Do you enjoy working at your 9 to 5 job so much that you plan to work until you’re 65 or older? Or would you rather retire early and spend time doing things you love? There’s nothing wrong with working, but I’m certain most people would choose early retirement if they could. If you’re one of them, have you started planning for it financially? If yes, great! If not, it’s time to start thinking about it. There’s a saying “Better late than never”. While this may still be true, it’ll be so much better if we can start this as early as possible.
Whether you plan to retire in your 40s, 50s, or 60s, the way you spend money now will likely continue into retirement. So, it’s important to understand your spending habits. Knowing not just what you spend, but also what you earn, save, and invest every month is key. Once you have a clear picture of your money, you can figure out how much you’ll need each month, each year, and for the rest of your retirement.
As I walk through the basic fundamentals about financial situations and planning, you’ll notice that I have a pessimistic mindset. Meaning, by being skeptical and expecting the worst outcome, any turn of events that turn out in my favor would put me in a better position because I have anticipated the worst from beginning. This is purely from my perspective and others may disagree, but when it comes to planning finances, I can be certain that being pessimistic will outperform the optimistic mindset. Let’s go through the basic principles that will contribute to your financial independence.
What are 4 key components for planning your financial freedom?
Income
Understanding your cash inflow is fundamental to grasping your current financial situation. Whether you earn a living through hourly wages or a salary, the first thing you need to do is determine your after-tax monthly income. It shouldn’t be too challenging to calculate your monthly earnings, particularly if you have a stable 9-5 job that provides a consistent income. However, for freelancers or contractors, this scenario might not apply. In such cases, I suggest you make an estimate based on your historical income, leaning towards a lower range of monthly income or averaging it out. I recommend using a lower income range because, should you earn more than planned, this creates extra cash inflow for you to spend or save. Obviously, if the income range starts from 0, use your judgement. However, remember, it’s better to adopt a cautious planning mindset rather than an optimistic one.
Now, the monthly income you’ve defined should serve as your maximum monthly budget. By the end of this article, if the result of your income minus expenses is a negative amount, it’s clear that some adjustments are needed. I can’t stress enough that your expenses cannot exist without your income. Having multiple credit cards doesn’t mean you should max them out. Doing so will only deteriorate your financial situation and your credit scores. Conversely, even if you’re spending responsibly and frugally, but still living with monthly debt, it simply means you need to increase your income. This could be achieved through various means such as working additional hours, finding a higher-paying job, embarking on side hustles, and so on. I will delve into these solutions, offering tips and opportunities to alleviate financial distress in an upcoming blog post.
Expenses
Defining your cash outflow can be challenging, especially if you haven’t been tracking your expenses. By the end of this exercise, you may find yourself surprised at the numerous payments you make each month.
The first step is to identify fixed monthly payments such as mortgage, auto loans, HOA fees, utilities, etc., which are essential for your daily life. After pinning down the fixed costs, it’s time to track your daily expenses. Finance apps like ‘Mint’ can be helpful in categorizing expenses, and I use this app as well. However, I recommend developing a habit of manually tracking your expenses since apps like Mint may mis-categorize certain transactions. For instance, purchases from websites like Amazon could be for either essential or non-essential items, which should be categorized differently.
Starting to track your expenses doesn’t require a sophisticated setup. A simple Excel or Google Sheet can do the job. Create a form to fill in your transaction data, including but not limited to:
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- Date (Month & Year)
- Transaction Method? (Debit or Credit Cards – Create another column for credit cards if you have multiple and want to track spending on each)
- Spending Category (Monthly recurring, Grocery, Gas, Eating out, Shopping, etc.)
- Vendor
- Transaction Amount
Throughout this process, I’ve stumbled upon beneficial insights. For instance, it helped me spot fraudulent payments or unrecognized transactions. Despite financial institutions’ efforts to alert us about suspicious activities, there were instances where I identified fraudulent transactions that could have gone unnoticed. Another rare scenario was discovering that a restaurant had altered the tip amount after I had signed the receipt. Being fully aware of all your transactions can indeed be beneficial in the long run.
Once you’ve filled out your transaction data in the Excel template, create a pivot table or other summary forms to understand your spending by category each month. This data will aid in setting spending limits per category. While I’ve advised underestimating your monthly income previously, when planning for expenses, it’s wise to overestimate or use a higher range of your monthly spending. This isn’t about setting a higher expense budget to max out the limit, but for the following reasons:
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- It alerts you as you approach that limit
- It helps you determine affordability based on your income
- Spending less than your limit leaves extra cash for saving or investing
Summarizing spending data visually through charts can be helpful if you prefer a visual representation. Comparing your monthly spending with your monthly income will reveal whether you are in good standing or overspending. Reiterating, if your total monthly expenses match or exceed your monthly income, it’s a red flag signaling the need for financial adjustments. Maintaining the habit of tracking expenses and adhering to your budget plans will foster a healthier financial status.
Not everyone knows how to cut spending or where to start. In a separate blog, I’ll share ways to reduce spending and save money. Ultimately, your dedication to change and the actions you take will make a significant difference.
Savings
At this point, I hope all of you have some cash remaining after covering your expenses for saving. If not, no worries! Everyone’s financial situation is unique, and my primary aim is to guide you on a collective journey of financial learning and growth. Together, we can work towards achieving financial stability and setting the foundation for financial freedom.
Assuming your expenses are less than your income, any surplus should ideally be channeled into savings. The concept of an emergency fund is probably not new to you; Emergency fund is a stash of money set aside to cover necessities in times of financial distress without having to rely on credit cards or loans. Therefore, this step is non-negotiable! It’s prudent to save an amount equivalent to at least 3 to 6 months of your monthly expenses. Common situations to list a few are like medical expenses, car or home repairs, or living expenses during a period of unemployment. If you’ve managed to achieve this, you’re already ahead of the curve compared to many others!
Why is the notion of an emergency fund resonating across the board? The events of 2022 and early 2023 have shed light on this. Many corporations, including tech giants like Microsoft and Amazon, initiated layoffs, affecting thousands due to economic pressures and internal organizational dynamics. These companies seemed very stable with high paying positions with highly qualified employees, yet many individuals found themselves facing unexpected unemployment. The harsh reality is, in today’s volatile job market, there’s no such thing as guaranteed employment. While we hope such misfortune bypasses you, if and when it does, there’s no guarantee that immediate job will be lined up for you to start right away. In such scenarios, your emergency fund is a financial lifesaver during the job-hunting phase without the worry of mounting bills. This safety net is particularly crucial if you have a family dependent on your income, ensuring their basic needs are met as you scout for new employment opportunities.
A common misconception about the emergency fund is its utilization for significant expenditures. I’ve encountered individuals contemplating tapping into this fund for travel plans, mortgage down payments, or new furniture acquisitions. However, none of these scenarios qualify as “emergencies.” I would advise to keep the emergency fund in a separate high yield savings account and/or partially save it in CDs (Certificate of Deposits) where it pays you the most interest. Do make sure that this fund needs to be easily accessible as the time can come unexpected, but until then, tell yourself that this money doesn’t exist!
Investing
Before starting the journey of investing, establishing a solid understanding of your income, expenses, and savings is paramount. This financial trinity forms the bedrock of sound financial planning, setting the stage for informed investment decisions. Firstly, creating a budget by understanding your income and expenses ensures you live within your means, paving the way for effective savings. With a clear insight into your financial standing and risk tolerance, you’re better positioned to make judicious investment decisions that align with your long-term financial aspirations. This disciplined approach not only fosters a culture of financial literacy but also guards against impulsive or premature investment decisions that could potentially derail your financial future. Now, with a strong financial foundation laid out, exploring the importance of investing becomes an exciting and insightful endeavor, opening doors to financial growth and stability.
Investing is like planting seeds today to reap the harvest tomorrow. It’s about putting your money to work in different avenues like stocks, bonds, real estate, or mutual funds, anticipating a reward in the form of profits or increased wealth down the line. When you invest, you’re not just saving money; you’re giving it a chance to grow and multiply. The beauty of investing is that it lets your money work for you, potentially leading to a more robust financial outlook and a cushion against life’s financial hiccups.
Now, why is investing a big deal? Well, it’s your ticket to financial independence, a comfy retirement, and the ability to weather the storms of inflation. Imagine having a money tree that grows over time, that’s what investing can do thanks to the power of compounding. Plus, it’s a shield against the rising costs of living, ensuring your hard-earned money retains its purchasing power as time rolls on. Investing isn’t just about growing your wealth, it’s about protecting it too.
Embarking on the investment journey is about understanding your financial goals, how much risk you can stomach, and the timeframe you’re looking at to reach these goals. The sooner you dive into the investing pool, the longer your money has to flourish and weather the market’s roller-coaster ride. Whether you dream of buying a cozy home, giving your kids a solid education, or enjoying a stress-free retirement, investing is the vehicle that can drive you towards these life milestones. However, it’s crucial to arm yourself with the right knowledge, perhaps seek advice from financial gurus, and carve out an investment strategy that resonates with your financial dreams. Remember, investing is less about following the herd and more about understanding what works for you.
Now that we’ve unraveled the essence of investing and its pivotal role in financial planning, our expedition into the financial realm is far from over. In upcoming blog, we’ll delve deeper into the diverse landscape of investment avenues. From the tax-advantaged realms of Health Savings Accounts (HSAs), 401(k)s, and Roth IRAs, to exploring other investment platforms, the journey towards amplifying your financial acumen continues. Each investment type comes with its unique set of benefits, rules, and considerations, which could be instrumental in tailoring a robust investment strategy. Stay tuned as we embark on a deeper exploration of these topics, equipping you with the knowledge to make well-informed decisions on your path to financial prosperity.
Start today! Surround yourself with like-minded individuals and encourage one another! Financial Freedom isn’t about competing with others, it’s competing with your own!
Grasping the basics of income, expenses, and savings is the first step towards a secure financial future. By managing a budget and saving wisely, you create a safety net for unexpected events. As you venture into investing, you take a significant stride towards financial freedom and preparing for a comfortable or even early retirement. Investing allows your money to grow, aiding in achieving your long-term goals. The journey from understanding your finances to making informed investment decisions is critical for planning a stable retirement and working towards financial freedom. By tackling these steps, you’re not just planning for the years ahead, but you’re also setting the groundwork for a prosperous retirement and a legacy of financial savvy.
Should any questions or confusions arise from the discussed topics, or if you find yourself seeking suggestions regarding your personal financial situation, feel free to reach out. Although I’m not a financial advisor, I’m here to engage in a financial dialogue. You can get in touch by submitting a request through the ‘Contact’ form. I look forward to hearing from you and diving into more financial discussions to help illuminate your financial path.
