This step is a hugely important advance in getting control over your finances with the ultimate goal of moving away from living paycheck to paycheck and instead working towards a situation in which you live on last month’s income. Being one month ahead of your finances takes away a lot of stress and worries and gives a small extra financial cushion in your account. I’ll discuss the advantages and disadvantages of this practice first before looking at how you can implement this.
Being one month ahead essentially means that you are using last month’s income for your current month’s expenses. It means that you are ahead of your finances by having an extra month’s pay in your bank account. The money that you are earning this month won’t be used until next month.
The advantages of getting one month ahead
The biggest advantages of being one month ahead include:
It doesn’t matter if you get paid 2 or 3 days late, or if a bill comes in earlier than expected.
You don’t have to worry about going out next week instead of this week if you haven’t yet been paid.
If a bill is larger than expected or budgetted, you don’t have to worry about not having the money and it gives you time to readjust your budget next month.
Lastly, if you have a variable income, you can see a lower income month coming with some warning in order to make any necessary adjustments in your spending .
In the previous step we’ve looked at asset allocation and using the yearly rebalancing technique to keep the right balance between your various assets in your portfolio, even if some of your assets grew more than others, thereby taking up a bigger percentage of your portfolio. In step 73 we’ll look at how rebalancing your portfolio can also help to readjust your portfolio when you get closer to your goals. In the examples below I mainly use retirement as a goal, but it can of course be other goals too that you might have in mind for your investments, such as a college fund for a (grand)child, a down-payment for a house etc.
Let’s assume that you have a 70/30 shares / bonds allocation to start off with in your portfolio and that the main goal for that portfolio is to use it as (an addition to) your pension provision. With time when you start nearing retirement, you might become a little nervous about the possible volatility of this portfolio however. What happens if there is a sudden crash in the market and you lose a big chunk of the money in your portfolio right before or after you were planning to retire? It means you suddenly wouldn’t have the same amount of money available that you maybe planned to have, which would probably compromise some of your pension plans. Of course when you’re 30 or 40, having a portfolio with a bigger risk factor doesn’t matter as much as your portfolio still has time to recover after a possible crash before your retire. But when you’re close to retirement age, you don’t have the same luxury of time and you probably don’t want that same volatility anymore as when you were younger. Continue reading “Step 73: Lifestyle Investing Option”→
This and the next step look at managing your assets in your portfolio on a long-term basis to ensure they remain aligned with your goals. With time some assets might grow faster than others, goals might change or you might want to change the risk level of your portfolio the closer you get to your goals. In all cases this can be dealt with by rebalancing your portfolio and re-allocation your assets. Similar to the investing principle of “buy when everybody else is selling”, which we discussed in step 54, the rebalancing of your portfolio is another investing concept which is easy to understand and execute logically, but can be difficult to implement psychologically.
The yearly rebalancing of your portfolio ensures that if one area of your portfolio does really well in one particular year, you don’t deviate too much from the original asset allocation that you had in mind for your portfolio. If one assets grows much more than another, it might make your portfolio too volatile or too safe for your goals and risk tolerance.
Let’s look at an example and assume that you want a 70% shares and 30% bonds allocation in your portfolio. You put in $10.000 and the moment you enter the market both bonds and shares happen to be $100 per unit. Ignoring costs for the sake of this example, that means you’d have $7.000 in shares and $3.000 in bonds. A year later the shares have far outperformed the bonds, and even though both have gone up in prices, your bonds are now worth $3150 (a 5% increase), whereas your shares are now worth $8050 (an increase of 15%). The stocks and bonds allocation is now no longer 70/30 but 72/28. Not a huge difference you might think but if the shares keep outperforming bonds by that much for a few years, you might end up with an 80/20 portfolio in just a few years. Continue reading “Step 72: Rebalance your Portfolio”→
Once you’ve got a taste for investing, you’ll likely want to investigate other options that allow you to invest some money, either to diversify your portfolio, support a small start-up, increase returns or simply for fun to see what happens.
A hugely popular new way of investing (or indeed raising money if you are on the other side of it) is crowdfunding. Crowdfunding is a way for companies, entrepreneurs and start-ups to get together a sum of money to set up a business, launch a new product or expand and open a new project or department.
Types of crowdfunding
There are different types of crowdfunding:
In P2P (peer-to-peer) lending, capital is raised by getting many different loans of small amounts together. Instead of getting one loan of $30.000 from the bank, entrepreneur(s) might get as many as 200 different people lending them amounts between $50 and $1000 for example. Like with a bank loan, the entrepreneurs are then paying the loans back over time with interest to their investors.
Pre-sales in which people can pre-order even before a product has been produced. Those initial investors will get a first release or even a small present several times a year (for example a new exclusive wine or another small new release).
Selling shares and having people invest in your company in return for a small ownership in your company.
Now that you’ve been through the various steps on expenses and budgeting, saving, pensions, investing and planning for your future, it’s time to go back again to the bit on debts with one debt in particular which is probably your biggest debt: your mortgage (providing you have one – otherwise you can skip this step). We of course spoke about paying off debt at the start of our mission, but as we said there, since your mortgage has a lower interest rate than most of your other debts, chances are you haven’t yet started paying it down faster.
As commented before many people would argue that a mortgage is a different type of debt and therefore not to worry about as much as they see having a mortgage as an investment. At the end of the day they say, your house is an asset that will probably increase in value over time. I disagree for several reasons:
first of all it isn’t the same type of assets such as stocks and bond that you can just sell to generate some extra money. The only situations in which you can argue that your house is an asset like any other is when you don’t need it anymore for example because you decide to:
move in with somebody else
live in another house that you already own or rent
scale down and don’t need a mortgage on a new house
live on the streets
secondly, you never know when you can sell your house. Some houses are on the market for years, so liquidating that asset isn’t as easy as with other assets.
thirdly nothing guarantees your house will truly increase in value or have increased in value by the time you need or want to sell. During the recent house market crash, many houses were sold below their original purchase price.
fourthly you are still losing money by having a mortgage in the form of interest payments and you are tied to paying back regularly so until you pay off your mortgage in my eyes this is a debt that takes a big toll on your monthly finances.
In the previous step we looked at how setting aside even small amounts of money can give your (grand)child(ren) a very nice mini-fortune by the time they turn 18 if invested well. Of course you (or they) might be unlucky and the market might just hit a bad year when they turn 18 (or 21 or 25) but who’s to stop you from waiting another year or 2 until the market has recovered again before you hand over the investment account?
But then what’s to stop them from spending all of the money – the money that you set aside deligently for years, making the most of that compounding interest – in one weekend, on one holiday or on a (in your view) stupid purchase?
Of course the problem with this is that you might be skimping and saving to get this money together, but once you give it to your child, remember it is their money. Whether they splurge on a luxury vacation, use it to fund their college or as a first downpayment for their house is ultimately their own choice..
That said, as a parent or grandparent you have a responsibility in educating your children about finances. Funnily enough we are totally cool and understanding of having to teach our children social skills in order to make friends and to respect others, help them with any maths or French homework and teach them basic personal care skills like cooking and the importance of having showers, but the financial education is often neglected. Whether people don’t want to bother innocent children with grown up matters, think that school will teach them this stuff or just generally feel uncomfortable about discussing money with their children I don’t know, but teaching children about money is an important role any parent has. And if you do your job well and teach them the real value of money, your children might be less likely to spend all of that money you gift them when they turn 18 in one go.
So let’s look at some ideas on how to teach children the real value of money from an early age on:
On a day out, or weekend away or even a holiday, give children a mini budget for themselves or tell them that as a family you have a total budget of say $40 that together you need to decide on how to spend. They get to vote (or decide) whether to have a simple sandwich and some money for an ice cream and a small souvenir or whether to go for that slightly fancier meal but not have any extra money for an ice cream nor souvenir. This helps them develop skills in budgetting.
Make them aware of bills that need to be paid, such as utilities and get them to play their part in turning off lights, closing doors and not letting the tap run when brushing their teeth.
Turn grocery shopping into a competition by finding offers, 3-for-2 deals etc.
Give them a small amount of pocket money from an early age on to get them to save up for a bigger purchase they want. It teaches them the value of saving, planning and prioritizing.
Open a savings account and get your child to deposit money in it, even if it is small amounts. Explain interest and compound interest to them and get them to see their money grow.
When your child is a little older, explain the concept of the stock market and investing and mention the investing account that you have opened in their name so they can also see how their investments are growing. Show them to sit tight when the market falls and the importance of patience on the long run.
Teach children about debt and how this is expensive in the long run. The best way for them to learn this is by giving them a small loan and charging interest on it. A tough lesson to learn but it will be a very valuable lesson. Even if they end up paying $5 on a loan of $10, those $5 will teach them a life long lesson on how interest and compounding interest on a loan will ultimately be a killer to their personal finances.
Go through credit card statements together with children or spend your weekly administration and filing system together with your “personal assistant” to teach them the importance of checking financial statements regularly for errors and to stay up to date on how (un)healthy your finances are.
Consider some type of “savings match” or interest you give children for every dollar they save if they haven’t yet got a savings account. This could be done monthly by showing you how much they have saved and after you count it together you give them a certain amount of interest or match their monthly contribution.
Explain to children how we are constantly tempted to spend money by adds and peer pressure. Teach them how these adds work and get them to evaluate whether they really need that new gadget or toy and whether it will add new value to their life.
Get children involved in sharing their wealth through donating to charities or fund raising for charities so they get to appreciate that there are many others who are far less lucky than they are and that that they can make a difference to the world by giving some of their money away or by getting involved in deciding which charity you should donate to.
Step 69 – Involve your Children – in detail:
Discuss with your partner the importance of teaching your children about the value of money and agree on a basic approach to this. It is important to discuss this and be aware of each other’s involvement and ideas so that you don’t clash over this.
Consider a set time a week, maybe at the weekend, which is dedicated to finances. This could be 30 minutes in which you discuss something new, go through a new target for the week or count savings and update financial statements. Depending on your child’s age these activities might evolve into more complex activities and the 30 minutes might become longer.
Find a balance between teaching your children the value of money, saving and investing without taking away from the fun. Make sure not to turn ALL of your fun family days into skimping or budgeting days – kids should also be able to enjoy these days! Don’t overload your children with information but see it as a step-by-step progression that takes time, skills and awareness to develop (a bit like compounding interest come to think of it!).
If done well, these finance lessons can become a great headstart for your children in life as it gives them so many skills that others might take years to discover by themselves when they are in their 20s and 30s. Just make sure to make it appropriate to your child’s age and awareness. Happy teaching!
Children cost money of course, even just their day-to-day expenses seem endless: clothes, food, extra activities and birthday parties to name just a few. But I take it for granted that if you have children, grandchildren or nieces / nephews (even if they are “adopted” and your friends’ children), that these expenses are covered in your budget, either in your regular categories, or under ‘presents’ if they aren’t your own children. If you haven’t yet got children, but are planning to have children, I again assume that by now you are financially savvy enough to have set up a savings account in order to pay for the initial “start up costs” for children: baby room decoration, push chair, car seats, clothes and all other assecories you’ll need.
But what about “later”? This might sound like a long time away still, but those children will at some point reach their 18th birthday and will go and try their luck in the real world, whether that is at college, travelling or trying a “real” job, there will come a time when they no longer depend on you (at least not officially – they might still come back home from time to time to ask for some extra money).
Wouldn’t it be nice to be able to give them something more than just a $50 bill when they leave the house, to get them set up? Or what about giving them something when they get married, buy their first house or have their first child.. Whatever it is that you decide, think about what you can do now to help them later. And remember that if you start on time you have the advantage to look ahead and use that best friend of ours: compounding interest to create a small fortune for your (grand)child(ren).
What and how to save
Let’s just calculate through some different scenarios to give you an idea on how to get started. For all of these we assume that you start contributing to these saving plans from the moment the baby is born (or let’s be realistic and say you do it as soon as your (grand)child is a month old).
Scenario 1: Open a savings account and set aside $10 a month. Assume an average return of 5% (which unfortunatley is not likely at the moment though!), an inflation rate of 2% and that you keep contributing $10 a month until you give the child the full amount. Your (grand)child would then receive the following amount: (numbers in 3rd and 4th column rounded to $50).
Total paid in
Nominal value at end
Adjusted for inflation
Not at all bad if you could give your (grand) child some $3550 when they turn 18 or even $6000 when they are 25.
Scenario 2: What about instead of opening a savings account (which is unlikely to give you anything close to 5% for a while), you put that money in an investment accout, assuming a 7% return and 2% inflation rate? That works out as follows:
Adjusted for inflation
As you can see, by just putting away $10 a month, even if you held it only til they were 18, you’d be able to give them more than $4300 or the equivalent of $3000 in today’s money.
Scenario 3: Of course, you might be able to set aside more than $10 a month. Let’s assume you’re lucky enough to live in a country that has a child benefit scheme in which you get some financial support from the government to help with the expenses for raising children. Imagine you were able to set all that money aside and invest it for your child? Child benefit varies greatly per country but let’s take the average of about $75 per month. Let’s assume we’ve still got an average of 7% return and 2% inflation rate. This is how much you’d have if you keep investing that child support:
Adjusted for inflation
By their 18th birthday you’d be able to give your child $32,500 (with a current value of $22,000)! That’s a small fortune to me and it for sure would be to most 18 year olds!
That said, child support is generally likely to adjust for inflation, meaning that you get $75 this year, but $76 next year and $77.50 the year after. As long as you keep adjusting your investments along with this, remember that you would then end up close to the nominal value anyway. In that case your child would receive around $32.500 on their 18th birthday.
Of course the above are just some examples of have careful financial planning might give your child a nice head start when they turn 18 or 21 or whatever age you decide. Maybe you can’t survive without the extra child benefit that you are receiviving and therefore can’t invest all of that money. But what about half of it? Or even just $25 a month? $10? Go back to the budgetting steps to read more about how to budget and to build in priorities to decide whether you really can’t or whether you decide to prioritize other goals for your money. Even just the $10 will still give your child a nice pot of money to start their adult life that not everybody gets.
Step 68 – Set aside Money for Children – in detail:
Let’s start with how many children, grandchildren, nieces / nephews or other children in your life you (might) have and who you’d like to help financially when they come of age.
Investigate and decide how much you can invest either monthly or yearly. Remember that if you have several children (or might have several children) or grandchildren, you probably want to set it up equally, so that you don’t invest $100 per month for child one and only $20 for child two. Plan ahead and try and keep it equal!
Open an investing account for each child but carefully check how to do the legal side: make sure you can open it in their name (in some cases only parents can do this). If you are a grandparent and you can’t open it in your grandchild’s name, consider opening it in your name, but stipulate the child as the beneficiary and make sure to include conditions in your will that the money is to go to the child when they turn 18 and not to your heirs.
Set up automatic payments into this investing account.
Remember that the earlier your start, the more time the interest can compound, but even if your (grand)child is a little or a lot older, that doesn’t mean you shouldn’t still open it.
Decide when you want to give the money or the original investing account to your child. Instead of giving them the money, consider that your child could just continue to grow the money. Tell you child beforehand so they can start planning on what to do with the money, as otherwise they might be tempted to take it all out and spend it in just one crazy weekend.
Remember to open a new account for any additional children
Saving / investing and seeing your money grow can be really rewarding, but there’s an extra sense of satisfaction you can get from setting money aside for somebody else, and seeing their fortune grow even before they are aware of it.
In the previous step we looked at how to organize your paperwork and file important documents to make sure you never have any financial document “misplaced” somewhere around the house when you need it. Of course in this day and age, having a physical filing system might not be your thing. Perhaps you prefer to have all your papers stored digitally.
There are a few advantages of digital filing:
it takes up less space in your house
a lot of your documents might already be digital (your utilities bills might already be sent to you by email instead of by post for example).
digital documents can be searched easier with tags or keywords
digital files don’t have the risk of fading or getting torn accidentally.
If you rather have everything in digital format instead of in variour folders in your home office, let’s look at how to set up a digital filing system quickly and efficiently.
How to digitize
You need to get all of your papers in digital format in some way and the easiest ways to do so include:
Opt to get as much as possible sent to you digitally: utilities bills, bank statements, insurance policies etc. Most companies and banks have an area in your personal area online (after you log in) where you can also find your last couple of statements.
Scan other documents such as receipts and payslips that you can’t get sent to you by email. This of course requires you to buy a scanner so you can scan these papers and send them to your computer.
take a photo of the document with your mobile phone (make sure it is of a good enough quality) and send it to your computer or filing app such as Evernote – there are some apps available that can do the work for you even better than your regular phone camera.
How to store your documents
Digitizing your documents is only step one: if you still don’t have a filing system in place to store your documents, but have them scattered all over the place on your computer or in your email, it is a little bit like having several big shoe boxes around the house with a collection of papers in them everywhere: you still won’t be able to find anything and you could have saved yourself the hassle of scanning all those papers. Here are some ways to set up a proper digital filing structure and save those documents in a logical way:
Use your email – some bills might already be sent into your email and if you use a scanner or the camera of your mobile phone, it is easy to forward these documents straight into your email. You can set up various folders and sub folders similar to what we discussed in the previous step on a physical filing system.
Use your local hard drive – create folders into which you download and save the documents.
Use an external hard drive – in addition to using your local harddrive on your computer make back ups on another external harddrive. If you don’t and your computer busts, you’ll be left with no filing system and documents. You can set up automatic backing up of your computer, for example once a month.
Use CDs, DVDs or a pendrive as long-term back ups in addition to the hard drive. You can decide to save your entire filing system easily in a few minutes. It’s a good idea to keep a copy elsewhere, away from your house, just to be safe. It can’t hurt to have your files stored away somewhere else in case anything ever happened.
Use the cloud – google docs or other online storing systems work well to make sure your information is safely stored and accessible from anywhere if you feel comfortable having your documents stored online.
Use a specific programme such as Evernote – this often lets you clip, store and attach photos to notes and documents, you can again set up a similar folder structure. Like google docs, an advantage of a programme like this is again that you can access it from anywhere.
Step 67 – Digitizing your Documents – in detail
First of, decide whether “going digital” is really your thing. If not, just stick with the physical filing system. You have to use what works for you, not what you think you should be using. If you go with a system that you don’t feel connected to, you’re just going to abandon it in a few weeks.
If you have decided that you definitely want to move away from a physical filing system, then let’s get started.
You’ll probably need a scanner of some sorts. There are great mini, portable scanners available or alternatively you might want to go for a standard desktop scanner.
Decide where your filing system will be stored: email, hard drive, Evernote, google docs etc. If you are already familiar with some of these programmes, it might be easier to also use them for your filing, but look around a little bit to make sure you find a system that works for you.
Before you start scanning your entire collection of papers, go through everything you have and throw away anything you no longer need. No point scanning those papers if they are redundant anyway.
Start little by little, commit to doing a section each weekend or to scan 10 documents a day.
As soon as you have scanned, make sure to file. Don’t just leave stuff on your computer or in your email un-processed, as it will all again pile up and become an unmanageable chaos.
Depending on the system you use you might be able to tag each file with keywords to make it easier to find them again at a later stage. This would especially be useful for receipts for example.
Make it a habit to scan new documents once a week and process them immediately. Consider using the same 5 basket system as mentioned in the previous step in which you sort your papers as soon as you come back home every day. The only difference is that your “file” basket would be used for papers that need scanning and filing instead of for papers that need to be put in a folder in your home office.
And that is all there is to creating a physical filing system my friends. Happy scanning!