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Evaluating Your Financial Situation

Now is a good time to evaluate your financial situation to determine if you are making progress toward your financial goals. To make this evaluation, prepare a net worth statement and analyze how your income is spent.

Net Worth Statement

A net worth statement lists all your assets and liabilities, with the excess representing your net worth. All assets should be included, such as vested balances in retirement plans and 401(k) plans, personal property, jewelry, and household items. Assets should be valued at the price you would obtain if you sold them now, not the amount you paid for them. Prepare a net worth statement at least annually so you can assess how much progress you made during the year. Ask yourself the following questions when reviewing the statement:

  • Has your net worth grown by more than the inflation rate? To make progress toward achieving your financial goals, your net worth should increase by more than the inflation rate. If your net worth is not growing, determine why. If stock investments are a major portion of your assets, then your net worth may have fluctuated over the past three or four years.
  • What is your ratio of assets to liabilities? A ratio of less than one indicates you have more liabilities than assets and a negative net worth. If that is the case, take active steps to reduce your liabilities. This ratio should increase over time, which indicates you are reducing debt.
  • What is the trend in your liabilities? Review the amounts and types of debt you have. Mortgages are typically used to purchase items appreciating in value and are generally considered “good” debt. Credit card balances and auto loans are used to finance items that typically don’t appreciate in value and should be kept to a minimum.
  • What percentages of your assets are liquid and nonliquid? Nonliquid assets include items like your home, other real estate, jewelry, and works of art. Although they may increase in value over time, they can be difficult to sell quickly at full market value. Liquid assets, such as bank accounts and stocks, are more easily converted to cash. You want sufficient liquid assets to cover financial emergencies.
  • How have your investments performed? Now may also be a good time to thoroughly analyze your portfolio’s performance over the past year. Measure the performance of each investment, comparing it to an appropriate benchmark. This can help you identify portions of your portfolio that may need to be changed. Also calculate your overall rate of return and compare it to your targeted return. If your actual return is lower than the return you targeted when designing your investment program, you may need to increase your savings, select more aggressive investments, or settle for less money in the future.

Spending Analysis

Even if you don’t feel the need for a budget, analyze how you spend your income. This analysis can help you identify ways to reduce spending so you can increase saving.

First, prepare a cash flow statement that details your income for the past year and your expenditures by category, which will reveal your current spending patterns. Looking back over an annual period will help you identify normal monthly expenses as well as periodic expenses, such as insurance premiums, tuition, and gifts. Canceled checks, credit card receipts, and tax returns can provide much of the needed information. However, you might want to keep a journal of all expenditures for a month or so if you are unable to account for large sums of money.

Divide the expenditures among fixed and essential expenses (housing, insurance, taxes, saving, etc.), variable and essential expenses (food, medical care, utilities, etc.), and discretionary expenses (entertainment, clothing, travel, charitable contributions, etc.). Analyze the statement to find items you can cut back on, allocating those sums to savings.

Your budget should incorporate your financial goals and serve as a guide for future spending. Some points to consider when preparing a budget include:

  • Make conscious spending decisions. Don’t just assume you’ll spend the same amounts as last year.
  • Prepare a flexible budget. Unexpected expenditures are bound to happen and your budget should incorporate the possibility of them happening.
  • Budget for large, periodic expenditures, such as tuition or insurance premiums.
  • Don’t try to be too exact. All members of the family should have a reasonable personal allowance that can be spent without accounting for it.
  • Periodically compare your actual expenditures to your budget to ensure you stay on track.
  • Your budget shouldn’t be a dreaded exercise, but a tool to help you achieve your financial goals. So keep it short, simple, and easy to implement.

These two tools can help you evaluate where you currently stand financially. Prepared annually, they can also help you assess your progress and keep you on track toward achieving your financial goals.

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