Making sense of the mess

“Everyone has a plan until they get punched in the mouth”

Mike Tyson

Chili on spaghetti?! Mike Tyson quotes? What is going on here?

Getting intentional with our money

I give these pictures and quotes because it is symbolic of where many of us are before we get our financial house in order. I imagine if I were to poll 10 people off the street what their monthly spending looks like probably 9/10 would answer incorrectly upon deeper investigation.

Now all the accountants in the audience may be scoffing and saying that is preposterous. But I imagine that most people reading this are not accountants and might be cringing a bit to hear that they too could not accurately quantify their monthly expenses.

Now, if you are a member of the Financial Independence community, Brad Barrett’s words may be rolling through your mind saying “Life is lumpy”. That is true!

I’m not saying that I expect anyone to know their expenses down to the dollar. However, having a general ballpark and understanding where their money is going is paramount to being intentional and progressing along their Financial Independence journey.

As part of the recent journey to EconoMe I’ll use the terms that were discussed during the Case Study. If you want to read more about EconoMe, check out my review of my first time.

Definition of terms

Net Worth Statement

In the Net Worth statement, we are listing all of our assets and liabilities with the intent of calculating our Net Worth.

Assets

First, we have assets. Assets can easily be broken down into different categories, but I’ll focus on 4. These 4 categories are Cash/Cash Equivalent, Invested Assets, Retirement Assets, and Use assets.

Cash/Cash Equivalents

This one is pretty self-explanatory, but these are your most liquid assets. Some examples would be cash in any number of forms. For example, cash in a checking, savings (or high-yield savings), Treasury Bills, and some would even argue Cryptocurrency if you’re into that sort of thing.

Invested Assets

The next most liquid bucket would be invested assets. While these funds can still be accessed generally you do not want to if possible as you are trying to generate a larger return with these assets or have some sort of repercussion for accessing the funds (penalties, taxes, etc.). Some examples here would be a taxable brokerage account, 529 accounts, and I would argue cryptocurrency as it’s not generally used as a form of currency.

Retirement Assets

In this category, we have many different types of accounts that you may be familiar with and further discussed in Getting your Financial House in Order such as 401K (both Traditional and Roth), 403b, 457, IRA (both Traditional and Roth).

Use Assets

Here we have a number of assets that have a value associated with them however you are actively using them. Therefore, some might argue this should not contribute to your overall net worth unless you are willing to actually sell the asset. Some prime examples here are a primary residence and any automobiles.

Liabilities

Next, we have liabilities. Just like before we’ll break these into 2 different categories, Current and Long-term liabilities.

Current Liabilities

In short, this is a short-term debt. The most common example would be carrying a balance on a credit card.

Long-Term Liabilities

More commonly, many people have long-term debt such as auto loans, student loans, and a mortgage on their primary residence.

Net Worth

As we investigated in 5 Levels of FI – Demystifying the Noise, calculating our net worth is critical to understanding our FI number. In this example, we should total all of our assets and subtract the sum of our liabilities to get our net worth.

Annualized Income and Expenses

In our annualized Income and Expenses sheet, we will list all of our income and expenses to ascertain how much we can save and supercharge our journey to Financial Independence.

Income

I imagine we all know what income is, but in case you don’t this is where we would list any money that is coming in like a W2 (including any bonus/profit sharing, etc.), Real Estate, Business income, and so forth.

Deductions

Next, we calculate any deductions that will reduce the contribution amounts to any other savings. Additionally, some of these may decrease our adjusted gross income (AGI) reducing our tax bill. Some examples may be any traditional IRA, 401k, 403b, 457, or in certain circumstances a Roth IRA.

Another deduction that we need to account for is our tax amount. As the saying from Benjamin Franklin goes, “In this world, nothing is certain except death and taxes.”

Finally, we have any other deductions that will not reduce our AGI, but will still reduce the amount that we are able to save each year such as a taxable brokerage account.

Expenses

As we know very well there are things we buy all the time called expenses. We can slice and dice these in any number of ways, but the categories that I’ve set aside for myself and my family are Mortgage/Rent, Housing Expenses (Taxes, Insurance, Maintenance), Utilities, Auto (excluding any loan), Health/Medical, Other Insurance (Life, Umbrella), Food, Clothing, Subscriptions, and child-specific.

Of course, your categories may vary as I’m sure your life situation will not be the exact same, but this should cover the most common expenses.

Debt Service

This one is pretty straightforward as well, but this would be anything where you are paying interest with the exception of a home. Add your monthly payment and multiply by 12 to get your annualized amount.

Unallocated Excess/Deficit

In many FI circles and sayings, this is commonly called “the difference”. The amount that we have left over from our income after all our expenses are paid is hopefully an excess.

If you are trying to speed up your time to FI, invest this amount to get to your FI number faster. However, don’t be afraid to listen to your own risk tolerance whether that means keeping some portion of this in cash or some other method.

If this happens to be a deficit, then you are considered “in the red”. Essentially, this means that you are spending more than what you make.

Percentage Allocation Sheet

In the percentage allocation sheet, we bring a higher-level overview of what percentage of our income a particular expense category takes. For example, if our total household income was $150,000 and our mortgage was $30,000 annually that would represent 20% of our income that we are spending on our mortgage.

Bringing it all together

Some common sayings that I’ve heard from non-FI practitioners are “there is no way that I could ever retire early”, “I like my job, why would I leave”, “I like too many nice things to deprive myself”, etc.

My retort to some of these statements is that this is not an all-or-nothing approach.

Just because you love your job, doesn’t mean that there won’t come a time that perhaps your employer may have to make a hard decision and downsize and you’ll have no option in the matter.

Not thinking you could ever retire could mean that increasing your income or reducing your expenses could have an even bigger impact on your trajectory.

As mentioned in 5 Levels of FI – Demystifying the Noise, there are practitioners in the FI space that follow Fat FI who aspire to not live any sort of deprivation at all in retirement, yet still wish to achieve Financial Independence much sooner than typical retirement age. Additionally, I would challenge an outsider’s view of the movement seeing it as deprivation and not for what it truly is — intentionality.

I hope walking you through some of these building blocks along the Financial Independence journey helps shine a light on your money and truly see where it is going.

As some of you have noticed and asked, I help those interested in 1:1 financial coaching. Walking through these building blocks is essential to level set on what is happening today and then understand your goals and help move in a direction that aligns with those goals.

Thanks again for reading and drop a note in the comments if you found this helpful!