Planning For Wealth

Before you can start making specific goals and plans for getting out of debt you need to know where your money is going and how much you’re in debt.  To do this you need to gather several pieces of important information.  Gather your latest pay stubs, banks statements, credit card statements, and other bills.  Also gather together all those recipts you’ve been keeping since you started tracking your spending.  From these bills and statements you will get a good idea where our money is going and how much you are in debt.

First, you need to know where your money is going.  The image to right is a spending plan I made up to determine where my monthly income goes.  I set this form up using Excel so I didn’t need to worry about doing the math myself.  Using this form as a base it’s easy to see how much you spend on housing, groceries, credit card bills, or auto fuel.

Start by determining what your income is.  Write all your sources of income and add them up.  Use the monthly average of any income sources that change from month to month or are received only every 2 or 3 months.  Then using your bills and statements divide your monthly expenditures into various categories.  Its a good idea to break each category into several sub-categories to help you better determine where your money is going.  Now write down the total amount for each sub-category.  For items like auto insurance that you pay every 6 months, use the total payment amount divided by the number of month covered.  Add up the total for each category, then add up all the categories to get your total expenses.  The last step is to subtract your total expenses from your total income.  This will give you an idea of how much extra cash  or short fall you have at the end of the month.

If you have extra cash at the end of the month you’ve got a good start at finding cash to pay down you debt.  If your expenses are greater than your income then some extra work will be needed to reduce your expenses. 

Now that you have a better idea where your money is going every month you need to find out just how much you’re in debt.  For every credit card you make payments on, every loan, charge account, or personal debt write down who you owe, when the payment is due each month, the minimum payment amount, and the total remaining balance making a separate column for each item.  Add up all the values in the minimum payment column.  This lets you know what the minimum amount is you need to payout each month to stay current on your debt.  Then add up all the values in the total remaining balance column.  This amount is your current total debt.  The due date column is there as a  reminder of when each payment is due.  At this point it does not matter what order your debts are listed in since we’re just wanting to determine your total debt.  I’ll discuss different ways to order your debts when paying them off in an upcoming article.

You’re at a good point for determining how to get ride of your debt now that you know where your money going each month, your minimum monthly debt payments, and your total debt.

To reduce debt we need to know where our money is going.  We know this by tracking our spending.  Tracking our spending helps us in several important ways:

• Know where our money is going - This one seems obvious but is often over looked.  Most of us think we now exactly where our money goes every month.  Then we are surprised when there is still 1/3 of the month to go when we run out of money. 
• Identify cash leaks - Cash leaks are things we do or buy that take money out of our pocket without giving any tangible return.  Cash leaks can be small or large.  These leaks could be getting a coffee from Starbucks everyone morning, eating lunch out every day, or replacing your car every 2 - 3 years.
• Setting Goals - Once we have an idea where our money is going we are able to develop goals for making better use of our money.  We set short term goals for eliminating cash leaks.  Then set short, medium, and long term goals what we want to accomplish with our money.
• Basis for spending plan - By tracking our expenditures we are able to determine how much we spend in different categories such as auto fuel, groceries, housing, etc… These various categories can be used to as the basis of a spending plan or budget.
• Saving money - After we start tracking our spending it s usually easy to identify one or more areas where we can save money by cutting or eliminating spending in some area. 
• Identify areas of under spending - This one may seem out of place but it is important.  If you are not setting money aside for an emergency fund you could be setting yourself up for trouble.  The main area for underspending is insurance.  Most of us have either no or too little insurance.  This includes all categories of insurance; life, health, property,aand auto just to name a few.

To track your spending start by keeping all receipts no matter how you paid.  Ask for a receipt if you did not receive one.  Don’t rely on checks you’ve written as a receipt.  It could be a month or more before you get that check back from the bank.  And we want to know the details of the check now.

At the beginning of each month set up a worksheet or your favorite spreadsheet for recording your receipts.  Make a column for who you paid and the total amount paid.  Then make a column for every category of spending you think you will need.  Leave room for additional categories in case you’ve forgotten some.  It doesn’t matter whether you use an electronic or manual method.  And it doesn’t matter what categories you use as long as they are meaningful to you and that they are used consistently.  Now, at the end of each day go through each receipt for the day entering who you paid, the total amount you paid, and enter the amount paid under the appropriate category.  If the amount falls under more than one category then split the total between the appropraite categories.  At the end of the month total each category to see what you spent during the month.  You may be surprised at how much you actually spend on some things.

Keep a record of each month’s expenditures.  Record the total of each month’s expenditures on a separate worksheet.  This second worksheet is so you can easily compare each month’s totals.

Start right now.  The earlier you start tracking your spending the better equipped you will be when you start setting your goals and developing a spending plan.

Sit back, relax, and take a deep breath.  Don’t forget to exhale.  Being debt free is the first step towards building wealth.  For many of us getting out of debt seems an insurmountable task.  But it doesn’t have to be.  I’ve had several family members end up with $15,000 to $20,000 in credit card debt.  Each of them were still young and had low incomes but with careful planning, controlling their spending, and patience they managed to pay off their debt.

Below is a list of several key concepts we all need to understand to be debt free.

Good Debt vs Bad Debt:  There’s two basic types of debt - good debt and bad debt.  Debt from home mortgages and school loans is considered good debt.  I also include investment debt in good debt.  Good debt is debt that provides a necessity for life, increases you current and future income, or provides investment asset growth.  Credit card, revolving lines of credit, and other consumer debt is bad debt.  Bad debt takes money out of your pocket without putting any back.  See my post Good Debt, Bad Debt for more info on debt.

Track Spending:  To reduce debt you need to know where your money is going.  We know this by tracking our spending.  It doesn’t matter whether you use an electronic or manual method.  Keep all receipts and organize them into various categories like gasoline, groceries, utilities, housing, etc…  Then keep a record of each month’s category total.  This will help you know where your money is going each month.  Start right now.  The earlier you start tracking your spending the better equipped you will be when you start setting your goals and developing a spending plan.  See my post Get out of Debt: Track Spending for more info on tracking you expenditures.

Know Where you Stand:  You need to know where your money is going each month and how much you are in debt.  Gather all your pay stubs, bank statements, credit card bills, and recipts you’ve saved from tracking your expenses.  Add up all your income and subtract all of your expenditure to know where your money goes.  Then add up the minimum payments due and the total remaining balance for your credit cards, store credits, and loans.  These will give you your minimum monthly payments to stay current on you debt and your total remain debt.  See my post Get Out of Debt: Know Where You Stand for more info on determining where you money goes each month and your total debt. 

Set Goals:  The final goal is to be free of debt.  But this one goal is not enough to get you through the process of reducing debt.  There are two basic types of goals needed to help us through this process: milestones and action goals.  Milestones are targets you want to achieve during the debt reduction process.  A milestone would be a goal like payoff the Visa card by January 1.  Each milestone usually occurs only once during the entire process.  Action goals are goals to take a specific, often re-occurring, action.  Pay an extra $100 a month to MasterCard until the card is paid off is an example of an action goal.  Start with small goals and work towards larger ones.  Whatever goals you decide on they need to be obtainable.  These goals should also challenge you.

Make a Plan:  Now that you have a set of goals you need to make a plan on how to accomplish those goals.  It helps to write down your plan along with your goals.  This keeps them together and acts as a reminder of how they work together.  The plan should state where that extra $100 is coming from for you action goal and how you’re going to reach each milestone.  Break larger goals down into several small steps you can take and include these in your plan.  Your plan can be pretty simple as long as it provides all the necessary information to guide you to meeting your goals.

Create a Spending Plan:  Many people call this a budget.  I prefer spending plan.  Budget implies a limitation on what you can spend.  If you are like me you hate the idea of someone saying you can’t do this or can’t do that.  Spending plan implies the ability to spend which helps us feel better about the plan.  A spending plan is part of your overall plan and includes a month by month break down of what you expect to spend in various categories.  The categories should closely match those used when you started tracking your spending (gasoline, groceries, utilities, housing, etc…)  I also like to include a cash flow report as part of the spending plan.  A cash flow report shows the source and total of all income and expenses for a month and the difference between the two.

Pay Yourself First:  This means the first thing you should do every month is put a portion of your income into savings.  Do not touch this money unless you absolutely have to.  In the short term this money will most likely act as you emergency fund.  In the long-term this money will build your retirement fund.  Also, the longer money earns interest the faster it will grow because of compounding.  $50 set aside every month for 360 months will grow to about $41,600 at 5.00% interest.  The total interest earned is about $23,600. At 8% interest the final total is about $74, 500 with about $56,500 in earned interest.

Create An Emergency Fund:  Everyone should have an emergency fund that covers 3 to 6 months of living expenses.  This fund helps you cover expenses should an emergency occur.  Your plan should include funding an emergency fund but only after you are all the way or mostly out of debt.  After you are out of debt it’s up to you how quickly you fund your emergency fund.  But remember the sooner the better.  Usually we get little to no forewarning when an emergency will occur.

Live Within Your Means:  This is the most important step in getting out of debt.  Never spend more than what you make.  If you spend more than you make then you’re only making your debt worse.  Living within you means also include controlling you spending.  Do you really need those designer pants or shoes?  Do you really need a second skidoo or that gas guzzling SUV?  Buy a used card instead of a new one.  If you need a good commute car get a Mazda or Nissan or Saturn instead of a BMW.

Review Progress:  Review your progress regularly.  This will let you now if you are on track or need to make adjustments to your spending plan or work on cutting spending more.  Some months will be worse than the others.  Doing regular reviews will help you stay in control of your finances and your plan.

Be Patient:  Getting out of debt will takes time.  You will need to be patient and stay focused on your goals if you want to get there.