Financial Freedom by Forty

What I need to do to get my goal:

$1 Million Here I Come

So I’m short by approximately $400,000.  That’s not chump change for me or anyone else who is interested in reading this blog.  The next step is to determine what I need to do to get to the goal and where I want to focus my savings.

Where to Focus

I have three significant 10 year goals.  First, I love the outdoors, including hiking, fishing, hunting and the privacy of a large property with no neighbors in eye or ear shot.  As a result, I would like to purchase a camp or vacation home.  In order to accomplish this, I’ll need to continue to save money in the Assets that will be available to me in 10 years (savings and after-tax mutual funds).  Secondly, I would like to provide my children with a quality education at a low cost to them.  I’ll due this through savings in the 529 plans.  Lastly, I want to be free of my mortgage.  After this burden is lifted, financial freedom is just around the corner.

The Path

With the three goals above in mind I’m going to do some trial and error on my net worth calculation spreadsheets in conjunction with the savings calculators at www.bankrate.com.  This will take you some time but the calculations should be self-explanatory.  Keep general goals in your mind for each category.  For example, I’d like the mortgage liability to be $100,000, my available savings to be about $350,000 and the college savings to be about $100,000.  I know this isn’t nearly enough to send 2 kids to college, but I’ll still have about 10 years or so to save so I should be pretty close.  I’ll type these values directly into my spreadsheet.

The Numbers Work

The specific goals that I have correspond well to the overall goal.  I’ll need to have a net worth of a little of $1 million to make the numbers work out.  This is what I expected.

Drum Roll Please

The trial and error method has shown me that I’ll need to save an extra $1845 total each month to meet the goals.  See the attached spreadsheet for each category for savings specifics.  That’s a lot, almost a whole extra salary especially once you factor in taxes.  At a rate of 33% total taxes my added income will need to be – $2754 per month (~$33,044/year).

The Break Out

I’m going to assume that I can save 1/3 of the total $1845 I need and I’ll have to earn the other 2/3’s.  So total extra monthly savings = $615 and total income will need to be $1835/month (after tax = $1230).  I’m going to have to get creative because this isn’t going to be easy. 

The Stage is Set

Now that the preliminary calculations are done we can get to work.  The rest of the articles will focus on The Break Out from above.  Trying to save $615/month and earn $1835/month.  I don’t expect to do this in the first month or really even the first year, so as I progress over the next decade, I’ll have to save and earn even more than the above stated amounts.  But for now, the savings and extra earning goals will be the same.

This article will focus on where I will be in 10 years if I maintain everything exactly how it is today in regards to savings and interest rates.

Article 2 described a simple plan for defining point A and Article 3 gave some general advice on how to determine your destination or point B.  This article will determine the route from A to B.  What are the specific savings and earnings that we need each month to obtain the goal we have set?

Let’s start with earnings.  I’m not going to divulge my yearly income, but I will share the amount that I am able to save each month.

1. Mortgage – Over paid by about 10% per month. 
2. College Funds – Contributions equal about 5% of take home salary.
3. Savings – About 5% of take home salary.
4. 401K pre-tax contributions – 7% of pre-tax salary.

Alright, so we have the beginning amounts of assets in our current state.  If we continue at the savings rates we have set forth above we can find where we will be in 10 years.  There are some excellent calculators that will help us make these calculations at www.bankrate.com.  See the following screen shots below.  Since my checking account is my “spend” account I’m going to assume no change over the next 10 years

Savings – ASSET

Let’s start with savings.  From the screen shot/example below you can see that I’ll accumulate $23,674 in 10 years at the current (and putrid) rate of 1% and additional savings of $100 per month if I start with $10,000.

You get the idea.  So I won’t include screenshots on the rest.

Miscellaneous Investments – ASSET

Mutual fund or miscellaneous investments can be calculated in exactly the same was as a regular savings account.  I recommend looking at your funds/stock’s performance over the period of time that matches your goal.  Use that interest rate in order to determine an estimate of what your investment will be worth at the end of your goal period. 

College Savings – ASSET

I did the same calculations for my college savings funds for the kids.  By the way, I contribute to a 529 guaranteed savings plan.  This type of plan basically allows you to buy credits at today’s cost and use them when your child is actually in school.  Average tuition increase over the past several years at state universities is approximately 8% in my state and that’s where I got my APY.

Retirement Investments – ASSET

This category is the wild card.  I assumed 5% growth over the next 10 years in my retirement investments.  This is a low ball figure since historically the markets have returned about 8%.  I’m being conservative given the volatility of the markets.  Who knows what the rate will actually be but even a couple of percentage points is a major factor.   For example, if I use 8% instead of 5% the total retirement savings can differ by more than $100,000 depending on your starting point and contribution rate.

Home Equity –  ASSET

This one is a little tricky to calculate.  The first thing that I did was assumed that the value of my home would at least keep up with inflation over the next 10 years.  Again, who knows if this assumption is correct (the housing market may crash yet again???), but given historical housing prices of the area that I live in this assumption is close enough for an estimate.  If you know the value of your home you can calculate what it’s worth will be in 10 years by using the same simple savings calculator.  Just enter the current value of your home with an interest rate of 2.5%-3.0% for inflation with $0 contributions and that will give you the future value of your home in 10 years.   Now that you have the value of your home, you’ll have to find out how much more principal you’ll have put into it over the next 10 years.  You can use a mortgage calculator on bankrate.com.  You’ll need to know the current amount on your mortgage, how much time is left on your mortgage, the interest rate and how much extra you are paying.  If you put all of this information in the amortization table will tell you how much is left of the mortgage after 10 years.  Subtract this number from the total value of your home calculated above.  In the future, I’ll make sure to devote an entire article to the use of mortgage calculators.

Mortgage  - LIABILITY

You’ve already calculated this one in the step above.

Car Loans  - LIABILITY

For the sake of the exercise, I’ll calculate how to find out how much you’ll owe on a loan in 10 years.  It is exactly the same as calculating the balance of a mortgage.  In fact it is actually easiest to use a mortgage calculator to determine how much of any loan you will have left in a certain amount of time.  For my example, I’ll use a loan of $35,000. I want to know how much principal is left on the loan in 4 years.  The loan has a 5 year term with an interest rate of 4.0%.  This amount is equal to $7,570.   

 For most reading the article, it is realistic to assume that you will always have a car payment.  If you don’t you can add it to the savings that will be needed to achieve your goal after the car is paid off.  BY the way, vehicles are the absolute worst investment you can make in my opinion.

 Student Loans – $0

Student loans and home equity loans can all be calculated the same way as the car loan was calculated above.  In my case, my student loans will be paid off in 10 years, finally!

Credit Card Debt – N/A

This is a floating amount for me that is paid off each month.  Calculating credit card debt is complicated if you are still adding money to the principle.  If you are just paying the card off and not adding anything else, you can calculate the same as any of our other loans.  If you are still adding and only paying a minimum amount on the credit card – STOP.  The compounding interest will kill you. 

My summary shows that I’ll fall about $400,000 short of my $1,000,000 goal if I continue at my current savings rate.

Where Do You Want to Be?

Well, if your experience going through the current state spreadsheet was anything like mine you might be feeling just a little bit disheartened right now.  The journey to your financial goal may seem impossible to reach.  Look on the bright side at least you now know what you are dealing with and as stated in the previous article, you can only improve what you are measuring.  My recommendation is to go through your current state spreadsheet once per month.  Track your month to month Net Worth and see the improvement or degradation over time.  This will help you stay focused on your goal. 

WARNING:  I’ve known some people who have become obsessed with their financial situation and have caused some serious damage.  For example, an acquaintance of mine getting close to retirement age would watch his 401K account daily.  He was emotionally involved every day and made changes to his account on a weekly basis at least.  It caused him to lose a significant portion of his retirement savings.  Had he stuck with his original plan, he still would have lost some, but he could have gained it back when the market turned back up in March of 2009.

So whether you are reading my blog for the entertainment value or are seeking some guidance on your own financial goals you may think that the task is insurmountable.  I basically have to save $1,000,000 in the next 10 years.  Starting from scratch, even I am starting to waver.   Should I change the goal?  Should I make it easier to obtain?  Maybe $500,000 or even $200,000.  Ah, what the hell.  We set out on this journey to become millionaires so let’s go for it.  We’ll shoot for the stars and if we land on the moon, that’ll be ok too.

My goal is extremely general on purpose.  I’m using this blog to disseminate as much information as possible on earning and saving money and how to get to a specific goal.  I recommend making your goal as specific as possible.  For example, in 10 years maybe you’d like to buy a vacation home or have enough saved to send a child to college.  Pick a goal that means a lot to you and strive to reach it.  I’ll maintain my goal of millionaire status in order to stretch myself and use every method possible to earn/save money.

A couple of sentences ago, we used the word “insurmountable”.  Maybe, but we have a couple of tools in the bag that should help us overcome the obstacles:

1. Compound Interest – We’ll see in some future articles the power of saving in interest earning accounts.
2. Saving – A penny saved does not necessarily equal a penny earned.  Assuming that 30% of your income is taken by the government you need to earn $1.42 to spend $1.  If you save a dollar you don’t need to pay taxes.  In essence a penny saved is $0.0142 earned.  Ben F. is likely rolling over in his grave (I doubt he ever envisioned taxes at these rates!)
3. You – Bet on yourself.  Be confident in your ability to achieve your goal.  Drive toward it and don’t get discouraged.
4. Discipline – Much like betting on yourself, discipline and focus can be game-changers in achieving your goals.

Admittedly, this isn’t my best article but will work as a good transition to the next article which will get down to number crunching to see what we actually have to save in order to meet the goal.

In order to understand how to get from point A to B, you need to have a pretty thorough understanding of exactly where A is located.   As noted in a previous post it doesn’t really matter what your point A or B is.  The following is a technique of understanding your situation and how you’d like to change it. Engineers like to say you can’t control or change what you can’t measure.  This article will discuss how to get to your bottom line or net worth.

We will define net worth as Assets – Liabilities.  Assets are anything that is convertible into cash, including cash itself.  Liabilities are debts that require repayment.  A list of examples for each is below neither of which is all inclusive:

Assets

1. Bank Account Balance
2. Checking Account Balance
3. 401K/Pension Balance
4. Other Retirement Savings
5. College Savings
6. Miscellaneous Investments
7. Equity on Vehicles
8. Equity on Home(s) – Including rental properties

Liabilities

1. Mortgage(s)
2. Vehicle Payments
3. Student Loans
4. Home Equity Loans
5. Credit Card Debt

Each of the above items under liabilities and assets is important enough to have its own book (and many do).  For now though, let’s forgo the details on each and just talk numbers.    See the attached spreadsheet.  This spreadsheet is a starting point.  You can add rows for other Assets or Liabilities that you have but use this as a starting point.

Just going through and finding all of the information regarding your current situation is valuable for the following reasons:

1. You have to find the current information.  In my case I do most of my banking/bill paying online.  This exercise forced me to remember passwords and websites.  This can help you organize your paper statements or go paperless and have your statements sent to your email address.  Remember, the more thorough you are, the more you will get out of it.  You could use the spreadsheet as an estimate which is fine, but if you really want to know where you are and how to access your key financial vital signs delve into the details.
2. It is an eye opening experience to see how far you have to go.  I thought I was doing pretty well, but it turns, I’m only worth about $10,000.  Yikes, I have a long way to go.
3. The more accurate you are with your spreadsheet the better you’ll be able to see what you need to do to reach your financial goals, whatever they might be.  We’ll continue to use this spreadsheet in the next article in this series – Future State – Where do you want to go?

The spreadsheet that you have opened up has several tabs.  The first is “Current State – Me”.  That’s an example of my own Net Worth spreadsheet current state.  The other tab you’ll be interested in at this point is the “Current State” tab.  This is a blank sheet that will allow you to fill in your own information to see where you’re at.  Feel free to use it and let me know what you think.

I’m having a difficult time uploading the Excel File.  While I’m working on that if you would like to have the file please email me at moneyman91798@yahoo.com.  Sorry for the inconvenience.