Do your own Financial Reality Check Photo source startuplawblog
There’s a bank out there with a clever slogan right now: You’re Richer than You Think. Well, are you? There’s only one way to find out and that’s to take the time to assess your current situation. You need to look at a number of factors to gauge your financial health:
1. What’s your Asset Allocation?
Take a snapshot of the proportion of equity vs. fixed income in all of your investment accounts combined (include your Defined Contribution Pension account in this mix).
In the equity category, include: stocks, stock-based mutual funds, Real Estate Investment Trusts (REITs), stock-based Exchange Traded Funds, and income trusts. In the fixed income category, include: bonds, preferred shares, bond-based mutual funds, bond-based Exchange Traded Funds, and cash. If you have a mutual fund with the word ‘balanced’ in its name, split it equally between the two categories.
What to do with this information: First, compare your actual asset allocation to what you thought it was in your mind. Then, compare your asset allocation to your goal and ask yourself if the risks you’re taking are in line with that goal. How many years until you spend the money? How rigid is the timeline for when you spend the money? How important is the goal? Finally, align the type of investments you own with your realistic goals, not your goals when you originally made the investment.
2. What’s your Rate of Return?
It probably goes without saying that your personal rate of return reflects your gain or loss over a given period, including the initial purchase price, subsequent buying at lower prices (averaging down) or higher prices, subsequent withdrawals and contributions, dividends, interest and compounding. It is expressed as an annualized percentage.
Ask your investment advisor to produce a report for you showing your performance over time versus a relevant market benchmark. Or use the information on www.morningstar.ca, as above, to compile the performance data yourself.
Then ask your investment advisor to take out their trusty (or dusty?) financial calculator and do some what-if scenarios for you: what if your portfolio’s rate of return continues to be the same as the average of the last three years? What if you do not save any additional money? What if you increase your savings rate? What if you shift your asset allocation to be more aggressive or more secure/certain? How do these what-if scenarios affect the likelihood of you meeting your goal on your preferred timeline?
What to do with this information: First, assess the results of the above what-if scenarios. Then adjust your asset allocation to reflect the return you want, need and risk/uncertainty you can tolerate.
3. How’s your Household Budget?
Try tracking your cash flow for at least a few months to see where your money is going. See if you like one of the free budgeting websites like the highly regarded www.Mint.com. I’m not going say much on this one – you’ve all heard and read the rules of thumb regarding what percentage of our income we should spend on our mortgage, how much we should save and so forth.
Just be realistic, is all I have to say. The result of your personal reality check is likely to be obvious in terms of the degree to which you must, should, or don’t have to adjust your personal spending to meet your goals.
What to do with this information: Once you have your realistic average monthly expense budget, just be conscious about where you could cut back if you had to if your reality check ends up telling you that you need to save more. If you’re keen, you can use www.Mint.com to set a target budget and use the goal function.
4. What’s your Debt Load?
Add up your recurring monthly debt expenses, such as payments on your mortgage, line of credit, personal loans, credit cards. Divide the sum by your monthly gross income and multiply that amount by 100 to find your debt as a percentage of income.
Compare your situation to typical guidelines of having your housing payments of less than 25% of your gross income (before tax income) and keeping your overall debt at less than 35%.
What to do with this information: Tackle the debt with the highest interest rate first. Get rid of your credit card debt. Period. Use a Line of Credit if you need to – you’ll pay lower interest rates on what you owe compared to a credit card.
5. What’s Your Savings Rate?
Tally all of your after tax monthly income and call this your disposable income. Subtract from that number all of your expenditures including housing, utilities, food, entertainment, and so forth to find out how much money you have left at the end of the month.
Divide that number by your disposable income and multiply by 100 to find your personal savings rate.
What to do with this information: Do you have an emergency fund? If not, start one. A decent option is to set up a Line of Credit at your bank but keep the full amount available to you to use in an emergency.
6. How’s your Insurance Coverage?
Dig out all of your insurance policies including homeowners, strata, critical illness, disability and life insurance coverage. Schedule time in your calendar one Monday morning to call your employer’s Human Resources department and ask for information and details on your employer-provided coverage.
Ask your investment advisor or insurance consultant to do an insurance audit for you if you don’t want to do it yourself.
What to do with this information: Ask where you are exposed and vulnerable and where you have potentially too much coverage. Ask if you can switch policies to better reflect your current life situation and realistic risk exposure.
Pulling it all Together
What the above steps in your personal reality check will tell you is if you’re on track to meet your goals, if you need to adjust your goals, if you need to adjust your investment strategy, or if you need to adjust your lifestyle in order to save more and spend less.
Please contact me if you’d help with the above—it’s worth your time and effort!
Heather Holden, PhD, CIM
Wealth Advisor, ScotiaMcLeod
Heather_Holden@ScotiaMcLeod.com
604-661-1523 (direct)
