Hmm… just writing the title and thinking about the topic tells me that it’s a one to write about!

Should you spend and enjoy life right now?

Should you pay off your debts and save money for your retirement?

What if you die at 45 and never had one great trip in your life?

What if you die at 95, starving in a small apartment for the past 35 years since you hadn’t saved a penny?

How do you balance spending now and saving for later?

First off, am I the right person to tell you anything about this topic? Since 2008, I have increased my debt faster than the Canadian Government. While my assets and my income are growing even faster, I’m not sure that I am managing my budget right now. I spoke of this issue recently in my net worth update; I’m having a hard time managing my bi-weekly paycheck while I am receive 30% of my annual income in a bi-annual bonus. This causes an obvious challenge to balance a budget throughout the year. But in the end, I always payback my debt… go figure!

Spending Vs Saving; it’s all about risk management!

Some will tell you that you are better off spending all your money as you earn it and enjoy life as they know someone who passed away too young to enjoy life. Others will tell you  to live a simple life, pay off your debts and that you will have all the time in the world to enjoy your retirement once you are there.

I think the first group of people is not thinking enough about tomorrow, but they are surely enjoying life to its maximum right now. The latter will never enjoy their retirement. In fact, most of them will continue to save money and live a simple (and perhaps boring) life. After so many years of restraint, it becomes a habit. And many people that are used to this lifestyle and feel uncomfortable when they spend money. So there is no right answer; it’s all about risk management.

Do you want to take the risk of not having enough money at retirement versus taking the risk of never using your hard earned money? This is the right question.

So Where is the balance? The balance is in the bucket!

I think the balance is found when you are able to create a bucket for each goal. At first, you can start with a simple structure of 2 buckets:

Bucket A: Having fun

Bucket B: Saving money for later

The point is to setup bucket B pretty soon:

- establish automatic payments on all your debts (to make sure you pay everything according to the plan).

- establish an automatic investment plan for your retirement account (pay yourself first).

- take out life, disability and critical illness insurance (protect your biggest asset: YOU!)

Then, should you have enough money left over to fund bucket A, have fun:

- extra spending (dining out, clothing, traveling)

- extra (controlled) debt (remortgage for renovation, car loan, etc.)

Bucket A should be a lot smaller and not as restricting as bucket B (which is a major problem for most people; they spend more on hobbies and extra debt than on their house payment and retirement investment account!).

When I look at my situation; my bucket B is pretty solid:

- I have maximized my RRSP contribution (and continue to do so each year)

- I have a solid pension plan

- I have a set payments on my car loan and my mortgage (and I don’t plan on changing cars for the next 5 years or more).

Then, I can play with my bucket A:

- spending on vacation with the kids, clothing budget is on the kids too!

- extra debt to finance my central A/C

My only problem is my credit card debt repayment (which is being done with my variable income). Since 2008, my things have gone a bit sideways but now that I am well established, I’ll have to increase my bucket B and start paying them off within my monthly budget and not wait for my performance at work to use my bonus!

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Close your eyes.

Get on your knees.

Close your fists.

You are nervous.

You are starting to sweat.

You know it’s coming: a guy with a baseball bat will take a full swing at your face.

How does this feel?

Let me tell you: It ….. HURTS! You wish you were never born!

This is what happens when you track your expenses and calculate them at the end of the year! Well… this is what happened to me last week when I opened my year end credit card statement.

I’m a smart guy. So I spend 95% of my expenses on one credit card; the same credit card paying me tons of points. As I pay it completely each month, there is no harm in terms of interest costs. I just gather points (which I will use to fly away on vacation!). But while I am improving my credit score and gathering points, my credit card also works for me; it tracks down all my expenses for me!

I have a confession to make: I’m lazy.

I’ve used Microsoft Money for about 18 months right before starting my home renovations 2 years ago. Since then, I never opened the software anymore. Why? Because I was able to track all my expenses through a year end statement: my credit card statement. It piles up all my expenses throughout the year and separates them under several categories.

I’ve already told you how I suck at not paying my debts off… well I’m worse than I told you!

My ever-increasing spending has been covered throughout the years because I always got nice, substantial raises. Even last year, I increased my income from 106K to 135K. But this time, I’ve gone too far. Even though I make some real good money, I’m definitely spending too much.

In 2010, I have spent… $57,000 on my credit card! This amount is so huge I still can’t believe it! Here’s how I have spent it:

This has to change

I’ve already discussed my financial goals for 2011. One of them is to pay off my debts (especially my credit card debt) by $22,000 in a single year. I will use my favorite gun to fire my debts (increasing my income) but I will also need to cope with spending habits and learn how to save more. I think I can certainly hit the restaurant area as spending close to $500 per month in this category is just ridiculous (especially since I spend a lot on groceries and healthcare at the same time).

Since I want to eat healthier (I’m still struggling with my weight being stuck over 180 lbs), I think I will be able to cut down on dining out. I also want to control my big expenses as I will limit myself to buying central A/C and won’t consider building a garage, a terrace or installing a pool (or a spa).

Have you ever been hit like that? I mean, spending $57K in a year is just stupid! Has it ever happened to you?

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Hey! You know me by now; I always think about how to make more money. I’m trying to get as many raises as possible from my day job and always looking for a way to make more money through my online company. After using my extra money to buy a lot of stuff, I am now calming down and started to think seriously on how to spend my extra income. Here’s my current list:

#1 Pay off my debts

This is the first time since I started working (back in 2003) that paying off debt is part of my priorities. Only a year ago, I was still trying to make more money to cover for my lifestyle. But I realized something in 2010; nothing is eternal. What if I can’t make a huge bonus at work next year? What if my online company starts crumbling down? What if interest rates hike big time? (I’m in variable rates on all my debts).

While these 3 examples are less likely to happen in 2011, I want to pay off my debts for another great reason: I want to reach financial freedom at a young age. Financial freedom is a combination of 2 achievements:

#1 Being debt free

#2 Having a recurrent income

While I have worked my way to building a solid income stream, I never looked at paying off my debts too much. It’s now time to clear the mark over my head.

#2 Invest in my house

I will use part of my bonus to make improvements to my house. I think it’s important because you spend most of your free time at home. This is why renovating or adding equipment to your home is a good idea. This year, I will work on my landscaping since it doesn’t cost much and I will also install central A/C. I know, I am talking about taming lifestyle inflation and simultaneously announce that I will spend a few thousand on my house…

But having A/C this summer is definitely a must. We had to sleep in the basement for more than 2 weeks last summer. I wasn’t super productive during that time!

What I also like about spending money on your house is that you don’t lose it entirely. When I renovated the basement of my previous property, I made back each dollar spent at the moment of the sale.

#3 Thinking of my kids‘ education

With my 2012 bonus, I will fund my kids’ RESP. I have been neglecting this aspect of my personal finance for too long already. Now that my RRSP is maximized and will be paying off a few debts this year, I will be able to use the 2012 bonus to make sure my kids will have a great future.

Education will definitely not be free and if you don’t save 15 years in advance, the bill will be pretty hard to cover when they reach University. In Quebec, we get a 30% subsidy from both provincial and federal governments. So if you invest $1,000, you automatically get $300 for free added to the account. Very interesting concept!

#4 Investing

A part of my extra income automatically goes to investing. It’s either by maximizing my RRSP or by not taking money away from my online company. While I want to drop my debt level in 2011, I’m still a firm believer that one should start investing before paying down low interest rate debts.

The stock market shows great investing opportunities (just look at my recent stock analysis over at The Dividend Guy Blog to know what I am talking about). I will see how the year goes but I might want to get back to my first idea of restarting a Smith Manoeuvre account…. We will see!

#5 Minimal rewards

There is one thing very important when you make extra money and it is to reward yourself. Extra money often means extra effort, extra hours worked and ultimately, extra sacrifices of time spent away from your family and friends. This is why it is important to reward yourself for what you do. In 2010, I went a little bit too far on the reward side of the equation (new big house, new sports car, new furniture and a huge load of clothing…). This year, I will do it differently!

What do you do with your extra income?

Are you traveling? Buying something? Saving? I’m curious to know what you do with your extra income?

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Is there really a such thing as good debt? Can you really classify any debt as not being a negative? Do you see all debts dragging you down to apply for a IVA debt to avoid bankrupcty?I’ve noticed that there will be folks that classify themselves as being in “good debt” and they will frown upon those that are in “bad debt.” At the end of the day, debt is still debt and I’m here to debate if good debt really does exist.

First of all, I’m sure we all know by now what’s considered good debt. What exactly is good debt? Let’s look at each level of supposed good debt to see the pros and cons of it.

Education.

Using student loans to pay for your college education is a classic example of supposed good debt.Investing in your education through loans could be an excellent strategy for increased earnings in the future. Unfortunately it could also cause a steep burden. Let’s look at using debt to obtain an education.

Why this debt can be considered “good”:

You may increase your income earning potential. It’s no secret that going back to school to earn your Master’s Degree or to pick up a whole new education, could do wonders for your wallet. Higher credentials could be just the thing that you need to hit your income goals… and who knows? Maybe even get rich!

You can pursue opportunities you may not have otherwise. From types of work to new business startups, all kinds of new opportunities could come your way once your earn your education. You could enter a totally new field that interests you more or you could move up the latter in your company much quicker.

Why I would argue that this is “bad debt”:

You earn an education that you don’t care for. As you young person you may not consider the financial consequences of acquiring massive amounts of debt to pay for your education. Consequently, you might be in school for the sake of being in school and earn a degree in a field that you’ll never work a day in your life. Is it really worth going into debt for this?

You don’t consider working. Many people often don’t consider working in college. Some will even use debt to live and pay for living expenses for the time that they’re in school. This debt creates a false level of security because this money needs to be paid back eventually.

Home purchase.

A mortgage is the most common form of debt. A home mortgage is also often considered a form of good debt. Actually let’s be honest, many people with a mortgage don’t even consider themselves to be in debt. Has anybody ever purchased a home with all cash? Does anyone consider a mortgage to be bad debt?

Why this debt can be considered “good”:

You can use leverage to invest money in an asset that will appreciate greatly. When you obtain a mortgage on a home and it appreciates greatly in value in a short period of time, you’ve essentially made a solid return with using debt as leverage. This is assuming that you sell the property at the right time and you don’t lose your savings on interest payments.

It’s a solid financial goal. We often have problems with saving money. It’s just too easy to spend money. A home purchase, with the mortgage payments that follow, can be financial goal that we need to start saving money. For some there only investment is their primary residence. A home can often be the best financial decision that some people make.

Why I would argue that this is “bad debt”:

You blow lots of  unnecessary money on the property. From home maintenance (taking care of your lawn) to all of the other costs that go into a home, you’ll find yourself spending lots of money on top of your mortgage payments. This is money that you must consider as you decide if a mortgage really is a form of debt debt.

Interest payments. You must remember that the more money you borrow, the more money you’ll spend on interest in the long run. You’re not borrowing this money for free so you must factor in interest payments into any profits or appreciation that you calculate.

Taxes. The property taxes on a home are enough to cripple some people. This is money being spent on top of everything else.

Other unrelated costs. From a new home entertainment system to repairing a furnace in the middle of the winter, there are many other unrelated costs that go along with a mortgage.

Do you believe that there is a such thing as good debt?

(photo credit: me and the sysop)

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Mike just wrote about why he borrows money so often. Borrowing money has really worked out for him and yielded some solid profits. Borrowing money and using debt as leverage can be an excellent financial strategy. The thing is that many of us are not savvy enough to borrow money and profit off it in the long run. Many young people are guilty of borrowing money today and worrying about the consequences tomorrow. This is why today I wanted to look at what you should consider before borrowing any money at all:

Why are you borrowing this money?

Do you absolutely need to borrow this money? Many times there are two viable options to not borrowing money: delaying the purchase or not making the purchase at all. A new car may seem like a good idea at the moment, but is it really needed? At other times the purchase can also be delayed (home purchase) by a few months or years until you have the sufficient funds needed. Of course you run the risk of losing out on a great bargain. This is why you need to clearly understand why you are borrowing this money.

Will you be able to repay this debt?

How steady is your income? When you’re making lots of money and many great investment opportunities come your way, it’s easy to rack up debt to be used as leverage. The critical question here though is whether or not you’ll be able to sustain this income in the long run and successfully pay off the debt? If you have a stellar plan to repay this debt then by all means go for it. You just need to have a backup plan in case you can’t pay off this debt.

What’s the interest rate?

With an amazing credit score you could potentially find yourself a low interest rate on a loan. In my opinion, the interest rate should be a deal breaker. If your poor credit score constitutes a high interest rate, then the interest paid on borrowing this money could be much more expensive than any profits you might gain.

What’s your level of risk tolerance?

Can you sleep at night knowing that you’re thousands of dollars in debt? We all have different levels of risk tolerance. Some of us can engage in complex investment strategies and feel perfectly comfortable with everything. Others get nervous just having to make car payments. Before you borrow any money at all it’s important that you assess your own personal risk tolerance to debt.

What type of debt are you acquiring?

I won’t get into the whole good debt vs bad debt argument. That’s another debate for another day. Why you borrow money and how much you borrow should depend on the type of debt that you’re acquiring. You could borrow money to go for your MBA, increase your income by $20,000+ a year and then pay off your debt with your increased income, and feel great with your new position. You could borrow money to buy a new car and then want to switch cars after a few years. There are many different reasons to borrow money (education, car, home, personal, investment, and emergency). The type of debt you acquire should really dictate why you borrow money and how much you borrow.

Have you borrowed money recently? What’s the deciding factor for you when it comes to borrowing money?

(photo credit: Antoine Hubert)

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