Keep-It-Simple Financial Planning (Part 1)

CoinsWhen you look at your finances, do you feel empowered or depressed? There are few things in our personal lives which run to such extremes as our finances. Do you understand how to pay off your debts? Will you be ready for your retirement? Will you be able to retire? Do you get calls from collection agents because you have late bills? When an investment advisor tells you they have the perfect investment, do you know how to do the research for yourself, or do you blindly follow along, and get burned when the "hot" investment is a failure? If any of these are true for you, then I have good news: you can live comfortably now, pay off your debts, and prepare for the unexpected problems in the future.

Humans live with an insatiable amount of desires. We have more desires than we have resources to fulfill them. Bill Gates, the richest person in the world has them, I have them, and if you examine yourself carefully you will find that you have them too.

There are two ways for us to deal with all of these desires: we can spend for every desire regardless of our income; or we can think about what we really want, control ourselves and make a plan to reach our real goals and desires. The first option will cause us to dig a financial hole that we may never dig ourselves out of. The second option will allow us to achieve our true goals, and help us to achieve financial freedom.

Striving to follow the common-sense notion of "plan and save" is hard, because there are people constantly trying to convince us that there are things we need now. They use phrases like "You Deserve It!", "No Money Down!", "Thirty Days Same as Cash," "Buy Now, Pay Later," "Buy with your _____ Card and Save 10%!" These messages are powerful siren songs that lure people away from their paths.

Economists talk about how people choose between desires in terms of utility. For example, when we have a dollar and choose to get ice cream over candy. We have decided that --at the time-- ice cream has a higher utility to us than candy. Sometimes, the messenges above convince us of utilities that may drive us into debt.

So, is debt bad? The answer is yes and no: debt is a tool, which can be used to accomplish good in your life. It will help you get through school, buy a house or car. Debt can also be bad. If you are spending more than you make, you will eventually be unable to pay off your debts. Then you can lose your home, your car, or ruin your credit, which is your ability to gain new loans.

There is an old saying in the business world -- "Those who understand interest, collect it, and those who do not, pay it." When you take on a debt, the debt amortizes. This means that you have the same payment for the length of the loan, but the amount of the payment that is interest will be greater at the beginning of the loan. For example, if Mr. Jones buys a house for $200,000.00 at 15% interest rate for a year, in a 30 Year loan each of his payments will be divided between that interest and the principal. Principal is the amount of the payment that actually repays the loan. Interest is pocketed as profit by the lender. On this loan he will pay $2,528.89 a month for the loan. In the first month of the loan he will pay $2,500 in interest, and $28.89 in principal. In the last month of the loan he will pay $31.20 in interest, and $2,496.30 in principal. So, in this loan, Mr. Jones will pay $710,398.31 in interest over 30 years. The process of amortization of a loan is usually expressed in a table, starting with the first month of the loan, and ending in the last month of the loan. Interest each month is figured by multiplying the monthly interest rate by the balance on the loan after paying the principal the previous month. Your loan's Annual Percentage Rate, or A.P.R., is found by multiplying your monthly rate by twelve. We'll get back to this a little later.

Because our finances are a very important part of our lives, we need to track them, and know where we are at all times. I suggest that you keep all of your financial information together in at least two places. You can make a finances section in your handy planner, keep it in a separate folder in your office, on your computer, and so forth. This information is too valuable to lose, and it also needs to be where you can easily see it when you need to.

I suggest that you decorate your financial planner with images that show you why you are going to stay on top of this aspect of your life, and make a plan to get, and stay out of debt. Some suggestions for inspiration could be pictures of family, images representing your dreams, and goals for your life. Just be sure to keep ALL important financial papers in a safe place that will survive a major natural disaster. This way, if the papers are destroyed, then they are easily misplaced.

What are some possible contents of a financial planner section? The following are some possibilities:

  • A Net Worth Analysis, a summary of what you own versus what you owe.
  • A Get Out of Debt Plan, a solid plan in writing to pay off your debt.
  • Monthly Budgets, to handle the tracking of your finances throughout the month.
  • A Bill Tracker, a list of all of your bills in one place, with payment amounts.
  • A Financial Plan, your overall plan to reach your financial goals.
  • A summary of all accounts -- a listing updated regularly of the balances on all debts, bank, and investment accounts.

Remember this should be YOUR planner, make it what you need to be successful.

Net Worth formThe first step of starting your financial plan, and therefore getting out of debt, is to conduct a Net Worth Analysis. It's snapshot of where you are financially, right now. Basically, we are going to list what we make, and what the items we own are worth if sold, and subtract from that all of our bills and debts. I have made a sheet for this exercise, called Net Worth Worksheet. Let's start by printing out the Net Worth Sheet, which is attached to this article in a zip file (see below) containing a PDF document and its source file, done in OpenOffice.Org Draw.

Let's start with assets. An item is an asset if it makes you money, or can be sold for money fairly easily. Some examples of assets are:

  • Houses
  • Automobile
  • Computers
  • Furniture

You should also remember to include your income under assets. I suggest that you record your income after taxes, and multiply one month's income by twelve, to get a year. Once you have listed all of your assets under assets on the Net Worth sheet, add up the values of each asset and list it under Total Assets. Remember to write down both the name of the asset, like "car," and its value, like $1,500.00.

Now list out all of your liabilities. Something is a liability if it takes money away from you. Start by listing all of your bills, and multiply each monthly bill to be a yearly value. Next list all of your debts, items that you pay because you owe someone money.

The last step is to subtract your liabilities from your assets. Something is a liability when it can be considered money that you owe. This can be debts or bills. I suggest that you take one month's payment and multiply it by twelve for a yearly bill. List each liability with its name and amount. When you have all of your liabilities listed, then add up the amounts for all of them, and record them under Total Liabilities.

Is the number positive, meaning you have more assets than liabilities? Or the number negative meaning you have more liabilities than assets? You now know exactly how much money you owe, who you owe it to, and what it will take to pay them off. With this knowledge, you will be able to create a full blown plan to get out of debt after my article next week!

AttachmentSize
NetWorth.zip42.25 KB
Syndicate content

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.

Debt and Dave Ramsey

According to Dave Ramsey, a way to financial peace is to pay cash for everything except your house. And assign every dollar a place to go based on priorities and then make sure it gets there.

Thank you

Thank you so much. This is honestly the very first financial explanation I have ever read that seemed to be clear and written in terms a layman can understand. It is very much appreciated and will be valuable to me in the future.

Spelling correction

The part of a loan repayment which refers to the amount borrowed is actually known as principal.

The word principle has a completely different meaning.

I couldn't bite my tongue about this, given that the author made a point of (mis)defining the word.

Correction made

Thanks for pointing out my error. I have corrected my spelling.

Typo

In the following sentences from your article:

"Just be sure to keep ALL important financial papers in a safe place that will survive a major natural disaster. This way, if the papers are destroyed, then they are easily misplaced."

Probably you meant for the last word to be "replaced", rather than "misplaced". :)