Getting Started – Part One – Where Am I?
As I’ve said previously, on many an occasion before I became a reformed spendthrift, I would decide to get my finances under control. The biggest barrier to success wasn’t my lack of understanding that things needed to change, but rather a major deficit in my appreciation as to just how bad things were and poor planning on my behalf in terms of turning things around.
Starting out can be tough; simultaneously overwhelming and scary. This is particularly true if you have consumer debt in several places, major goals that need to be reached in the short term or have recently suffered a significant financial setback (like losing your job).
With this in mind, working out your situation – your starting point – isn’t something to be tackled by the fainthearted. That said, it won’t get any better the longer you put it off!
So, here’s the recipe for getting an understanding as to your current financial situation.
Step One: Add up all your debts. This includes obvious things like your credit card(s), mortgage(s), car loan(s) and personal loan(s). Lots of people tend to forget stuff like zero or low interest finance plans (for say, a TV), rental agreements for electrical equipment (like laptops) and mobile / cell phone plans where you’re paying off the phone (if you got it for free less than 24 months ago, chances are you have one of these). What you’re adding up here is the total amount owing, not your periodic payments. So, if you owe $200,000 on your house, that’s what you put down.
Step Two: Add up all your assets. Again, some of this is obvious – things like your house and car are assets. With the glorious advent of sites like eBay, more and more of the items around your house can be considered liquid assets. With this in mind, chances are it’s not practicable for you to sell literally everything in your house and we’re not adding this up for insurance purposes. Considering this, include only the items of major value. These might be items like artworks, antique furniture or particularly valuable wine. For me, I include my handbag collection! The distinction here is things you could either do without, or replace for a cheaper item.
The difference between these two figures will give a net overall indication as to your financial situation.
If your debts are greater than your assets (something we’re seeing more and more at the moment, with house prices plummeting and some unfortunate folks being caught with their mortgages worth more than their house) you have a negative net worth. This means that even if you sold all your assets to pay off your debts, you’d actually still owe money. It sounds horrible, but it’s easy to do when people get into consumer debt (for example, shopping up a storm on credit card, or paying bills on credit). I’ll be honest, I’ve been here and it’s not good.
If your assets are greater than your debts, you have a positive net worth. The good news is, this means if you sold all your assets you’d be able to cover your debts in full. Don’t start celebrating just yet though, the bad news is that depending upon the ratio of assets to debt, that is, how big the difference between the two numbers is, you could end up with a negative net worth pretty easily. For example, if you had a large unexpected expense like your car needed major repairs or a big medical bill came about that wasn’t fully covered by insurance. Alternatively, if you were to lose your job. Without a buffer in place you could be in trouble pretty quick.
The other thing to consider is that this formula doesn’t account for your incomings and outgoings. That is, income from your job or investment income from things like dividends and rent on investment properties, as well as required expenses – stuff like utility bills, payments on your debts and basic food. Once these are incorporated you can get a more accurate assessment of your financial situation and start to budget for your future accordingly.
Part Two in the Getting Started series will look at determining where you want to be so that you can set yourself some goals for your future.
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