For many people, January means scraping together enough money to pay December’s bills. But instead of digging another financial hole in February, Canadians should consider stepping back to view their long-term financial future.
One effective way to do that is through a five-year net worth plan. Net worth is basically your personal value in dollars, which helps determine your own economic position. You can choose any time period you like, but five years is short enough to achieve realistic goals, and long enough to average out short-term deviations. It can also act as benchmark for where you want to be at any point in your life and ultimately, in retirement.
First, you must determine where you stand now. That means calculating your present net worth by subtracting your liabilities from your assets. The key is to be realistic and consistent.
- Savings: anything in your registered retirement savings plan (RRSP), tax-free savings account (TFSA), non-registered accounts and company pension plans.
- Appraised value of real estate: determining the current market value of your home or second property can be tricky. The assessment that your municipality uses to determine your property tax rate could be a good start, but it is often a low-ball estimate. Again, the key is to be realistic.
- Property that holds value or appreciates: Most cars and appliances do not hold value, so it doesn’t make sense to add them to your net worth. A coin collection, for example, could hold value. When appraising the value of anything, accuracy is important.
- Mortgages and secured lines of credit
- Consumer and student debts
- Personal debts (assuming you want to stay on good terms with friends and family)
Subtract your liabilities from your assets and that is your net worth. Don’t be discouraged if it is negative because a good plan will boost your net worth with three engines: debt reduction, savings, and capital appreciation.
Using your asset and liability list, chart your five-year plan by setting targets one year at a time.
Net worth targets:
- Debt reduction: lowering debt actually adds to net worth. The higher the interest, the bigger the return on your ‘investment’ of debt reduction. When your liabilities fall, more of your payments chip away at the actual debt instead of interest.
- Savings contributions: determine how much you will squirrel away in RRSP and TFSA contributions. You can boost savings by re-investing RRSP refunds or joining company savings programs where they match contributions.
- Asset appreciation: talk to your advisor about how much you expect your assets to grow each year. It’s a bit of a guess, but most conservative investment portfolios should yield an average annual return of five percent. Also, factor in the estimated appreciation of your home based on where you live.