Budgeting basics

I’m sure everyone has heard the following basics of building financial security, but because they are the basics they are worth reviewing:

1.Spend less than you earn.
a.This can be a huge topic unto itself.  Canadians have been spending more and more of their income over the past 15 years, to a point where many are spending more than they take home.  In order to do this they are going deeper into debt.

b.What are they spending money on?

• The biggest house and mortgage they can afford, even when they don’t need one that big (5 bedroom house with only 1 or 2 kids).  Unfortunately this often also comes with more property taxes and high heating and electricity bills, making it cost even more.  These costs often make it difficult to cover other expenses.
• Brand new vehicles, bigger and with all the extras that jack up the price by 30 to 50%.  These large vehicles (SUVs, 4 by 4’s that never see gravel…) also mean higher insurance rates and often poor fuel mileage.
• Eating out or eating prepared foods.  I know most people are very busy, making it difficult to make meals at home, but when eating out costs at a minimum of $8 and easily up to $25 per visit it may be time to review both eating and spending habits.  This is a very expensive consumer habit that can change your monthly spending by $200 to $500 per month.
• The latest toys.  People are going into debt to have the newest TV or sound system, video games, newer washing machine…  Often people are buying new versions of these even when the old one still works just fine (replacing at 27” TV with a 47”).
•  Holidays.  I can’t believe how many people take at least one vacation to Mexico, Cuba, or Las Vegas every year, and put the whole thing on their credit card.  They believe they deserve the break, because they are working so hard.  The thing is they have to work so hard to pay for last year’s vacation.  When someone is having difficulty making mortgage payments, a $1,500 trip to Las Vegas probably isn’t the best thing to do.

2.  Have a 3 month financial back up.
a.At any time having 3 months worth of finances saved is a good recommendation.  You can dip into the funds when vehicle or house repairs come up, and then top it up again ASAP.  It’s a good fund to have in case of loss of employment, or sickness or injury.  In fact there or more advisors saying that if you can do it, 6 months would be even better.

3.  Pay yourself first.
a.I always think hearing this one is a bit cliché, but the truth is that paying yourself first includes what you put away for retirement.  If you don’t put away a portion right off the paycheque, it will be spent and you will have saved nothing.

4.  Beware of debt.
a.My dad always told me there are only two things worth going into debt for:

• A modest house – owning a house that meets your size needs but has payments which are manageable is a good, and even comfortable way to build up equity.  Too large of a payment makes life difficult for a long time, so you shouldn’t buy too much house.  Over the past several years people have looked at houses as investments to be flipped when they gain in value, but the truth is that over the past 50 years homes have increased in price very close to the rate of inflation.  The high increases that occurred from 2002 to 2007 were not normal, and we will probably see fairly flat prices over the next decade, similar to price trends between 1984 and 1996.  This mortgage debt should have some kind of return over the long-run and give you a asset ownership whereas rent gives you only shelter over the long-run.  However, rent means you are not locked in to ownership and the fluctuations in the housing market, so it does have some advantages, especially if you are only going to live in an area for a couple of years.
  
• An education – whether it is university, college or a technical school, your education should provide a return on investment to you.  My dad always said to take something that will provide skills for a variety of job opportunities.  Even with education debt, however, people can take on too much, which makes life very difficult for the decade after their graduation.  I personally will encourage my kids to work at a couple of different jobs for a year or two after high school, so they can save for college and so they can figure out what direction they may want for their career.

b.    Pretty much all other debt is bad debt. A good article on this can be found at Wealth Web Gurus.

• Vehicles are not investments because they depreciate so much so quickly, sometimes even 25% in the first year.
• Credit card rates are typically over 18%, with many store cards at 24%.  This can easily double and triple the cost of the items you purchase.  Lines of Credit are usually much less expensive than credit cards.
  
• Debt for entertainment and vacations has no monetary return.  Save $100/month or more to pay for these with cash.

I know none of these ideas are new or exciting, but they are the basics.  Everyone would benefit from reviewing the basics every year or so. ( Just like driving, I wish everyone reviewed the basics every year or so)
Jerry