Chuck, you are starting to sound like you are heading towards budgeting. If that is what it takes, then I would suggest that you create a budget. What I am getting at is many people really don’t have a handle on what they spend. The key here is the age-old axiom that the way to financial success is to spend less than you make. Do you really know how much money you spend a month?
The actual term for this is debt-to-income ratio (DTI)? Basically, you take your monthly gross income and divide this by your total monthly expenditures. I personally find gross monthly income a booby trap because you should use your net monthly income. The reason for this is that we all must pay taxes and that gets paid to the government immediately. That leaves us with the remainder, or net income, to spend on our monthly expenses. These expenses include anything we spend money on every month: interest payments, living costs, housing costs, car payments, and so on.
Why is this important?
The most important reason for many people is that you cannot get a mortgage if your debt-to-income ratio 43% or lower. Naturally, the lower the better and if you have a low DTI, you will get a better rate.
This brings us to buying cars, getting loans, or getting a line of credit. Banks look to your DTI to determine if you are a good credit risk or not. You may not be planning on getting a loan or anything right now, but you can never tell when a major expense hits you and you need cash. A very good article on DTI can be found at Investopedia.
BNN Blomberg reported on December 11, 2020, that Statistics Canada says household debt has risen to 170.7%. What does that mean? For every $1 a Canadian earns, they spend $1.71. It doesn’t take a genius to figure out that you will end up in serious financial difficulties very quickly. The article goes on to say that credit market debt rose 1.6%, while the Canadian household disposable income fell 3.1%. The takeaway is that here is more debt and less money.
In the US, 42% of Americans reported that their income fell. NerdWallet did a survey in late 2020, and the results were shocking. They found that 51% of Americans said their household income fell, 30% had a large unexpected large expense, 28% reported their expenses increased, 22% lost their job, 9% had family members diagnosed with COVID-19, and 5% said they contracted COVID. The average American spends 8.69% of their income on debt and their debt-to-income ratio is 115.1 .
The bottom line is that on average people are spending well over their means.
What can you do?
Keep a copy of the receipt for every purchase you make for a month. If you have a spouse, keep track of all the receipts of the family spending. At the end of the month, use a spreadsheet and tally these up per category: mortgage/rent, food, gas, car insurance, house insurance, personal insurance, phone, cable, internet, clothing, liquor, banking, credit card fees/interest, charity, medical, pets, utilities, hair/nails, going out/restaurant/fast food/coffee/snacks, home repair, and savings/holiday account. Don’t cheat — you will only be hurting yourself, so be complete.
Tally it all up, compare it with your take home pay, and see where you stand. Are you in a position to save or do you have to tighten your belt for a bit?
Then do the same exercise again for Month 2. Some months will be more expensive than others. See how you do the second month? Did you learn anything from Month 1?
For an excellent calculator, you can go to Debt.ca to use their debt-to-income ratio calculator (Debt-to-Income Calculator).
Or you can go to the spreadsheet page to find an Excel template for all kinds of Financial Calculations (Financial Calculator Templates).
This does lead to budgeting. My wife considers budgeting a four-letter word, but it is a fact of life around here. A budget is not a document meant to punish anyone; it is meant as a guide to make sure that we don’t overspend and get ourselves in financial challenges. It doesn’t take much, and it is a very quick slippery slope. I will go into budgeting in much more detail in the next article.