Finances are scary and intimidating for a lot of people, but they shouldn’t be. Finances are science, an exact science I might add. Numbers don’t lie. One plus one will always equal two. The principals you need to follow to win in your finances are simple: make more than you spend, save, and invest. The “how” it is done differs from one individual to another. That’s why it’s important to understand the concepts of money management but you also need to adapt those concepts to your personal life. We see people who build wealth through real estate, others through the stock market, and others through entrepreneurship. There are even millionaires who work a regular 9 to 5. What works for me might not work for you. My financial freedom will look different than yours.
The 4 financial numbers you should know
Regardless of our individual path to financial freedom, there are four key numbers that I think everyone should be aware of. I mean your specific numbers, not what the society says is the “ideal” numbers.
1. Monthly Expenses
How much do you need to cover your household expenses for one month? This number should only include necessities (housing, food, transportation, utilities, childcare, etc. and for my Christian brothers & sisters, tithes). This number affects everything, and you can’t afford to ignore it. Your monthly expense number tells you if your income is too low (or your expenses too high). It dictates how much your emergency fund should be. Financial professionals recommend a 3 to 6 months emergency fund (if you are a little paranoid like me and want to have a backup to your emergency fund, I wouldn’t advise against it!). This number also affects your ability to save or pay off debt. Even worse, this number can be the reason you are in debt. So, yes. It is VERY important to know what your monthly expenses cost.
2. Saving Rate
The number one rule in finances is that you have to make more than you spend. Monthly income – monthly expenses = disposable income. Part of your disposable income should be saved and invested to build wealth. The saving rate is a ratio of savings over income. The standard recommended by professionals is between 15% – 20% of your GROSS income. Again, use this only as a guide. I want you to set your own saving rate: (1) set your savings goal, (2) set a timeframe, then (3) calculate how much you need to save per month to achieve your goal. Dividing this number to your monthly income will give you your target saving rate.
Calculation
If you want to save $50,000
In the next 5 years (60 months)
You will need to save this very month
50,000/60 = $833.33
If you monthly income is $5,000, your saving rate should be
$833.33/$5,000 = 16.67%
PS: this is just regular savings. If you are putting money into an investment account, you will need to take into consideration the rate of return. There is a great calculator here you can use.
3. Retirement Number
I hate to say this but just because you turn 65 years old doesn’t mean you can retire. Uncle Sam might not be able to give you the retirement you deserve. Social security benefits are not guaranteed. The good news is that you also don’t have to wait until you are 65 years old to “retire”. By retirement, I mean the ability to stop working because you have to. Some might call it financial freedom: you have enough money to last until you die even if you don’t work at all. As Chris Hogan says: retirement is not an age, it’s a financial number. You can retire once you hit your retirement number regardless of how old you are.
The 4% rule of retirement states that you can withdraw 4% of your retirement portfolio each year without running out of money. This rule is not 100% recession-proof, but it’s a very good estimate since no one really knows how long they will leave or what will happen to the stock market.
Your retirement number is annual withdrawal times 25. So, if you plan to withdraw $50,000/year in your retirement years, your retirement portfolio should be at least $1.25 million ($50K X 25). Once you have a number to work toward, it’s easier and motivating to stay focused. You can calculate your number here.
4. Net Worth
Last but not least, you need to know your net worth. In simple terms, net worth is the difference between what you own (assets) and what you owe (liabilities). Your income is NOT the same as your net worth. Having cash in your bank account doesn’t make you wealthy. Don’t get me wrong, cash is great to have. But if your debts far exceed the cash you have, you can have a negative net worth. Why is this number important? It shows if the things you have are making you wealthy or not. It also pushes you to evaluate the liabilities you have and see if you can reduce them. More importantly, it’s a point of reference from where you are to where you want to be. Like any other numbers discussed above, once you know it, you can put together a strategy to get you where you want to be.
I got another formula for you: target net worth = (your age – 25) x (1/5 of gross annual income).
For 40 years old with annual income of $100,000, the target net worth would be: (40 – 25) x (100,000/5) = $300,000. Again, this is just to give you a starting point. Your ideal net worth will depend on your goals and lifestyle.
It’s not that scary…
I love numbers. They tell a story, whether we want or hear it or not. And because it’s an exact science, if you follow the steps you will get results. If you don’t follow the steps, you WON’T get the results you desire. IT IS THAT SIMPLE. Another tip, if you feel overwhelmed, try to break your goals into smaller ones. It’s more manageable to work on weekly/monthly goals than annual goals. Remember, it’s your finances, make it personal!
“The rich don’t work for money, but money work for them, while the poor work for money. Illiteracy, both in word and numbers, is the foundation of financial struggle” Robert T. Kiyosaki
