Saturday, July 14, 2018

Be your own financial planner – The Balance Sheet

Be your own financial planner – The Balance Sheet

Click on sheet to magnify
Pretty obvious or what?  It is just like any corporate spreadsheet. So if you can do this for yourself you should be able to analyze any other business.

Current Assets and Current Liabilities are short term holdings, usually expiring within a year.  So a Mortgage maybe a liability but if you plan to pay it off in the current year then it becomes a ‘Current Liability’. Got it?  If you actually shoot a Lawyer and you get convicted for life, that idiot becomes a (Long Term) liability.  If , instead, you just fire the bloke ASAP then he-it-she is just a current liability.

Now add up everything you own and that doesn’t just cost money.   Subtract everything that costs you money, i.e. the liabilities. I am talking about things not expenses!   As a land lord,  you may put in a new $3000 kitchen in your rental apartment. If you pay that out of this year’s rental income it is basically an expense.  Only, that would give you too much of a tax deduction according to revenue Canada and they want you to write down the costs over a number of years.  So now the kitchen is added to the asset value of the apartment but every year you can write the value of that kitchen down as a ‘wear and tear’ expense which is called depreciation. Depreciation is an expense.  Got it?

If you buy stocks, they are assets. If you borrowed the money (not always or often not advisable) the loan is a liability and that loan's costs are the interest you pay and which you ‘expense’. As such, since the loan is to enable you to make taxable income on your asset (e.g. dividends), the interest is a tax-deductible expense. Here is a beaut: Your house is an asset that as your primary residence is tax free when appreciation results in capital gains. In return, the interest you pay on the mortgage on your personal residence is not tax deductible.  However…  if you pay off the mortgage and THEN take out a loan, i.e. another mortgage or a home-equity-line-of-credit (heloc) and use the money borrowed to invest then the interest IS tax-deductible.  This is where some financial planners go wrong and consider a home not an asset!  Right! Tell that to long term home owners in Toronto!  After years of massive appreciation upon sale these ‘non-assets’ finance their owners’ entire retirement.  You bet your residence is an asset and even when you live in it, it can appreciate, or you could use it to make money through Airbnb, or Vacation By Owner, rent the basement suite, and through many other creative ways.

Your house is a substantial part of your net worth.  If you have a job consider it an asset valued at 10 times your take-home. So is Canada Pension! Say the average retiree makes around $1050 per month in CPP and Old Age security (on a before tax basis) then that is $12,600 per year or equal to an asset value of 10 times 12,600 or $126,000 – part of your Net Worth although you cannot take it with you to your grave! An asset it something that generates income and your Canada Pension and Old Age Security certainly do.

Not all liabilities nor all debt is bad!  You, the individual, can make money using other people’s money! If you take out a loan for say a vacation, that is maybe good for your personal well being but it typically does not make you money. Unless you write travel columns for well paying news papers! In general, though, it is a bad form of debt.  Just like credit card debt is typically bad – especially at a 20% interest rate!  But you can use borrowed money to make more money than you have to repay in principal plus interest. Then it may increase your Net Worth.  It is a liability but the investment you make with it is offsetting it as an asset!  A loan on a boat is typically a bad loan but if you use the boat to make a living as a fisherman then it is ok - provided the fishing after debt repayment and interest makes YOU money!

Think in terms of a balance sheet for everything you do in your life. You may find many creative things to do that increase your net worth while having a blast! You see, that kind of thinking is not the deadly ‘retirement thinking’ of the past but the thinking process of a financial adult or one in the making!  Now this was certainly not rocket science or higher financial thinking for which you need a financial planner!  But this is how you should think not only today but probably far into the future.  Especially in a world were automation may take away many 'traditional' jobs.

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