Since money is a taboo subject that is often only spoken about in a whisper, it is difficult to know whether you are ahead, behind or right on track for where you need to be in your financial life. Even if you are the type of person who can discuss what you have financially with friends and family, it does not mean you are getting constructive feedback. However, there are several metrics that you can use to determine where you are on your journey to building assets for retirement. Once you evaluate these barometers of building financial independence, you can better chart a path to improving your financial plan.
[See: 10 Tax Breaks for People Over 50.]
The wealth equation. If you are a fan of the late Dr. Thomas Stanley's books, such as "The Millionaire Next Door" and "Marketing to the Affluent," then you are probably familiar with the wealth equation. The equation is fairly simple:
10 percent X age X income = expected net worth
This equation will help you determine if you are an average, prodigious or under accumulator of wealth. If you divide your actual net worth by your expected net worth and calculate a number greater than 1.84, you are classified as balance sheet affluent, which is an indicator that you have built up a nest egg that is working for you. This equation is especially helpful for those in their 50s or older, but isn't always as useful for young people who are beginning to save.
Your retirement number. A few years back there was an advertising campaign from ING that showed people doing ordinary actions like waiting for an elevator or walking down the street with a number hovering above their head. That number was what they needed to accumulate to be considered financially independent. There is a simple calculation that can help you determine what your number should be.
Multiply your income by 25 = your retirement number
For example, if you make $50,000 you would need $1,250,000 ($50,000 x 25) for retirement. The 25x factor is a quick way of calculating how much you need to save to replace your current salary while using a 4 percent withdrawal rate in retirement. If you consider a 4 percent withdrawal rate to be too conservative, then you could always come up with some variation between a 4 to 5 percent withdrawal rate by adjusting the multiplier between 20 and 25.
The need for a financial baseline. Both formulas require a basic understanding of your financial life. It's important to take an active role in managing and inventorying your financial situation. Here are the baseline items you need to understand:
What is your net worth? Your net worth statement is an individual or family's balance sheet. It is a way to measure your assets and subtract your outstanding liabilities. Your net worth is a big determining factor for your financial health.
What is your income? You need to have a complete understanding of all your sources of income. This might include:
-- Earned income: Money made from paid work, including wages and self-employment.
-- Unearned income: Income from investments outside of your day-to-day job.
-- Gross income: Income from all sources before taxes and retirement deductions.
-- After-tax income: Money after all federal, state and local taxes are paid.
The beginning of a new calendar year provides an opportunity to evaluate past decisions and implement new behaviors that can put you on an improved course toward financial success. This is a great time of year to create a net worth statement and review your various income sources and outflows from 2016. Use these two formulas to take stock of how you are doing. If you find that you are behind, develop a strategy to get things back on track. While building financial independence is not easy, you can improve your situation if you understand where you are and develop a plan to get where you are heading.
Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".
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