PERSONAL FINANCE : PREPARING YOURSELF : THE BOTTOM LINE : How to Get a Picture of What You’re Worth
So you want to save money for a down payment on your first home, or for your children’s college education. Or you are trying to build a nest egg for retirement.
Can you do it?
To find out, you need to create a personal financial plan. Such a plan will help you determine, among other things, if you are saving enough to meet your financial goals and if you need to adjust your spending.
“You have two options,” says Roy Weitz, executive director of the American Assn. of Personal Financial Planners in Woodland Hills. “You can save or spend. If you spend your money on consumer goods that won’t increase in value, the money is gone from your life forever.”
Creating such a plan could cost you a few hundred dollars if you had a financial planner do it for you. Here, for free, are steps to begin creating the plan for yourself (if your household earns less than $25,000 a year, this plan may not apply to you because, realistically, you are not expected to be able to save very much):
1. Make a list of your goals. They could include buying a mountain retreat or a new pleasure boat. Rank them in order of importance to you.
2. Fill out the accompanying personal net worth sheet. It will give you a snapshot of your financial condition and help you determine whether you have enough money to meet your goals. It will tell you how much you are worth and can give you a fast reading on how you spend your money.
To prepare your net worth sheet, first look at your assets. They are divided into two categories: liquid and illiquid. Your liquid assets are cash and securities that can be converted quickly into cash, such as stocks, bonds, money market accounts and mutual funds.
Financial planners say you should have enough cash readily available in bank accounts or money market funds to cover between three to six months living expenses, in case of a financial emergency. This means that if your monthly expenses are $2,500, you should have at least $7,500 put away to get over tight spots, such as a job loss.
The fund can also be used for unplanned expenditures. For example, “if you see a $1,000 chest of drawers, you can buy it with the money set aside,” says Roger Schwarz, a Los Angeles financial planner. But, Schwarz notes, be sure to replace the money.
Next, look at your illiquid investments, or those that aren’t so easy to convert to cash. Your employer can tell you how much you have in your 401(k) account and other benefit plans. You’ll have to do some checking to place a value on your other possessions. Look at real estate ads to estimate the value of your home. Auto ads might help indicate the value of your car.
Be careful not to overestimate the value of your possessions; you might not be able to get what they are worth if you had to sell them quickly to raise cash for an emergency. Weitz says he encourages clients to assess their valuables at whatever they would receive from Goodwill Industries.
“No one sells the furniture unless they are desperate,” Weitz says. Putting too high a value on personal possessions, such as pianos or exercise equipment, “can make you think that you’re better off than you really are,” he says.
Now that you have a picture of your assets, take a look at the numbers. Financial planners say that liquid assets should be 15% to 50% of your total assets, depending on the size of your financial goals. This means that if your assets are worth $500,000, you should have at least $75,000 in cash and securities.
“Goals require cash or available cash,” Weitz says. The money you need to meet your goals “does not come out of furniture, cars and toys.”
Now it’s time to take a look at your liabilities, or debts. First, add up your unpaid bills, including charge account balances, mortgage or rent payments, utility payments, tuition payments and medical bills. Next, add up the total amount of what you owe on loans, including mortgages, car and education loans.
Financial planners say your unpaid bills and outstanding loans should total no more than half your assets. If your debts are higher, you have too much debt and are probably finding it hard to save.
3. Fill out the accompanying cash flow statement. It will help you find out where you can reduce spending to save more money.
Start with your annual income and subtract all taxes--income, property and others--to get your after-tax income. The best place to find these numbers is on the income tax form you mailed to the Internal Revenue Service.
It’s a little harder to trace your yearly expenses. “People know what they earn almost to the penny but have no idea how much they spend,” Weitz says. “It’s really an accounting problem.”
Weitz and other financial planners suggest going through your checkbook and credit card statements to trace your expenses. Add up your cash withdrawals and try to allocate them among other expenses, such as entertainment, food or recreation.
Again, don’t underestimate your expenses, especially in such vague areas as entertainment. As Schwarz says: “Food you cook at home is a food expense, but food you eat in a restaurant is entertainment.”
The difference between your income and expenses is the amount left over for savings and investment. Financial planners say this amount should be 5% to 10% of your after-tax income--more if you’re trying to meet strenuous financial goals, such as a down payment for a home or college for the children, or a not-too-distant retirement. This means that if your after-tax income is $30,000, you should save or invest at least $1,500 a year.
Financial planners agree it’s toughest to save for a down payment on a home because most people want to pile up large sums as quickly as possible. At the same time, future home buyers often are unwilling to invest their savings in stocks or other risky investments that have the potential to rapidly add to their savings.
For a down payment, financial planners recommend investing your savings in a bank account or in a money market fund. Advisers warn against locking money into long-term certificates of deposit. If your dream home comes along before the CD matures, you’ll pay a big penalty to cash it in.
If saving for retirement, don’t forget to include the money that is in your company 401(k) savings plan or any other retirement plan. You might find that these plans are taking care of much of your retirement savings needs.
If you’re self-employed, don’t neglect saving for retirement. “If you put every dollar you make back into the business, you’re going to be a lot worse off at retirement than your neighbor who works for Lockheed or General Motors,” says Schwarz.
Financial planners say you should start saving for your child’s college education early. Once your child approaches college age, it will take more aggressive saving to accumulate enough funds for ever-increasing college tuition.
What if the money you have left for savings and investment is less than 5%? You are probably spending too much on entertainment or possessions that won’t increase in value, such as clothing or furniture. Go over your cash flow statement and look for places where you can cut back.
Recognize the danger signs. Are you drawing on your credit card lines to pay living expenses? Are you raiding your savings accounts or your child’s education fund to pay bills?
Financial planners say there are a few ways to determine where your spending problems might be. Look at your net worth and cash flow statements. Compare your after-tax income from your cash flow statement to your total debt on your net worth sheet.
Weitz says that non-mortgage consumer debt--car loans and charge card balances--shouldn’t be more than 10% of your annual before-tax income. If it is, “what should be going to savings is going to your charge cards.”
What should you do if your spending is falling short of your goals? First of all, financial planners say, don’t panic. You have plenty of company. Many people spend more than they should.
Next, commit yourself to a change in life style. Get rid of most of your credit cards and stop buying extra clothes and other niceties you don’t really need. And, financial planners warn, don’t borrow large sums to buy possessions that won’t increase in value. Weitz says it’s a mistake to borrow several thousand dollars for a vacation, for example.
Also learn to keep track of your spending. Weitz says one trick is coding your checks. Divide your expenses into categories and assign them a code. For example, clothing could be “C” and entertainment “E.” Write this code on your checks and then record them in a ledger. Very quickly, you should get an idea of where the money is going.
Financial planners also encourage you to look for tricks that force you to save. Schwarz suggests whole life insurance policies because they have a savings aspect. Other financial planners suggest using any payroll deduction plans available at work that will help you save.
And, says Weitz, don’t forget to increase your savings as your income rises. If your wages rise by $30 more a week, add some of that amount to your savings. Otherwise, your savings won’t keep up with inflation.
