The core tenets of a proper financial plan should cover the following topics and we will discuss them over a few individual posts to chunk the whole topic into manageable portions. For those of you with financial planners, hopefully they have gone over all these topics and these posts are just a refresher. Unfortunately, it isn’t uncommon to have many of these areas skimmed over and not given the appropriate due diligence.
1.Current Financial Position or Net Worth
2. List of Assets/Debts
3. Consolidation and Review of Debt Cost
4.Your Financial Personality – Know Thyself
5. Financial Goals – Not just “Retirement”
6. Cash Flow Needs to Maintain Existing Lifestyle
7. Savings Requirements to Achieve Financial Goals
8. Incorporating Your Professional Practice
9. Emergency Funds
10. Insurance Needs
11. Estate and Will Planning
12. Investment Selection and Asset Allocation
This post will cover the first three – Current Financial Position or Net Worth, List of Assets/Debts, and Consolidation and Review of Debt Cost. Before we can establish your net worth, we need to understand its components.
Assets are essentially anything that could be sold for value – both now or in the future.
A liquid asset is anything that can quickly be turned into cash to buy anything.The most liquid asset would be cash in a bank account, but many forms of investments can be sold that day with cash in hand by the next business day.
An illiquid asset is one that has value, but may take longer to sell or has a fixed duration where you can’t access the cash value yet. Examples of this would be selling a rental property. It may take several weeks to plan and execute the sale. It then may take a month or two to actually close the deal and receive funds. This is poor liquidity and you could not rely upon this type of asset for any sudden cash need unlike for liquid assets.
An appreciating asset has characteristics that likely will lead to an increasing value over time OR it may produce additional cash flow on a consistent basis. The asset classes listed in investing basics posts will all be appreciating assets.
A depreciating asset can be sold for cash value, but it often will consistently lose value over time and/or require substantial costs and maintenance during its life. Cars, boats and most consumer goods fall into this category.
In theory, you could count every piece of clothing or consumer good in your house as an asset for sale in your net worth calculation. The problem is their asset value would be difficult to predict, need to be sold at discount pricing, and likely would be quite illiquid or difficult to sell. In my opinion, being prudent with what you choose to count as an asset for net worth purposes will be a better approach. Essentially if you don’t plan on ever selling the asset or it would need to be replaced by a similar consumer good after selling it, you should ignore its asset value for net worth. On a controversial point, I don’t consider a primary residence to be truly an asset for net worth calculations, although it is often the most valuable possession for Canadians. This is hotly debated in personal finance and I will leave this for a future post to explain my rationale. At minimum, I would only include the purchase price for the value I attribute to your home versus what you think it may be worth currently.
In summary, for a net worth calculation, your assets would typically be:
a) All chequing and savings accounts
b) Corporate accounts and investments
c) All registered investments (RRSP, RESP)
d) TFSA, non-registered investments
e) Rental properties
f) Estimated Pension Values if Withdrawn Today
g) Primary Residence (At Your Discretion)
Adding all these assets up will produce your total assets.
Some excessively prudent individuals will actually reduce the value of their assets by the cost to sell and by any applicable taxes to better estimate the true cash asset value. I only do this for assets I plan for sale within the next one year (which is rarely anything given I am still in the wealth accumulation stage and not choosing to retire now).
Liabilities are essentially any debt or cash owing for goods/services.
This should include:
a) Mortgage Debt
b) Car Loan/Financing
c) Credit Cards
d) Government Student Loans
e) Bank Lines of Credit
f) Corporate Debt
g) Anything else that you have financed on a scheduled payment plan that will reduce your recurring cash flows
Once you add up all the totals outstanding, you have your total liabilities. Some individuals like to further breakdown their liabilities by the timing of when they are due for payment.
Current liabilities would be debts that are due in the near future (typically 1 year or less).
Long term liabilities are debts that may have no fixed repayment schedule or are due in greater than one year.
Viewing liabilities in this way will give you an idea of how much cash flow you need to direct in the short term to your debts and helps plan how much savings you can achieve that year.
Consolidation of Debts
As part of the net worth calculation, I like to also write out the terms of any outstanding debt.
An example would be:
Credit cards $5000 at 18% interest compounding monthly
Mortgage $400K at 2.5% interest fixed rate
Car loan $15K at 4% fixed monthly payment
Student Debt $150K at prime interest no fixed schedule
Writing these all out may give you the ability to quickly achieve some savings by consolidating debt. An absolute must for personal finance is to NEVER have any credit card balance remain past the monthly due date. If you currently have ongoing outstanding credit card debt, this needs to become your immediate priority. Ongoing credit card balances implies spending beyond your monthly cash flow ability. I have never fallen into this category due to prudent advice from my parents at a young age, but I would take the following steps if I had ongoing credit card debt:
- Cut up the card so it can’t be used on an ongoing basis. Pay any future costs only via cash or Interac.
- Search for any other debt you can take on via cheaper interest such as a line of credit or a debt consolidation service. Move as much of the credit card debt into these cheaper forms of debt immediately.
- Direct 100% of future cash flows to the remaining credit card debt until the balance is paid off.
- Consider not using credit cards until you have consistently achieved a positive monthly cash flow. This shows you have learned to live within your means.
- Choose credit cards that maximize your cash back or points via spending and eventually consider directing all spending onto these cards as long as monthly balances can always be paid off.
You should also consider consolidating any student or car loans onto your cheapest source of loan. As a professional, you should be able to get a professional line of credit (LOC) that is at the prime rate assuming you haven’t had anything negative on your credit score. Outside of a mortgage, a prime rate will likely be the best borrowing rate you can achieve anywhere. If any readers have achieved lower then prime, I would love to hear about it! I have heard from many doctors that they are told prime + 1 or 2% is the best rate they can get. I would strongly suggest meeting with other banking institutions to see if anyone else is interested in your business. For every $100K in student debt, 1% equates to $1000, but is really closer to $2000 pre-tax revenue. Taking the time to get the best rate can make a huge difference to achieve significant savings related to student debt.
While on this topic, I suggest for all medical residents or soon to be professional grads to meet with their bank prior to graduating about their student LOC and general banking. There should be 3 main objectives here:
1.You are likely at a prime rate on your student LOC. Ask to convert your LOC into a professional LOC category and keep the same prime rate forever. A category conversion will always need to occur at some point after graduating from student to professional category. If you do this ahead of graduating, the bank will be more likely to give you favourable terms of prime than if done after graduating. You have a lot of business to give the bank soon from your medical career and your negotiating position is at the highest just as you graduate.
2.Try to get your banking fees to the lowest possible. This won’t be huge savings, but nobody likes being nickelled and dimed for ever transaction. The VIP packages at banks are generally a rip off and you should be able to get a monthly fee in the $4-9/ month range on each account that is mostly all inclusive for your banking needs.
3. Try to get your professional/student LOC up to the maximum available borrowing limit possible, even if you don’t think you will ever need it. For many reasons we will learn later, having these types of LOC’s create incredible financial flexibility later in life. Even to those that are debt adverse, I will show you strategies that can benefit from having these LOC’s and it costs you nothing to not use it. These professional LOC’s have great unique features such as being unsecured (this means you don’t have to put any collateral like a house or a pledge from a guarantor which is the case with most loans) and no fixed repayment schedule that make them quite advantageous compared to most forms of borrowings.
Net worth is simply your total assets minus total liabilities. This can be a positive or negative net worth number. After finishing any kind of professional school it is quite common to have a negative net worth secondary to student debt. This can be frustrating, but your excellent income earning potential should take care of this in no time after applying the right financial principles.
I believe doing a net worth calculation at the end of each month is an incredibly positive financial planning tool. I would strongly encourage all readers to complete a calculation at the end of this month and continue forever. I have been doing this monthly since 2011 and it allows me to monitor progress on short term and long term financial goals. It gives you a snapshot into what may or may not be working in your overall financial structure. It also acts as excellent positive reinforcement when you see the changes you are making reap rewards. There are many online tools that allow you to create an account and track your net worth with minimal effort. I personally use Net Worth Share, but I’m sure there are many others to pick from. Once you become used to the monthly net worth calculation, it should only take about 30 min/month to complete. Dedicating this small portion of time ensures you will be giving some regular review to your finances and becoming more personally invested in your future.
Now that you know your financial position, we are ready to start discussing financial goals in our next post.