Money Management 101
Most of us start our work life with the future in mind. The goal is to build our net worth so that we can live comfortably, give our kids a good education and enjoy our post-work life any way we please. Making that happen comes down to some very practical, immediate realities: keeping track of the money you have coming in and going out, paying down most expensive debt first and building up assets.
While no one likes to hear the dreaded word, the fact is that a budget is a tool that helps to ensure you have the money available to meet your goals. By analyzing where your money is going today, you have the information you need to make some changes and allocate your hard-earned dollars to the goals that are most valuable to you. Which is more important: to have that new big-screen TV, to have enough money to go on vacation next year, or to save for a down payment on a condo? Only you can decide. But if you want to have all the facts to make the right call, a budget is your best bet.
- Keep track of all expenses for three months using our Cash Flow Worksheet, even the out-of-pocket nickel and dime items.
Then estimate how much you spend per year in each category. You may be surprised at what you find!
Did you know that spending $5 every workday on that latte costs you $1,250 per year? Maybe you'd rather spend that money on something else. Our clients can use BMO's MoneyLogic tool to help identify these opportunities and build a budget for their day-to-day money management to reach their financial goals sooner.
- Use the information you've collected to make the budget.
This is where you get to decide what you want your ideal monthly spending pattern to look like. It's a very personal decision–you have to decide what's important to you and what you are willing to sacrifice in order to meet your goals.
- Get creative if you need to reduce spending.
Cutting back doesn't mean doing without. Look for cheaper alternatives, such as using the library instead of buying books. Plan to eat lunch out once a week instead of every day. If you find an opportunity to "bundle" expenses, take it. Many Internet and cable providers now offer telephone and mobile service as well. Bundling those services together can produce a significant monthly savings.
The difference between assets and debt is your net worth. And while growing that net worth may sound simple—own more than you owe—the fact is, the average Canadian household now carries a ratio of total debt to after-tax income of over 150%.1 Addressing that shortfall requires a clear understanding of the type of debt you're carrying and taking the necessary steps to pay down most expensive debt first.
When you analyze your spending, you may find that you're paying a lot in interest charges on your credit card, car loan, or line of credit. Most of this is what financial planners* consider "bad" debt. Bad debt is debt that you take on to buy personal items, such as cars, vacations and appliances. These items depreciate in value—they do not contribute to your net worth. Furthermore, the interest you pay isn't tax deductible, so it's a very expensive form of borrowing.
That said, the reality is we often have to take out a loan to buy an item such as a car that depreciates in value. It's important to try to reduce or eliminate bad debt as quickly as possible. Here are some tips to think about:
- Keep your amortization period short—the shorter the borrowing period, the less you'll pay.
- For major purchases save as much as possible to put towards your purchase, as a down payment
- Do your research to find the best rates such as a secured line of credit.
- Work on paying off your highest interest rate debt first.
- Limit yourself to one credit card that you pay off in full each month.
- If you have outstanding credit card debt at a high interest rate, it may be worthwhile to pay it off with a personal line of credit at a lower rate. Check out the chart below to see the benefits of moving a $10,000 balance from a credit card at 19.9% to a personal line of credit at 4%. Not only would you have the debt paid off 13 months earlier, you'd save over $4,053 in interest charges! Even by moving to a credit card with a lower rate, you'd still save money. If your interest rate dropped to 12.9%, you could have that $10,000 balance paid off eight months earlier and would save over $2,231 in interest charges!
|Credit Card||Low Rate Credit
|Interest Rate||19.9%||12.9% with an
annual fee of $45
|Total Time to Payoff||4 years, 1 month||3 years, 5 months||2 years, 11 months|
|Total Interest Cost||$4,678||$2,447||$625|
Good debt, on the other hand, is debt you incur to buy things that go up in value or add to your earning power—real estate, investments, education. With the exception of your principal residence, the debt you incur for these types of purchases is usually tax deductible.
The Bottom Line
Managing debt is a simple concept but can be much more challenging in practice. Assessing your spending patterns and determining whether you should focus on paying down debt or saving for other goals such as retirement can be hard, especially when there never seems to be enough money to do it all.
A financial planner can help. In addition to working with you to create a budget you can stick to, he or she can develop strategies to reduce your interest costs and make the most of the funds you have available. And that's what good money management is all about!
Let's talk. Call a BMO Financial Planner today at1-888-389-8030
1(2011, December 13). Household Sector Indicators. Statistics Canada. Retrieved March 12, 2012, from www.statcan.gc.ca
*BMO financial planner refers to Financial Planners, Investment and Retirement Planning that are representatives of BMO Investments Inc., a financial services firm and separate entity from Bank of Montreal.