Forecasting your Net Worth

When I started getting interested in personal finance, I wondered if I could apply my years of experience in corporate financial planning to my personal financial planning.

Companies create plans or forecasts for a number of reasons: giving management and investors confidence in the company’s progress, identifying detailed functional plans of actions that would help deliver on the targets, holding management accountable for achieving the targets, validating company’s assumptions on its revenues, costs and profitability.

All of those reasons rang true to me when I thought about my personal Net Worth. I had a long-term goal in mind of achieving financial independence. But I did not want to achieve it by any means possible at the expense of nice things in life. I wanted a balance between self-imposed financial limitations and achieving financial independence. I wanted to see how I should organize my personal finances to achieve my long-term Net Worth goal. I wanted to be able to see how my day-to-day behaviours impact my long-term Net Worth target. I wanted to better understand the profitability of my investments.

So I came up with the 8 step process to develop the forecast for my Net Worth, accompanying budgets and contribution schedules, and keeping track of how well I was able to achieve my Net Worth goals using a dashboard of key performance indicators.

Step 1. Set your investment and savings goals for the year

Setting goals is motivating. Goals will serve as a guidance for the rest of your Net Worth plan. Your goals need to be quantifiable (dollars), time-bound (what is the point in time when you want the goals to be achieved) and based on your priorities (from most to least important).

Investment and savings goals may include contributing to RRSP, TFSA, RESP or non-registered accounts. Also, savings goals may include various sinking funds, such as emergency fund, house repair fund, car repair fund, vacation fund, Christmas fund.

Step 2. Set your income and expense budget

Dig through your income and spending history. Identify patterns. There are several types of patterns that may come up:

1) Known amounts. If you have a set salary, rent payments, mortgage, insurance, childcare, cell phone bills, subscriptions — they all fall into the “Known” category

2) Budgeted amounts. You may want to set budgets for some discretionary expenses to keep your expenses in check. Some expenses that fall under this category are eating out, takeout, entertainment.

3) Average amounts. These are recurring expenses that may fluctuate month to month, but they stay within a corridor. Some of the expenses falling under the “Average” category are electricity bills, groceries. They may occur bi-weekly, monthly, bi-monthly, quarterly.

4) Ad-hoc amounts. The timing and amounts of these expenses may be hard to predict. They are best managed through the sinking funds. The examples of these expenses are various emergencies, vacation, car repair, house repair.

Step 3. Project monthly income and expenses.

Put your monthly income and expenses together to create your annual forecast. Identify which accounts or credit cards you will use to pay for each category of expenses. Doing this will help project your balances on your accounts at the end of each month. Calculate funds available monthly for investment and savings by deducting your expenses from your income.

Step 4. Project monthly contributions towards your investment and savings goals

List your monthly contributions together according to your investment and savings goals. Make sure that the differences between income and expenses, and your previously accumulated savings are enough to fulfill your investment and savings goals. If not, review your income, expenses and goals.

Step 5. Allow for uncertainties in your forecast

Forecast is the opposite of a crystal ball. You will never be absolutely right in your forecast. You can only try to be the least wrong. It does not mean that forecasting is a useless exercise. A well-designed forecast will give you the sense of direction, clarity and empowerment.

On a practical level of Net Worth forecasting, keep a buffer in your savings account to balance excess or shortfall. Zero-based budget does not work for everyone. It may create more peace of mind to maintain a buffer in a savings account to “insure” yourself from budgeting mistakes.

Step 6. Record balances on all your accounts and credit cards at the start of your planning period.

They will be the starting point to project how the balances will change throughout the year. Include chequing, savings accounts, credit cards, investment accounts and sinking funds. All these accounts are the components of your Net Worth. Their balances will change throughout the year depending on your incomes, expenses and estimated returns.

Step 7. Record actual transactions in your chequing, savings accounts and credit cards.

Download transactions from your online banking apps. Classify all transactions into income and expense categories you have set up in your plan. It is the moment of truth. You are now ready to see how you did and how your day-to-day actions reflected on your future Net Worth.

Monitoring your transactions will empower you to see your progress towards the goals and create accountability over your Net Worth forecast.

Step 8. Review key indicators of how close you are following your plan and course correct if needed.

Review variances of your actual income and expenses against your plan. Both positive and negative variances — they will indicate possible issues with your plan o with your actual spending or income. Course correct — review your plan or set limits on your future spend. If your plan no longer seems realistic, adjust your plan.