Be Financially Free – Lesson 4 – Current Pace

Looks like you're almost ready to get started on your road to financial freedom.

So far:

You've learned the starting point for your journey is your current net worth and that measuring your net worth is the only way to track your progress.

You've figured out your destination when you determined your number.

Some of you even took some time to sort through and handle any excess baggage (bad debt) that may slow you down on this trip.

Now all you have to do before you set off is to determine your current pace.

This article will help you answer:

Am I moving in the right direction?

How fast am I travelling?

When will I arrive at my destination?

So how will we do that?

Two words ...

...Income and Expenses.

Many of you shy away from your own finances because you are scared of numbers. This is one of the reasons why you are not financially free. Fortunately, I understand that numbers can be intimidating so I am going to give you a step-by-step process that any elementary school student can follow.

Let's start with income:

Step 1 - Calculate the gross (it just means before taking deductions like taxes, 401K, etc.) monthly income by adding up all the money you receive.

Example:

Gross Salary: $4000

Interest from Savings: $120

Stock Dividends: $230

Rent from Tenant: $1000

Total Gross Monthly Income: $5350

Easy, right?

Now for the expenses:

Step 2 - Calculate monthly expenses by adding up all the money that you spend on average in one month. For expenses that are once a year but recurring (i.e. christmas and/or wedding gifts), just divide the one time expense by 12. Taxes should be included in your expenses as well.

Example:

Rent: $1200

Utilities: $150

Phone: $80

Gym Membership: $20

Gifts: $1200/12 = $100

Income Tax (Federal and State) = $1300

So far so good? Great!

Step 3 - Calculate the difference between the money coming in and the money going out.

To help you with this calculation, click here for an income and expense calculator from frugalvillage.com. All you have to do is input your gross monthly income from step 1 and it will give you your "monthly spendable income" assuming a 33% tax rate. Then you input all your expenses for the month. At the bottom you will get the total left over for the month.

This total will help us answer the 3 questions above:

Am I moving in the right direction?

If your total is positive (you earn more than you spend), you are moving in the right direction. If your total is negative (you spend more than you earn), you are going the wrong way. If you have a negative total, the first thing you need to do is find ways to cut your expenses ... immediately.

How fast am I travelling?

The larger your number. The faster you're travelling. A large negative number means your travelling quickly in the wrong direction.

When will I arrive at my destination?

You will arrive at your destination when your current net worth is equal to your target net worth calculated from Lesson 2. Unless you already own a home, a business or other investments, the money you have in your bank and in your retirement accounts will make up the bulk of your net worth.

The income calculated from this lesson will determine how much you can save. Use this savings calculator from Bankrate.com to see how much you need to save monthly to reach your "number" within a set number of years.

Example using Bankrate's Savings Calculator:

How much do you want to save?  $1,000,000

How many years? Play around with this number to make the "monthly deposit required" = monthly amount leftover 

Interest rate: 6% Daily Compounding

How much money can you spare to start? $1000

Do you wish to skip 2 weeks out of the month? Yes

When do you make your first deposit? Today's date

Starting with $1000 I will save a million dollars ...

in 5 years, if I save $489/day

in 15 years, if I save $117/day

in 30 years, if I save $34/day

So if I started saving when I was 20, I would be a millionaire when I became 50 and all of this assuming a conservative interest rate of 6%. This is the power of compounding interest and the earlier you start saving the better.

If you haven't already, I highly recommend that you calculate the money you have left over each month after you pay all your bills and expenses. If the number is positive, use the savings calculator to see how long it will take you to reach your target "number" if you saved everything that was left over each month.

Once you know your pace, it's time to discuss strategy.

In the next lesson, we're going to answer the question:

What can you do to get to your number faster?