How to Determine Your Starting Point and Goals for Prosperity & Happiness
Where Are You Now? Where Are You Going?
You and Christopher Columbus probably have something VERY IMPORTANT in common. On October 10, 1492, Christopher Columbus had no idea where he was, where he was going and how he would get there! Does this sound like your financial plan?
After 30 days on the high seas, on October 10, 1492, Columbus’ crew wanted him to turn back to Spain because their food and water were dwindling. They were sailing westward based on speculation and hope that they would land in India but in reality, they had no clue whether or not they would reach their destination or even die at sea. The crew threatened to make Columbus walk the plank and planned to return to the safety of their home port. Columbus and his #2 officer convinced them to allow them to continue for three days before full mutiny. Luckily, two days later on October 12, 1492, they saw land of a Caribbean island.
We now celebrate Columbus Day instead of his demise!
Are you in a similar situation?
Do you know where you are financially? Could you tell me right now what is your total amount of routine monthly household expenses? Can you tell me right now your net worth? Can you tell me right now what are your goals for passive income, active income, emergency fund and net worth 10 years from now?
Most people don’t know their actual numbers! If you don’t know where you are right now and you don’t know where you’re going, then how on this round earth can you possibly chart a course to get there?!
Are you relying on speculation and hope like Columbus did? Or do you have a plan?
If you can’t define your goals for financial freedom, how will you even know where you are when you get there?! When Columbus landed on a Caribbean island on October 12, 1492, he called it the “West Indies.” Why? He thought he was in India! He didn’t know where he was when he got there! He was off by a whole hemisphere!
If you don’t know where you are right now and you truly want to find the most efficient path to get from where you are today to where you really need to go and AVOID WASTING 1-2 DECADES GETTING THERE, you need to first define where you are and where you are going! The goal of this article is to help you organize your thoughts and collect the data from your historical finances to define your financial STARTING POINT, then set specific measurable GOALS with actual deadlines.
If it ain’t writ, it ain’t thunk! Your analysis of your financial starting point and goals must be in writing.
Your Crucial Homework!
Following is a list of questions you need to answer in writing to serve as a basis for constructing your 10-20 year financial plan. Invest a few minutes (or a few hours) in yourself to compile the data of your personal situation that will likely save you a few years or decades. That’s a huge return on investment of time.
When you have your starting point and goals, share the data with your accountant, licensed financial adviser, coach and/or family.
1. Routine Household Expenses Review your bank statements and credit card statements and add up your ROUTINE recurring monthly expenses. This includes items such as mortgage/rent payments, food, gasoline, car payments, student loan payments, retirement contributions, utilities, insurance, hairdresser, medicine, gym membership and any other monthly or quarterly recurring expenses. It is best to analyze a full year of expenses if possible, though 3-6 months is a good start. 2. Special Household Expenses Review your bank statements, credit card statements and planned future SPECIAL expenses such as emergency fund, kids’ college, weddings, non-covered medical expenses, luxuries, vacations, down payments for your next house or car, cushion for a few months of job loss, funeral costs and any other special expense you can semi-reasonably anticipate for the future. Assign a number and a date for each of the predictable special expenses when possible. Some special expenses may be 15 years away, some may not be predictable on a timeline. But the mere action of putting these special expenses in writing will make you face the realities for which you can plan, instead of relying on hope and prayer shortly before the time comes to produce the money. 3. Routine Household Income
Add up all your routine after-tax household income including active income from jobs (salary), passive income from rentals, child support, social security, pensions (if you’re old enough) and any other reliable routine source of income. Write down your total amount from active income (job) separately from your total amount from passive income (rental real estate). Financial VIABILITY is achieved when your active income covers your routine expenses. Financial FREEDOM is achieved when your PASSIVE income covers your routine expenses. That is why you need to write down your active income and passive income separately. This will affect your long-term goal for financial freedom.
Add up the value of all your assets. Assets include real estate, stocks, bonds, mutual funds, retirement account balances, savings accounts, precious metals, collections of value (e.g., art), paid up whole life insurance balances and any other major asset that you have. Some people include their cars and others don’t because they depreciate by design. It’s up to you whether to include cars, but if you have large car loan balances or expensive cars, you should include them.
Add up the balances on all your loans and those of any judgments or collections against you. Include mortgage loan balances, car loan balances, student loan balances and any other chunks of money you owe.
6. Net Worth
Subtract your liabilities from your assets and you have your net worth.
7. Liquid Portion of Your Net Worth
Go back to your assets list and see which assets you can convert into cash within a week without incurring large penalties and taxes. That usually means adding up what you have in cash, savings accounts and investment brokerage accounts that are not in retirement funds. You can include any paid-up life insurance balances you may have.
8. Benchmark Your Status
Compare your routine household income to your routine household expenses. Hopefully, your routine household income exceeds your routine household expenses and if so, that is a necessary but insufficient prerequisite for bring “financially viable.”
Examine the liquid portion of your net worth and estimate whether that can handle the next reasonable emergency such as several months of job loss, a non-covered major medical expense or even a car breakdown.
9. Set Goals
Now that you completed compiling your numbers in Steps 1-8, you have a pretty good idea of which parts of your financial status are solid and where it is shaky.
When you set goals, they must be S.M.A.R.T. which means:
In other words, make sure your goals have numbers, have timelines and are reasonable based on your starting point even though they are ambitious. Make sure that achieving your goals will fit in to your overarching strategic life plan, not just build a pile of money without purpose.
When considering goals, many people are OK with their active income covering their routine expenses, but are not doing as well with their liquid portion of net worth being able to cover special expenses in an emergency or for a luxury like a vacation. Other people have high net worth but are cash poor because all or most of their assets are not liquid, being tied up in real estate for example or in pre-tax retirement funds well before age 59 ½. I know people who had a few million in net worth who filed for Chapter 7 bankruptcy 18 months after the real estate bubble because all their assets were in real estate that was not liquid AND was overaged at 80% loan-to-value when the real estate market dropped more than 20%.
If you’re pondering your income goals, let’s say your pre-tax active income is $6,000 per month, your after-tax active income is $5,000 per month and your routine household expenses are $5,000 per month. That means you are making things work but you are on the edge if you hit a bump along your path. Perhaps you may set a goal for your pre-tax income to increase by $2,000 per month to $8,000 per month within one year. That may be a reasonable goal and it may be achievable by doing one relatively simple flip per year (buy a distressed house, fix it and sell it at a $25,000 profit).
Let’s say you are 50 years old, are planning for retirement in 15 years and you calculated that your projected social security benefits and retirement distributions will be short by $3,000 per month to meet your expected routine household expenses. Then you may consider buying one rental property every couple of years to generate passive income by the time you retire. You might even want to do one flip every other year to generate the down payment for each rental you add to your modest portfolio of rentals.
Let’s say you’re 35 years old with two kids and you have a decade or more until your kids go to college. You can set your goals to be able to pay for their college (choose a dollar amount) by the date each enters college plus reach a certain amount of passive income by your expected retirement age. You might decide to achieve these goals by engaging in a combination of real estate investment strategies in a plan that is customized for your income, available time, skills, comfort zone and other factors personal to your specific situation.
Now that you have completed the analysis of your starting point and goals, you have done an effective job in preparing yourself for coaching by your team of licensed professionals, coaches and advisers.
In summarize, you now realize:
It is crucial that you know your financial starting point
It is crucial that you know your measurable time-defined goals
It is crucial that you use this essential information to figure out the most efficient path to get from where you are right now to where you want to be later. If not, you are likely to waste a decade or two to achieve your goals. Is it worth it to invest a few hours figuring this out? That’s a no-brainer. Now get to work!