Monday 30 July 2012

Managing Your Personal Finances

Okay, this may seem like an odd topic and maybe even an obvious one but somebody said something to me the other day which got me thinking about it and asking how anybody is supposed to know this stuff. I certainly didn't. I have heard tell over the years that the school system, well the system of my day, should have spent more time focusing on the practical things of life instead of the traditional disciplines.

Latin? Why the heck did I take Latin? The theory was to know the roots of our language but how did that work out? Why wasn't the focus on French or Spanish and doing what was necessary to see the practical value of learning those languages? And the title of the textbook? Living Latin. Now there's an oxymoron for ya.

Shop (for boys)? Well, I suppose but I can tell you that not once, not one single stinking time in my entire life has it ever come up that I needed to solder a watering can. Or make an ashtray. I could have used sewing on a button or doing a proper hospital corner or making an omelette. Hell, I can always buy a freakin' watering can.

I have heard in the last couple of decades that schools have taken to instructing students about basic finances like opening an account at the bank, how to write a cheque (sorry, "check" to you Americans), and how to calculate compound interest. When I grew up in the 1950s, schools didn't touch upon any of those topics. I think this is terrific but now that we are all in the wonderful age of computers, I wonder if everybody is doing enough in this regard.

Back in the mid-1980s in the age of DOS and the spreadsheet Lotus 1-2-3, I took up using my computer to manage my personal finances. I created a simple spreadsheet that laid out in a columnar fashion my income and my expenses and projected those items at least four months into the future. By dating when I got paid and when my bills were due, I could see at a glance how much money I currently had and how much I would need at any point in time. If I had $110 in my bank account and I could see that on Monday of next week I had to pay a bill worth $80, I knew that I had $30 to do other things. If I only had $70 in my account, I knew I had one week to figure out where I could get an extra ten bucks. ("Hello, Dad? I'm sure you're wondering why I'm calling...")

You may be reading this thinking this is so trivial it's kind of a dumb idea but I have periodically run into people who do nothing at all. And believe me, when it's a member of my family, it drives me bonkers. How the heck can anybody control their finances? How can anybody properly plan anything if they have no idea of how much they owe? In an age of growing consumer debt, I am imagining that there are a lot and I mean a lot of people who are not doing any financial planning at all.

Over the years I have migrated to Microsoft Excel and expanded my one spreadsheet to multiple sheets covering all financial aspects of my life. For instance, I have one to track my mortgage. I can see how much I owe and I can calculate into the future how much of my payment is interest and how much is paying down the principal. It was this more than anything else showed me in concrete terms what compound interest was and just how damn important a topic it is. I projected my mortgage to the end of the amortisation of 20 years then started playing "What if?" scenarios by sticking in supplemental payments and seeing what the effect was on the overall mortgage. I was stunned when I would put in an extra hundred bucks, yes just one payment of a hundred dollars and could see the effect cascade throughout the life of the mortgage and translate into saving me potentially thousands of dollars in interest.

What happened? Impressed by the potential savings, I started scrimping and saving to put together money to make extra payments on my mortgage. Every time I did this, I put the number into my spreadsheet and calculated the savings over the long run. It was amazing and it was also inspiring. Take a hundred bucks and blow it on something frivolous? That wasn't going to cost me one hundred dollars, no it was going to cost me maybe eight hundred dollars in extra interest I would be paying. Instead of being entertained by frivolous things, I became entertained by my mortgage and trying to pay it off early and save myself a ton of money in interest. Never mind a hundred dollars, even ten dollars would count!

An acquaintance put an addition on his house worth forty thousand dollars. He had a 25 year mortgage. I was so gung ho about my mortgage spreadsheets, I made one for him. I could show that if he continued to make the minimum payments over 25 years, he was going to pay back to the bank something like $120,000 or three times as much. What!?! I could show that if he paid an extra one hundred dollars per month which would come directly off the principal, he could pay off his mortgage in 15 years and the final total would be around $75,000. Is that unbelievable or what?

He didn't do it. To this day, I remain confounded by his lack (excuse the pun) of interest in his mortgage. Then again, I have come to realise that his approach to managing his finances was more like living hand to mouth. If he had a bill to pay of $100 but he only had $80, he paid on credit. It was as simple as that. Unfortunately that is a perfect example of somebody to think of when I read in the newspaper about growing consumer debt.

There is no dignity quite so impressive, and no one independence quite so important, as living within your means.
-Calvin Coolidge (1872-1933), American President (1923-1929)

Final Word
Is my spreadsheet the be all and end all? I'm sure others have devised better systems but my point is that it's better to do something than nothing at all. Living hand to mouth is no way to live and living in an unplanned fashion is a precarious way of living your life. However let me end by pointing out something which may not be at all intuitive.

We always associate being rich with big houses and flashy cars. Many times these accoutrements of the good life belong to professional people like doctors or lawyers. Being a professional doesn't mean you know any more about managing your finances than the next guy. I know stories of doctors who have gone bankrupt and lawyers who have spent it all. I also know of humble people in my home town who managed to become millionaires, not because they earned what a doctor or a lawyer makes but because they wisely managed their money over the years.

I have included below references to two fascinating books about finances. I would highly recommend to anybody trying to organise themselves and their finances to read them to better understand what's possible and what you yourself can do. I may not be Donald Trump and I may not win the lottery, but that doesn't mean I can't be wise about living my life and paying for it.

Slow and steady wins the race.
-Aesop, The Hare and the Tortoise


my blog: Book Review: The Millionaire Next Door
The authors originally set out to study millionaires in the United States. They visited posh neighbourhoods but discovered those people driving luxury cars and living in expensive homes didn't necessarily have much wealth. They began to discover something odd which went against their preconceived notions of what or who a millionaire was. These people may have had high incomes but they were spending it all.

Thomas Stanley, one of the authors was quoted as saying, "Most people have it all wrong about wealth in America. Wealth isn't the same as income. If you make $1 million a year and spend $1 million, you're not getting wealthier, you're just living high."

They found a group of relatively unknown people in society who were actually wealthy. Now not wealthy in terms we would usually consider, certainly not wealthy like a Donald Trump, but they did have a net worth of one million dollars or more. It just didn't show when you looked at them.

my blog: Book Review: The Wealthy Barber
At the tender age of 25, a young David Chilton sits down and writes a short book which encapsulates some wisdom about financial planning in an easy going, easy to understand story. This accessible guide to becoming financially independent goes on to apparently sell over 2 million copies in North America. When I first "discovered" the book in 1991, I became so enamoured with its message, I bought a dozen copies and gave one to every member of my family and then to several of my friends. It opened my eyes to some very common sense ideas which for some reason had escaped me.

Wikipedia: Compound interest
OMG!!! If you don't know anything about this you MUST learn it immediately!!! Are those enough exclamation marks?

About.Com: Basic Budget Worksheet for Setting Up Your Personal Budget
This is similar to what I do but it is even more detailed and complicated than mine.


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