Rule #5 Know your Monthly Expenses!

Know your monthly expenses!

We don't really have monthly budgets - we pretty much pay everything off every month - thats about our only rule regarding budgeting we have.  If we can't pay off something in one month, we've spent too much and its time to cut back our spending.  We do however know where our money goes because we've tracked our spending 3 times in the last 8 years, and thats my rule... know where your expenses are and what you spend on them... but how can you really know what you spend your money on?

At least once in your life, the earlier the better, keep detailed records of household expenses for a three month period.  Three months are better than one because it lets you smooth/average out expenditures such as groceries if you do the odd Costco run for example.  Diligently tracking your expenses is one of those exercises that is a royal pain-in-the-ass when you are doing it, but it can really be an eye-opener and a very useful tool to determine where your money is going.  Whats that? You already know where you are spending your money? I did too until we did it for the first time about 8 years ago.  We thought we were spending about $500 a month for the two of us for groceries.  The thing was, we were both buying groceries so we weren't always aware of what the other was spending.  In the end we were actually spending about $700 a month on groceries.  It wasn't a bad thing to spend that much each month for groceries - the point was we were spending 40% more than we thought we were spending.  We talked it over and said to ourselves "Is that a reasonable amount for a couple to spend each month on groceries?" In the end we changed a few things and settled on a number that we were prepared to pay and adjusted our spending habits.

We noted a few expenditures and then challenged ourselves whether we thought the money was well spent... I discovered I was spending about $80 a month for coffee at work.  I didn't realize I was spending so much on coffer for me and for other people.  People who know me, know that I am a very frugal man so spending $80 for coffee at work sounds like an excess, and on paper it was.   The thing is the industry I worked in had a coffee culture - one where relationships were usually built over a cup of coffee - and in that business, relationships were often just as important as technical ability.  I saw this as an investment in my career and work satisfaction so the $80 coffee budget stayed in.

The great thing about tracking expenses is that if and when you do decide to save and invest more, you know whether you even have left-over money to save, or whether you are going to need to make some adjustments.  Some of monthly expenses will be fixed such as rent or mortgage payment, but others will be variable such as spending on entertainment, booze, gasoline, heating costs etc...

Tracking your spending also has an interesting side effect.  Knowing that you will be documenting your purchases, I am pretty sure it will make you think more about what you are buying.  It actually makes you more conscious about what you are buying while you go through the exercise.  Give it a try.

Here are some of the buckets we group our spending into

Fixed Housing (Rent)
Variable Housing (Utilities, Heat, landline, internet)
Groceries
Entertainment
Booze
Car (gas, insurance etc...)
Clothing for Work
Clothing for our Kids
Gifts

Rule #4 Never Carry a Credit Card Balance... Ever

"Money is just the poor man's credit card" - Marshall McLuhan.

This one is super easy. Nobody is going to say its a bad idea.... If you do think its a bad idea, you may need your head checked.   Carrying Credit Card Debt to the point where you start paying interest, especially when you have access to cheaper interest rates, is a no-no.  I just did a quick search online and the lowest rate I could find in Canada was about  a 10% annual interest rate.  The majority of the standard credit cards, including the ones we have, charge about 18%.  And if you get a Sears, Canadian Tire, Home Depot credit card, or any other Non Visa or Mastercard, you end up paying 22-28%.  But Ryan, my monthly payment is so low, why should I be fussed about paying it off?  Because its two to five times the interest rate you could be paying if you just got a regular line of credit at 5-7% and moved the balance over.  Or better yet, save your money first and then buy it without having to borrow.  We generally never pay interest on something that depreciates in value (another rule I will write about later) so we almost never carry a balance on any of our credit vehicles.  We view it more as emergency credit.

Okay okay, some people won't save, or want to make purchases before they have the money.  Lets assume you do decide to borrow money to buy something on a credit card and let it ride from month to month. What is the comparison on the amount of interest you pay? Lets say you bought yourself a washer and dryer and it cost $1000, or maybe a hot tub for $5000, or how about a motorcycle for $10000.  Here's what you'd pay in monthly interest for an 18% credit card vs a 6% Line of Credit:

Quite the difference. Remember this is interest... the first 15, 75 or 150 bucks you pay each month on that credit card just goes to servicing the interest...As opposed to the Line of Credit amounts that are one third the credit card rates.  If this isn't a no-brainer I don't know what is.  Use a credit card to buy stuff, and then each month flip the complete balance over to a Line of Credit or better yet pay it off. Easy Peasy.  Don't you feel like a dumb-ass now for buying that motorcycle on credit card and NOT moving the balance over to your LOC?  If you ask me, paying that kind of interest, for consumer items that are worthless within a few years, is the beginning of the death spiral for your finances.

A note about introductory incentives... I once got a card from Sears just so I could get a smokin' discount on some patio furniture. Once I got the bill I paid off the balance and then canceled the card... That card had a 28.8% interest rate.  I kept getting solicitations for opening another card with Sears for years after that... I was in the vortex of their mailing and phone list just for signing up that one time... and I like my privacy... so now I wont even get a card for one of their promos.  They are just looking for a way to rope you into that mega-interest rate.

We use our credits card quite regularly for their convenience - mostly so that we don't have to bring money with us for bigger purchases when out and about, but we always pay them off within a week of making the purchase so that we are in the grace period where no interest is tacked on to the balance... This grace period is something like 21 days but there is nothing stopping the credit card companies from changing that, OR more likely if its not paid off right away I would forget about it and eventually get charged.

In the last 10 years, we have used our credit cards every month, but have not paid 1 red cent in interest on those cards.  We never ever leave a balance on them.  Ever.

Rule #3 Defining Assets and Liabilities

We aim to accumulate Cash-Producing Assets that increase their cash-flow over time at or above the rate of inflation.  This is one of our big overarching rules for our Financial Independence strategies.  At a later time, I will talk more about this strategy, but for now I want to tackle some definitions.    This strategy revolves around how we define things we own in our lives, and it is one of the rules where we tend to deviate from other financially-minded people.  We view almost everything we own as either an Fiscal Asset or a Liability.

Here are OUR definitions:

Asset: An asset is a thing that you own that produces positive cash-flow
Liability: A liability has negative cash-flow.... it pays you nothing or costs you money to own.

This sounds fairly straightforward until you start putting things you own in each of the buckets.  So lets list off some.

Some Assets would be:

• Rental Property 
• Stocks that Pay a Dividend 
• REITs 
• A Profitable Business you own or have shares in
• Bonds 
• Farm Land that is being rented for farming 
• Royalties from something you created, designed, or have the rights to 

Some Liabilities would be

• A Car
• A Home 
• Bare Land 
• Gold
• An iPhone
• Stocks that Don't Pay a Dividend
• A Television
• A Computer
• A Swimming Pool
• An Unprofitable Business
• General "Stuff"
• A Pet

While taxes and debt are also a liabilities, I will talk about those at another time as we treat them differently.  People often take exception of us putting a car, home, and swimming pool in the liability bucket.  Especially their home.  All of this things have intrinsic value so on a typical net worth statement, they would go in the Assets column, however the way we look at it, all of those things cost you money to maintain them once you own them.  So by buying them, you are also adding on a monthly-burden of other costs such as fuel for your car, taxes and upkeep for your home, a mortgage payment on bare land, a monthly plan for your iphone, cable for your TV, Internet for your computer, and chemicals for your pool.  You also need to store your "stuff" which may require that you rent or buy a bigger place to live in.   Its not to say that we don't own some of these things because we do, or have done so in the past, but we are very conscious of how much these things will add to our monthly operating expenses as a family.  These are not one-time buy-and-then-you're-done items.  They can add a lifetime of monthly costs to you.  Ultimately our goal is to minimize things in our life that create monthly-burden payments.

Gold and Stocks that don't pay a dividend are a bit special because many would consider them assets as they have a reputation for going up in value. Well, if you bought Gold at $1000 and it went up to $2000, how much have you made?  The Answer is $0 unless you sell it.  We don't count paper gains (or use mark-to-market valuations) as true gains like the banks do.  The very next day, your gold could go down to $900, and if you didn't sell it on the way down from $2000, now your gold is in a losing position.  Gold pays you nothing to hold it, the price can fluctuate up and down, and it never sends you a dividend cheque for all of your trouble and not to mention the risk you put up just to hold it.  I'm not saying you shouldn't buy some because it may make sense to you to do so.  Gold has appreciated in value quite a bit a these last few years, but there is nothing to say it won't go back down again.  This holds true for non-dividend paying stocks as well (Think Research in Motion - You only made money on it if you got in and out at the right time)  This is why we do not consider Gold, and Stocks with no dividends, assets.