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Financial Management and Budgeting

Financial Management: Financial management is the process of determining what your financial picture looks like. It takes into account a family’s cash flow detain income and expenses, a family’s net worth which details the assets and liabilities and laying out the near, mid and long term goals. As a result of this data and analysis a Financial plan is built. Rationale: Without data gathering, analysis and an understanding of one finances a financial, investment, and risk management plan cannot be built. In fact, the entire financial plan is based on this analysis. Therefore, understanding of how to collect this data, use and analysis is very important.

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Priority Planning Pyramid Speculative: Art/Tax Shelter/Investment properties (Верхушка пирамиды) Controllable : Retirement/ Education/ Major Purchase Uncontrollable Events: Death, Illness/Disability, Financial Emergency

Сourse Text The Personal Financial Planner’s manual June 2017, Gobeil & Associates https://www.gobeil.ca/pages/manual Topics 1. 2. 3. 4. 5. 6.

Employment Income and Benefits Money Management Process Home Ownership Behavioural Finance Planning for the disabled RDSP

Employment Income and Benefits • Employee-Individual who has entered into a contract with an employer • Must fulfil obligations to employer to continue receiving wages • Received guidance and direction from employer • For majority of population, main source of earnings • Often Direct and Indirect compensation

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Contractor: individual who enters and agreement to complete a specific undertaking Typically with limited guidance or direction from the other party of the contract. Increasing in popularity due to reduced employer obligations.

What does this mean for a financial planner?......you have to consider potential reduced work at times, unstable income, liked or no benefits and most importantly for planners is no pension. So savings are very important. Employment Income and Benefits  Contractor: individual who enters and agreement to complete a specific undertaking  Typically without guidance or direction from the other party of the contract  Increasing in popularity due to reduced employer obligations Direct Compensation  Salary: agreed amount of compensation paid out periodically with only an indirect amount of compensation tied to hours worked.  Hourly Wage: agree amount of comp for each hour worked  Governed by Provincial employments standards legislation  Also collective agreement or individual contract b/n employer/employee Consider: 2017 Minimum wage was $11.60/Hour 2018 gov’t change increased to $14/hour 2019 increase will be to $15/hour What is the cost difference for min. wage worker in 2017 vs. 2019 if they average 30 hours/week and 48 weeks per year Consider: 2017 Minimum wage was $11.60/Hour 30 hours/week and 48 weeks per year =($11.60*30)*48 = $16,704 2019 wage will be $15/hour =($15*30)*48 = $21,600 Commission  Commission is a form of compensation calculated on a unit basis or on a % basis  Arrangements can be diverse and complex  Common in Financial Services and Real Estate  A commission arrangement itself does not constitute an employer/employee relationship  Compensation arrangement can include salary plus commission

Real Estate Example: Susie is a realtor and is representing a buyer who just purchased a home for $1.5m dollars. Susie will receive 2% commission for the successful bid of her client. Susie can keep 90% of her commission with 10% going to his brokerage for back-office support How much will Susie receive total Insurance Example: John is an insurance agent working for a large national firm. After completing a thorough need analysis for his client, he successfully implemented $5,000 of insurance premium for them. John receives a 50% first years commission based on the total insurance premium, He will also receive a 150% bonus on his first year commission. How much will he receive

Indirect Compensation o In addition to direct compensation o Benefits vary greatly b/n employers o Can add 20% plus to HR costs/employee Examples include:  Cafeteria style benefits plan  CPP plan contributions  Pension Plans  Group Health Insurance Plans  Group Life/LTD Insurance Plans Indirect Compensation CPP Rules: • Employee/Employer contributions mandatory • Equal contribution amounts • Employer contributions non-taxable to you • You receive tax credit of 25% on contributions you make • Based on YMPE ($54,900 in 2016; $57,400 2019) • Contribution rate of 4.95% (employee/employer) • Max for each is $2,544.30 (5.1%;$2,748.90 2019) • https://www.canada.ca/en/revenueagency/services/tax/businesses/topics/payroll/payroll-deductionscontributions/canada-pension-plan-cpp/cpp-contribution-rates-maximumsexemptions.html Indirect Compensation o Tuition: Employers may pay for post-grad programs o Also industry courses (i.e. CFP) o May be taxable or Non-taxable

o Employer benefit vs. pure employee benefit o Company cars, low rate loans; living allowances all examples of numerous types available Employee Termination o Employer must give reasonable amount of notice before termination o If employee dismissed without reasonable notice employer may have to compensate o Provincial Laws determine min. requirement o In Ontario, typically 1 week of notice for every year worked up to 8 weeks (if employed 5 years plus) Other issues include: o Constructive Dismissal o Non-compete clauses o Social Contract o Downsizing & Restructuring o Mass Termination Cost to Raise Children • Adjusted for the increase in the CPI, the cost of raising a child to the age of 18 in 2015 dollars is $135,000 for a boy and $134,000 for a girl. • Average day care costs could increase this amount by $65,000. • These cost estimates only include direct costs (actual dollars that must be spent). They do not include opportunity costs, such as the income that may be forgone by a parent who chooses to remain out of the labour force to raise a child. Money Management • The more that Canadians earn; the more they spend. • Regardless of their income, many people avoid the financial planning process because they feel that they barely have enough money to meet their immediate needs; • let alone extra money for investment or savings purposes. Why is money management important in FP?......it is the basis of any future financial security a family could want. Money management is most important in the early years….why is this? This is where savings and time work on your side. Hence the concept of starting early. • Money is a powerful motivator of human behaviour and its effect varies greatly from person to person. • Depending on the individual, money may symbolize power, security, freedom, selfrespect, happiness or even love. • Your own attitude to money as an adult probably stems from your parents, family members, cultural background and your financial experiences.

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It is important that there is agreement regarding spending priorities before a cash flow plan is developed If a plan is developed based only on the priorities of one of the spouses or partners, the plan may be subject to sabotage by the other spouse. A compromise must be reached and the couple must be committed to the spending priorities for a cash flow plan to achieve the desired results. By understanding your own perceptions about money, you can work to overcome any attitudes that may be hindering the achievement of your financial objectives. All human beings have differing needs. Satisfying these needs is the strongest motivator of human action. Certainly, everyone needs the basics of food, clothing, and shelter, but once those needs are satisfied, other needs demand attention.

Monetary Philosophies The squirrel: Money is security. Only the most conservative savings vehicles are used or, worse still, money is hoarded away at home. The magpie: Money is for acquiring shiny things. Fascinated by the use of someone else’s money, the magpie is happy if someone is willing to extend it credit to acquire shiny things. The peacock: Money is prestige. The peacock is quite flamboyant in spending money on the right clubs and fancy cars to buy social acceptance. The lemming: Money is to die for. Tantalized by get-rich-quick schemes, the lemming throws itself into investments, which are doomed to failure. The beaver: Money is power. By using all available resources to build his own personal pond, the beaver impacts on everyone around him. The ostrich: Money is for spending. The ostrich sticks its head in the sand at the though of budgeting or saving for the future. Money Management is an essential component of any financial planning process. You need to have income to be able to sustain your lifestyle. Effective money management will help ensure that you will have some money left over after necessities and taxes to implement your long term financial strategies. Money management 5 Aspects of money management: • Step 1 - Setting money management objectives; • Step 2 - Collecting and analyzing information on income and expenditures; •

Step 3 - Selecting money management strategies;

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Step 4 -Implementation of budget and cash flow strategies; and

Step 5 -Monitoring of cash flow Money Management Objectives Step 1: An objective is a position or financial state you wish to achieve. • Objectives should be SMART (specific, measurable, action-oriented, realistic and time based). • Your money management objectives are different from your financial planning objectives. The objectives for your personal financial plan are longer term and cover a wider range. Money management must be realistic…..why is this? If its not you wont keep tou your plan. Documentation of your money management plan is also important as you can refer to it. Strategies to improve money management 1) Frugality is acquiring goods and services in a restrained manner, and resourcefully using already owned economic goods and service 2) Pay Yourself First 3) Account for your expenditures 4) Establish a simple budget: A budget is simply a plan for how you are going to allocate your money. A simple budget is an arrangement to set aside funds for various purposes with the intention of only using them for those purposes 5) Develop a comprehensive budget 6) Limit availability of cash 7) Use credit WISELY! 8) Establish an emergency fund

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Understanding Credit In order to have sufficient cash to implement your financial planning strategies, you must first manage your cash flow. For some, this may entail nothing more than arranging to have money directed from their income directly into a savings account For others, changes in the way they use credit, counseling and detailed budgeting may be required When you borrow money, the lender runs the risk that you may default on the loan. For this reason, lenders protect thri loans by requiring security and doing credit rating checks. Loans that are not secured have higher interest rates than secured loans. The higher interest rates must compensate the lender for the costs incurred by bad debts.

There are two systems used to provide consumer loans: revolving and consumer loans: revolving credit and consumer loans. Revolving credit: Lender to lend funds to a borrower up to a specified amount for a specified or indefinite period of time  Often no fixed repayment schedule The most common types of revolving credit used by consumers are bank credit cards, store credit cards and lines of credit secured by residential real estate. A consumer loan is a loan made to an individual for personal or household purchases, such that the loan required equal monthly payments comprised of interest and repayments of the principal. A consumer loan may be secured by personal property, such as an automobile, but not by real estate Amortization is the repayment of a loan over a specific period of time by equal period payments comprised on interest and repayment of principal The amortization period is the specific period of time for the repayment of a loan that is being amortized. An amortization schedule is a table showing the number of payments to amortize a loan Liquidity and The Latte Factor*  Recommended you have 3-6 months worth of savings.  If you were to save $7/day at 7% rate of return you would have the following: 2 years: $5,289 5 years: $14,693 10 years: $35,301 15 years: $64,205 20 years: $104,743 What is you Latte Factor? Discuss in groups and be prepared to share Liquidity and Debt Consolidation Average Canadian credit card interest rate is 19% (CTV.ca) 40% of Canadians do now know their credit card rate (CBC.ca) Average line of credit is 4-6% (Globe investor.ca) That is a 13-15% after-tax difference! A $5,000 loan at 19% over 10 years would cost over $6,158 in interest payments! A $5,000 loan at 6% over 10 years would cost $1,648 in interest payments. Automobile

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Your automobile is likely to be the next largest single purchase after the purchase of your home. An economy car costs around $20,000 to purchase, a luxury car costs over $60,000 and the average family car falls somewhere in between. Considering that the average life span of a car is seven years, you could end up spending more on automobiles than you do on your home, particularly if you have to finance the purchase

A depreciating capital asset is an asset that decreases in value over time. On the other hand, real property can appreciate, or increase, in value over time. Automobiles are depreciating capital assets. An automobile will depreciate about 30% in the first year. Discussion: Strategies to manage costs of car ownership   

A depreciating capital asset is an asset that decrease In value over time On the other hand, real property can appreciate , or increase, in value over time Automobiles are depreciating capital assets. An automobile will depreciate about 30% in the first year. Discussion: Strategies to manage costs of car ownership   

Automobile Financing Car loans are consumer loans, which are available from the car dealer, manufacturer or from a lending institution.  A car loan has the following characteristics:  36, 48 or 60 month amortization period, recently 72 months have been adopted.  Title of the car remain with the lender until the loan is paid off.  The car is collateral for the loan and may be repossessed if you default A lease is a long-term rental contract with a set monthly fee. The usual terms of a car lease contract are:  You pay a set monthly fee plus a down payment and freight charges  At the end of the lease, the leasing company owns the car unless the contract contains a buy-back clause, which allows you to purchase the car at a pre-determined price. Leasing: You must maintain the car and return it in reasonable condition at the end of the lease There is a limit to the total amount of mileage you may drive during the lease with a per kilometer penalty for excess mileage: and  There will be a penalty if you cancel the lease before its termination date

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Lease vs. Buy  Under the purchase agreement, you own the car at the end of the contract. Under the lease agreement, the car is owned by the leasing company.

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When choosing between the two options, a general guide is that if you like to change your car every two or three years, your best option is to lease a vehicle If you expect to keep your car for more than five years, it is more economical to purchase it

Home Ownership  Residential housing construction in Canada is a twenty billion dollar a year business  And in the course of buying those new homes, Canadians invest considerable amount of money in furnishing , appliances, legal fees and other expenses  In addition to cost of home, there are substantial costs incurred related to financing, maintenance and property taxes. Home Affordability This is a question that a client will often ask the practitioner to advise on. The answer given will depend on the situation, including:  The nature and value of the property  The state of the market  The net worth of the buyer  The income of the buyer  The other commitments and goals of the buyer  And other circumstances such as age and job security of the buyer While it is tempting to make generalization such as “spend between 25% and 35% of gross yearly income on housing costs”, the actual amount should be based on a careful review of the above and other relevant factors. The total debt service ratio (TDSR) is an affordability ratio that compares the cost of owning or renting a home and payment on all other outstanding debts to the borrower’s gross income. It is used by lenders to determine if someone who is applying for a mortgage can realistically afford to make payments on that mortgage. ((mortgage payments + property taxes + heating costs + 50% of condominium fees + payments on other personal loans)/ gross income) The gross debt service (GDSR) is an affordability ratio that compares the cost of owning or renting a home to the borrower’s gross income. It is used by lenders to determine if someone who is applying for a mortgage can realistically afford to make payments on that mortgage. Unlike the total debt service ration, the gross debt service ration does no take into account other consumer debt. The GDSR does not consider the cash outflows that are not directly associated with home ownership including personal loans, rent, or other debt obligations. Mortgages

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Few people have the personal resources to fund the purchase of a house and will therefore need to seek mortgage financing A mortgage contract is a contract in which the mortgagor (borrower) uses the property as security for a mortgage loan and the mortgage (lender) obtains a charge or lien on the property. The terms and conditions for repayment of the loan are set out in the mortgage contract, and the charge or lien on the property ceases once the mortgage loan has been fully repaid. A fully-closed mortgage is a mortgage that does not allow the mortgage to take any additional principal repayments during the term of the contract. A fully- open mortgage is a mortgage that allows the mortgagee to increase his mortgage payments, or to pay off the principal at an time, without penalty. A high-risk mortgage is a mortgage in which the mortgagee has made less than the traditional down payment The term of a mortgage is the period for which it remains in effect before having to be renewed. The amortization period is the period over which the mortgage loan is to be paid off. The interest rate will be stated in the mortgage contract as well as the method of calculating interest. Under most mortgages, interest is calculated semi-annually. The payment frequency is the frequency with which the payments on a mortgage are required.

Mortgages Terms to Know  Variable Rate  Fixed Rate  HELOC  CMHC Insured Mortgages  High Ratio

Step 2:Collecting and Analyzing Data In order to determine if your objectives are realistic, you must have a good understanding of your current income and expenses. This analysis exercise can help you determine if you have any chronic money management problems, such as excessive use of credit cards or a constantly overdrawn bank account. • Statement of Net Worth; • Statement of Lifestyle Expenditures; and • Statement of Cash Flow. What is a net worth statement?.....Assets less liabilities…it is what you are worth

Why is this important?.....it is a measure of the progress you are making each year. Strategies to improve money management 1) Frugality is acquiring goods and services in a restrained manner, and resourcefully using already owned economic goods and services. 2) Pay Yourself First 3) Account for your expenditures 4) Establish a simple budget: A budget is simply a plan for how you are going to allocate your money. A simple budget is an arrangement to set aside funds for various purposes with the intenti...