So now that another calendar year has almost passed, it’s time to reflect on the year that has gone by. And by reflecting, I mean crunching some good hard numbers to figure out what happened in your financial life this year.

The end of the year is a great time to perform a financial update of your life. First of all, you typically get a few days off, so why not take advantage of it, and secondly, after eating all that food, you’re probably just going to sit around on the couch anyway, so why not be productive when you’re doing it?

Getting Started

So, having cajoled you into action, what things should we concern ourselves with?  Well, one of the things that important for any self-directed investor to check is their yearly performance.  How do you do this?  Well, you compile the balance of all your accounts at the beginning of the year, figure out how much money you added to them and when, and then take the closing balance at the end of the year.  After compiling all this data, you throw it into Excel, use the XIRR function, and it’ll spit out an annualized rate of return for your accounts.  Not too shabby huh?

Now that we have a number (that is hopefully positive), what do we compare it to?  Well, that depends.  What do you think you should benchmark yourself against?  If you’re only investing the equity part of your portfolio and have bonds or fixed income components elsewhere, I’d compare your performance to the total return of the S&P TSX index of Canadian equities, and the S&P 500 of US equities.  The easiest way to do this is to pull up Yahoo Finance, plug in the appropriate ETF’s (XIU for the TSX or SPY for the S&P 500) and then look at the adjusted close numbers for January 1 and December 31 of the same year.  Personally I tend to adjust the return of the S&P 500 to account for the value of the Canadian dollar, but that’s neither here nor there.  Anyway, by doing this, you’ll get a good feeling of whether you’ve “beaten the market”.  This is a good exercise, as if you underperform the market for a long period of time (say 5 years), then you should probably either a.) give up picking your own stocks and just buy index funds, b.) spend more time making your stock selections and maybe use a different strategy, or c.) find a financial advisor to help you out.

Now, what if you have a more balanced portfolio?  Well, I’d wander on over to Canadian Couch Potato, and download the returns for his model portfolios.  They’re basically just balanced portfolios of index funds, but they serve as a good proxy of the return that you would make in a balanced portfolio over the year, so throw that in your comparison bucket as well.

Warming up

So, we’ve figured out our annual return on our investments, and compared them to some benchmarks.  What next?  Well, the next thing I would look at is your net worth.  Basically, figure out the value (as close as you can) of everything that you own (think bank accounts, real estate, cars, investments, etc.), and then subtract everything that you owe (mortgages, credit cards, things like that).  That’ll give you your net worth.

Now that you’ve figured that out (and hopefully it’s positive), a more interesting comparison is the increase in net worth over the year.  So you need to try to figure out your net worth at the beginning of the year.  This may be a bit harder to do, but dig back in your online bank statements and things and hopefully you can come up with a good guess.

Having calculated your net worth at the beginning and end of the year, you now know how much more ‘wealthy’ you are than you were a year ago.  Feel free to work out a percentage increase if it makes you feel better, I know I do.  Now, with you feeling nice and confident, we’re almost done.

Cooking with Fire

There’s a few other things you can check depending on how much time you want to spend and how much you care, these are a.) your free cash flow for the year, and b.) a breakdown of all your expenses for the year.

Now, calculating your free cash flow basically just gives you an idea of how much your net worth changed due to savings vs. investment returns.  Interesting information, but nothing you really don’t already know if you’ve actually been doing what I’ve outlined above.  Calculating a breakdown of your annual expenses I think is a little more interesting, as it can be quite eye opening to find out what you actually spend money on.  Now again, if you don’t track your expenses routinely, this is going to be very painful to do.  But, if your net worth increased less than you thought it should, this would give you an idea why.

Looking Forward

One final thing before we go is we want to set reasonable targets for the next year.  Basically, what do you want your net worth to look like a year from now?  Decide, and then plan how you’re going to get there. You’re probably going to have to have a handle on how much you can save per month, and a target for your investment returns in order to do this step, but I think it’s one of the most important ones.  Once you have your goal, you can now track your progress towards it on a monthly basis.  And if things aren’t going well for one reason or another, you can find out why and hopefully fix it.

So now when you’re sitting around during the holidays with nothing to do, you can pull up this post and get cracking.  Knowing where you’re starting from and where you’re going is one of the most important steps in investing.  Good luck with it!

Until next time,

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