like to put an investment minded slant to things, and included some personal finance ideas that relate directly to investing (linking the two subjects together).
Organize, Itemize, Track
Organize your expenses into categories, and track them monthly. First start with two sections, Essential/Necessities (Non-Discretionary) & Non-Essential/Luxuries (Discretionary). Break down the two sections into smaller categories/sub-categories. Here are some suggestions below (note some categories may show up under both depending on usage):
– Essential – Admin (mortgage, debts, loans, insurance), Transportation (gas, auto-lease, insurance), Utilities (hydro, gas, internet, phone), Living Expenses (groceries, medical, toiletry items, cleaning supplies, education, clothes, child care, etc), Other.
– Non-Essential – Food (snacks, dining out), Entertainment (movies, DVDs, games, party, etc), Living (clothes, gifts, hobbies), Travel (Vacations, trips, etc), Other.
Its generally a good idea to add an “Other” sub-category to cover any infrequent or uncommon expense items. Don’t worry about making it more complicated or detailed than this at first (unless you are all for it). The main thing is to get a basic tracking system going, which you can take to another level later. Don’t expect to see much information until a month has gone by, as regular expenses are usually on a monthly basis. Use Excel or any other spreadsheet program, which makes this an easy task. It can still be accomplished on paper without much difficulty as well. The internet has an abundant source of monthly expense spreadsheet templates that can help you get started.
After one month you should have tracked enough expenses to take an initial look at how your money is spent and exactly where it is going. After a few months, some non-monthly expenses will be captured. Some of these expenses may include ones that occur only every few months, or even just a few times a year. For example, car maintenance, clothes, birthday gifts, etc.
Once your simple tracking and identification system has been set up (i.e. can be done before identification). You can begin to prioritize the individual expenses within both the essential and non-essential sections. For the essential section, think about expenses that will cause the largest problems if they cannot be met immediately. Think about alternatives or options that may exist for each (even if they are not the most desirable). Items with other options available can be placed lower, because when worse comes to worse there are at least some options available. Think in a “survival” mode, not in a “what I want” mode, as we are just listing ideas right now. Also consider the complete removal of a particular item and the impact it would have (would it severely affect your health?). For example, the car may be a necessity to get to work, but it will certainly rank below being able to pay for basic grocery items, as there is no alternative to having basic food on the table. Medical expenses also need to be placed very high on the list, due to the long-term health issues that will be created if ignored (which also eventually become financial problems).
After prioritizing expenses, start thinking of alternatives and methods to reduce each expense. Start with the largest non-essential/luxury expenses first (easiest ones to reduce), and then work your way to essential items. This doesn’t necessarily mean total elimination though. but a reduction in the amount or frequency, and/or a better balance of things may be in order. Each person is different and it depends on your finances and current situation. This is also an area that people have a very difficult time with, as they wrestle with their wants & desires. Be smart about how you spend your money. Often, people live beyond their means, and live a lifestyle that they cannot yet afford. This doesn’t mean that they should never spend on those items. But it may mean not spending on those items at the current stage in life. Also keep in mind that these are just reduction ideas at this point. Later, a budget will help to shift around the “wants” so that you can have them once in a while. Here are some reduction/alternative ideas:
– Gift card program – Some gift card programs allow members to purchase gift cards for major retailers at a 20% discount. Look for a program that covers the widest range and retailers that you shop regularly. The savings impact can be huge as it may cover everything from household products, clothes, furniture, movies, electronics, hardware, books, to gift cards as Christmas gifts. With rebate cheques covering the membership fee, it becomes a no brainer.
– Lunches/dinners out – cook & brown bag lunch.
– Movies – rent new DVD, watch old favorites.
– Purchase used or trade-in – books, CDs, DVDs, video games, sports equipment.
– Vacation plans – Cheaper alternatives that are within budget? Every other year?
– Purchase non-brand names – You don’t need to purchase a brand name plain white shirt.
– Phone – Do you really need an iPhone? Is there a better cell phone plan? Pre-paid? Get rid of home line? Do you need a new phone (did your current one stop working?).
– Car – Reduce mileage. Transit? Better route? Too big?
– Mortgage – House too big for current family size? Unnecessary upgrades?
– Rebates & Coupons – take advantage of these, especially if you are going to buy the items anyways. Many companies like Proctor & Gamble have subscription coupons on their popular products.
– Discounts/Sales – Wait for discounts and sales, or for special seasonal sales (Thanksgiving, Christmas, etc).
– End of Season purchases – Wait for the end of the season to purchase seasonal items such as winter/summer clothing, to get the best deals.
– Comparison Shopping – Compare prices of regular purchases to find out which retailers offer the best prices for most of the items on your shopping list. For big ticket items compare with online prices, and use price matching policies. Did you know some credit cards offer a 30 day price protection guarantee as well?
Reduce costs of the most frequent expenses
Take a look at your most costly frequent regular expense. These items are ones you should try hard to significantly reduce. Because they are recurring expenses, a reduction in these items will help reduce their overall cost impact. For example, if you are buying 6lbs of meat each week at $10.99/lb, that works out to be $3429 a year. However, if you could get it for $9.99/lb that works out to be $3117, which is a yearly savings of roughly $312! That can be 100 shares of a $3/share stock, or it can go towards covering another much needed expense. The goal is to achieve some sort of economies of scale.
Question Perceived Worth When Spending
One way to help reduce spending expenses is to question the worth of the item. Think of the difference between the cost and the price you will be paying. Compare the worth of the item to other items of the same price.
– It costs the seller $ to make/obtain this, why is it selling for $$$?. You are paying for the intense advertising & marketing, not the item itself! This is usually the case on clothing items.
– Ask yourself if you are willing to pay that much of a mark up?
– Does the ticket price seem over inflated for what it actually is?
– Can you get a better deal/value?
– If you were to sell something back out, how much could you really get for it?
– How does a particular item actually improve your life (or by how much)?
– How many hours of work will it cost you? (How many hours did you slave away for it?).
– Are you voluntarily ripping yourself off?
– Are you paying for just the name/brand?
– How much better is the quality really, $$$$ better? Or is it more like $$ better?
– What could you buy with the same amount of money? (when a pair of shoes sell for the same price as a pretty decent digital camera, something doesn’t seem quite right).
Be picky, and be selective. Don’t just give your money away!
Reducing spending is also another way to raise capital. Deferring or pocketing the different on money you would normally spend. For example, each time you think about going out for lunch, put the money into your capital raising fund and brown bag your lunch instead. This way you know exactly what you are giving up and what it is going towards (your freedom).
The next step is to create a budget. It is basically setting target or guideline (goal) numbers to follow. The numbers reflect what you think or are trying to achieve, with reductions in expenses. Set a number for each expense item. Create a monthly and a yearly budget, as some expenses may not occur every month. You should use the monthly budget to keep monthly expenses in check, and the yearly one as an overview to ensure everything remains within the total limit. A budget also helps you allocate spending during the year. For example, if you are overspending in one area during a specific month, the next month you may need to cut back. As you approach the end of the year, you can see how much money is remaining for a particular expense. Regular referrals to the budget will help guide you from veering off course.
With a reduction in expenses there should be some extra cash flow. This cash flow should be accumulated, or saved. Savings should be used for padding unexpected expenses, emergencies, or investing. Strive to save a set portion of your paycheque each time you receive it. Aim for 30%, but you can start 10% and continually increase it as you reach that target. Saving connects much of personal finance with investing. It involves keeping capital at certain levels and trying to increase it. This is done via the activities of personal finance such as reducing spending & prioritizing (critical decision making), delayed gratification (not selling for short term gains), patience (waiting until the plan/strategy plays out), and emotional control of wants & needs (not allowing emotions get the best of you, while still being able to clearly see the picture).
One area of savings is in personal taxes. Keep up to date with personal tax law changes. Take advantage of any new credits/rebates that you may be eligible for. Investors always factor in the tax implications of their investments or businesses, so personal income taxes is a good way to start getting familiar with things. Hire a reputable personal accountant to help you with your taxes. Even though they cost more than filing your own taxes online, they can help you save more money due to their intricate knowledge of taxes, and tax planning strategies. They also work with you and strategies are customized to your personal situation. As you become more involved with investing, their usefulness increases.
For more info on taxes visit the CRA or IRS homepages. For Canadians, take a look at the site Taxtips.ca
A Note On Illegal Tax Savings
Avoid it! The most common illegal method that individuals use to save money is in the form of tax evasion or fraud. I cannot stress how illogical such a method is, because anything illegal carries too high a risk and price. The penalties for tax fraud are extremely high. In Canada and the US, many now carry mandatory jail time (record) in addition to large fines, for even what may seem like the smallest of actions. It should be noted that convictions related to taxes usually carry harsher punishment than those of other criminal actions. In the US it is even more so.
– Recent Canadian convictions: http://www.cra-arc.gc.ca/gncy/trdnt/ptc-eng.html
– Some US convictions: http://www.irs.gov/newsroom/article/0,,id=177063,00.html
– IRS tax enforcement: http://www.irs.gov/compliance/enforcement/article/0,,id=121259,00.html
Common forms of tax fraud in Canada that the average individual would be enticed with include false child care expenses/schemes, charitable contributions/donations, etc. Unfortunately many tax preparers and shady accountants entice their clients with the lure of larger tax returns. A successful investor does not need to resort to illegal activities of any sort!
One of the most common complaints people have is that they “don’t have any money to invest“, and so they stop there without going any further. However, this is really an excuse that they tell themselves, as they really don’t want to bother thinking of ways to raise capital. Raising capital is an essential part of being a successful investor. Using money from your paycheque and accumulating it until there is a lump some to invest with (raising capital) is one of the simplest methods. It is directly linked to the savings aspect of personal finance. If you are really good at reducing expenses and saving a large percentage of your take home pay, then this method will work really well. It may actually be the quickest and easiest method for some people. However, for many others it is very difficult (for a variety of reasons) and other methods can be used to accelerate the process. The main thing to keep in mind is that every little bit counts:
– Sell old/used items – on Amazon or EBay (DVDs, CDs, books, video games, clothes, sports equipment, etc.).
– Sell old/used car parts – on auto forums/clubs (tires, rims, mechanisms, switches, etc).
– Arbitrage opportunities using Amazon or EBay – This involves bargain hunting to purchase popular items at a huge discount, then reselling them at a slight discount to normal prices. This works well on very popular or high demand items, but not so much on generic ones. The initial purchase price must be at least 50%, so as to ensure you have a mark up of close to 50%.
– Garage sale hunting – This involves going around to garage sales to pick up vintage items or collectibles that may sell for more elsewhere. I’ve had mixed success with this one. However, other people have had success. It depends on your knowledge of vintage or collectable items.
– Pick up a part time job – You want something that gives some flexibility in hours, and that may require a different skill set than your day job. If you are your crunching numbers at your desk all day long, you may want something that involves simpler physical tasks. If you spend all day on your feet you may want a reception or customer service job. Some ideas may include a barista at a coffee shop, reception at the community centre, call centre, library, airport, etc. Keep in mind that this is probably not going to be a permanent thing, but will temporarily boost income.
– Part time business – Consulting based businesses (PC repair, teaching piano, martial arts instruction, tutoring in math, languages, computers, sciences, etc).
Debt usually refers to monetary obligations that can be good or bad depending on how one uses it. Investors usually use debt and leverage as a strategy for building wealth. It usually allows the investor to obtain assets, with the intention of having the returns from the asset paying for the loan itself. Bad debt, is borrowed money commonly used by the general population, to purchase or pay for expenses/liabilities. Leverage can be used to boost an investor’s return, if successful. However, if unsuccessful, they magnify the investor’s losses. For consumers, debt usually just magnifies the original expense (loss). Interest and fees are usually charged on the loan or financing activity, which is the premium paid for an advancement of money that the consumer does not currently have.
Household debt levels are at worldwide records. Reduce debt levels buy attempting to pay off debts with the highest interest rates first. Avoid using debt for expenses. If your debt level is increasing, it is likely that your income cannot support the expense. The simplest answer is to avoid purchasing it until it can be covered. Don’t spread yourself too thin either, to avoid dipping into loans and lines of credit. Financial institutions and credit card companies spend hundreds of millions of dollars each year on advertising and promotional material alone, in an attempt to lure people into debt. Once caught in the vicious cycle, it is very difficult to get out. Many people end up being able to pay only the minimum interest payment each month. Over the course of time, the interest payments become much more than the original credit (loan) amount. Debt has become the modern form of slavery. Start slowly, and work at paying off bad debt consistently.
If you can’t make time for personal finances, how will you be able to make time for investing? Investors are really busy, because the faster knowledge is accumulated and capital is raised, the faster wealth grows. The sooner one becomes wealthier, the more time there is to enjoy it. People say they don’t have time to dedicate to personal finances. As with anything else, you have to make time, or your life never improves. As your personal finances become more efficient, the less time it will actually require. This is because there will be fewer financial problems to deal with, and also tasks will become more automatic. Try to make your life more efficient. Dedicate a little bit of time each week to thinking about (or working on) improving your personal finances. Go over all aspects that we have covered in this article. Assess the current status, see how the tasks can be improved or made easier. Determine if other changes are necessary or employ different strategies. Be patient, it takes time to see some results. But once results start having an impact, they will accumulate much easier. Think of a snowball, once you get it rolling and it picks up a bit of snow, it becomes easier to roll the ball into a larger one. Just get started and dedicate some time to it. Here are some ideas that will help:
– Set one hour on one day of the week to go through everything.
– Set 15 minutes, a few times a week, to go through different aspects.
– Read up on personal finance while you are idling (bus/subway, waiting, etc).
– Listen to audio books during the morning/afternoon commute to/from work.
– Do groceries on the way home from work.
– Run multiple errands on the same day.
– Internet banking – its safe, and its fast.
– Keep records organized in an easy to find place. File folders and a plastic filing box/tub are great.
– Use a calendar for bills and other activities.
– Be proactive – Give yourself some buffer room by not waiting for the last minute to do things. If something unexpected comes up, you have buffer room to handle them, without causing other problems due to missed activities.
– Avoid shopping on the weekend (lineups are longer, and traffic is heavier). That time can be better spent actually enjoying your weekend.
This concludes the Personal Finance series. The main focus of my site is not personal finances, but investing. However, its importance and relation to investing is unquestionable. The baby steps outlined in this article will help get anyone started with managing and improving their personal finances. Put the concepts into practice, and keep in mind the ideas that relate directly to investing in order to stay motivated! Although over the course of a few days nothing will look like it improved, but over the course of a year every little bit will have counted!
You should also congratulate yourself, as very few individuals have the patience, attention, and motivation to make it to the third article in this series (let alone the second one)!
The internet is filled with blogs and sites dedicated to personal finance, I recommend continuing on the personal finances side by constantly scouring the internet for more tips and ideas!
Thanks & Happy Investing!
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