In order to create financial “sanity,” it is important to first define what, in this sense, sanity is. I proffer the following definition:
Financial Sanity is attained when two important things happen at once: 1) When one is living within one’s financial means, and 2) When one is living according to a well-conceived, written, and tested plan of action.The plan must consider the impact of reasonable possibilities that might impact the successful outcome of the plan.In applying this definition, you can discern that several very important steps are involved in
attaining financial sanity. You must have:1. A clear understanding of your financial and life situation.2. Goals that are synergistic to your values.3. Examined all specific threats that threaten your success.4. A written game-plan.Let’s focus on the first; a clear understanding of your situation. In order to gain financial clarity, it is important to know where your dollars are going and whether they are being appropriately applied in the direction that leads you to your goals.You must have an excellent grasp on your numbers. If you don’t know your numbers, consider using a financial application or program that will help you see clearly where you are and where your income is going.Begin with knowing your net worth. If you’re unsure how to do this, here’s an outline to help guide you.Assets:Cash in bank (checking/savings/etc.)Money owed to you by othersInvestments (not retirement accounts)Retirement accountsBusiness InterestsHome/property valueOther assetsTotal assetsLiabilities:Revolving debt (Credit card balances not satisfied)Auto loansHome mortgage/HELOCOther personal debtTotal liabilitiesBy subtracting your total liabilities from your total assets, you will arrive at your net worth number.Net Worth = Total assets – Total liabilitiesThat’s a great place to start.The next step is to understand the pieces. For example, do you have enough liquidity in case of emergency? Do you have too much? Are your investments arranged as a cohesive portfolio?Or alternatively, have you merely assembled a jumble of stocks, bonds, and/or mutual funds that lack genuine reason and are not created around an understanding of risk and time horizon?Your answer to these questions will give you a good idea of the pieces of your financial life.It’s also vital to look at the allocation and asset placement in your retirement plans and the nature of your other assets. As you look deeper and start to really understand your numbers, ask yourself: Do you have a clear picture of the interest rates you are paying on your debt and the terms of those loans?Related:
How to Avoid Regret When It Comes to Your Money LifeIf not, those pieces of the puzzle need to be assembled and integrated into your understanding.In understanding your net worth, which is a great way of charting your progress, you are seeing the direct impact of your spending decisions. Looking a little deeper, consider the following factors:1. How much are you earning on your assets?2. How much are you spending on debt?Let’s look at the first topic: There is an appropriate level of risk and return that should be applied to your assets.For example, your emergency fund/liquid reserves should not be at risk in the stock market or invested in any way that may alter the market value.On the same token, funds that are meant for the long-term should contain an appropriate amount of risk in order to achieve an appropriate reward. Long-term funds can take a certain amount of risk, as opposed to emergency fund/liquid reserves, which cannot take any risks.I can’t stress enough the importance of understanding markets and their impact on your net worth over the short term and the long term.For example, if you are investing for twenty years in the future, accepting market volatility in the short run is acceptable in order to meet your goals. However, you must be willing to endure periods of time when the markets will be down, flat, or produce less than stellar returns.This mindset is crucial to success so that you don’t act on any rash emotions when markets rise and fall.
You want your portfolio to be allocated appropriate to the desired outcomes.If all this causes your eyes to glaze over, it’s time to find help and guidance from a planner who will act in your best interest.The next part of this series will focus on cash flow and budgeting. Remember, it’s one step at a time.
