Part of a financial clean house is understanding where you are now and where you are going. What are your future financial goals and how will you get there?
Without a vision there is no motivation to make a difference. To save, invest and grow. One reason why many Americans don’t invest in their retirement account is because the idea of retirement is so far into the future, there is simply no motivation to feel deprived now in order to save extra money. Our society rewards instant gratification and provides very little encouragement and education to plan for the future. Spend money now, don’t think about the consequences down the road. With all the instant gratification, keep up with the Joneses mentality, it’s seems impossible to have money left over each month to direct towards a retirement fund. Vacations, dream homes and new cars take up whatever savings can be managed, leaving nothing for the long term.
If retirement seems too far into the future, and you don’t know where you want to go, you certainly won’t ever get there. Without a clear vision of where you need to direct your money as you plan for the future, there’s no reason to say no to the extra costs all around. The morning latte, eating out, weekend trips, new clothes, or happy hour at the local brewery.
But what if you knew exactly what you were saving for and why? What if that goal was so important to you that you want to spend money on that goal rather than anything else? Pay yourself now for the future you want. Then, spending decisions become so much easier with a path to follow and a clear reason why you are on that path.
If you live paycheck to paycheck, there is a reason. It’s not because you don’t earn enough. It’s because your expenses reflect the goals you have. In the absence of financial goals, spending is applied to instant gratification.
Instead, set a financial goal and spend money on that goal. Every dollar saved for that goal is money spent towards your future and your dream.
This post will review the three easy steps to set your financial goals so that you can finally take control of your money today.
Contents and Quick Links
Review where you are now
Track your expenses
The very first place to start is expense tracking. Why? Because this is the biggest area you can make a difference. It’s unlikely that you can significantly adjust your earnings next month, but you can dramatically adjust your spending.
Before you can make significant changes to your spending, you need to understand exactly where every dollar is going.
To read up on how to start tracking your expenses, visit How To: Track Your Personal Finances.
Review your spending by category
Once you have tracked your spending for a month or two, review the different spending categories. Where is most of your money going every month? What is the percentage breakdown for every category?
Start saving more
Now review the highest categories first and see if you could cut back and spend less next month. Your biggest categories offer the greatest savings potential.
As you go through the categories, you will find areas that you can save money on. And that money will add up.
Calculate your savings rate
The next step is to figure out how much you have to contribute to savings, then calculate your savings rate. This is the percentage of you income that you are able to apply to your savings. For example, if I make $100,000/year and I save $1,000 every month, my savings rate is 12%.
Read more about this at How To: Calculate Your Savings Rate.
Once you have made it to this step, you will have a very clear understanding of where every dollar is going every month, and how much you can save right now. As you do this every month you will gain awareness of how you are spending and more importantly, you will become more discerning in how you spend your money. The result of improved awareness is an increasing savings rate.
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Decide where you want to go
Without this step, you really have nowhere to go. If you have no clear vision of why you want to save your money, there is just no incentive to ignore instant gratification and deprive yourself of the shinny objects we encounter on a daily basis. These could be anything from the latest gadgets, clothes or experiences, or just that morning latte.
Learn how those little daily expenses add up: The True Cost of Your Morning Latte.
So take some time to dream big and imagine what you want to accomplish financially in the next year. Then think even bigger and imagine what you want in the next 5 years and then at 10 years.
Are you saving for a new home? Travel? Early retirement?
Remember, if you don’t know where you want to go, you have no clear path to follow.
Which leads to living paycheck-to-paycheck and an empty retirement account.
Visit 10 Year Goals and Why You Need Them Today if you need help developing your future goals.
Map out a plan to reach your financial goal
Now that you know why you want to save for the future, it’s time to map out a path to get yourself there.
If you have a path to follow, there is no reason you can’t or won’t get there.
Determine how much money you will need to achieve your financial goal. Then determine both how much do you need in savings and the timeframe to get there.
As an example:
You want to retire early. As in, the next 8 years.
Here’s what you know:
- Income: $125,000/year
- Savings rate: 40%
- Current savings: $200,000
- Expenses: 60% of $125,000 = $75,000
- Retirement expenses: 80% of current living expenses = $60,000
- Why lower? Since you won’t be earning as much, taxes will be lower. However, if you plan to increase your expenses by traveling more or living more extravagantly, you can maintain current expenses or add a buffer.
- Savings you need to retire with $60,000 in passive income: $1.5 million (4% rule, multiply desired income by 25).
- See how I calculate retirement savings at How To: Calculate Your Savings Rate.
Here’s what you can now calculate:
- You need an additional $1.2 million in savings
- You currently save $50,000/year
- It will take you 26 years to save $1.5 million and retire
Thankfully, with compounding interest, it only takes 13 years to reach $1.5 million.
What you now know:
It will take you an extra five years to reach your retirement goal. You will need to increase your savings rate by cutting expenses more or increasing your income such that you save $108,000 every year.
Obviously, it would be very difficult to go from saving $50,000 every year to $108,000. Thankfully, there are a few other options. You can decide whether to work an addition five years, or change your investing strategy to increase your net worth an additional $613,000 (the amount that you are short at year 8).
Additionally, you could invest in real estate to add net worth and passive income, or create a side hustle to earn more income over the next few years. You could also work hard to lower your monthly expenses and live on less per year. This way, you won’t need as much for retirement.
Now you know where you are, how much you are spending and how much you can save. You know where you want to go within a certain timeframe. And you know what it will take to get there.
You have a plan!
Take action and follow your plan. Revisit it often and remind yourself why you are working so hard to diligently save to get there.
Some ways to do this:
- Create a vision board
- Set small rewards along the way as you reach certain milestones
- Review your why, keep it handy where you see it every day, tell people about it
Visit 7 Steps to Successful Goal Setting for tips and tricks to stay on track with your goal.
If you aren’t sure you can save this aggressively, review Defining Your Enough: How Much Money Do You Need To Be Happy?.
If you feel like you aren’t saving enough, you aren’t alone. Thankfully, in just three steps you can turn things around.
- Review where you are
- Track your expenses
- Establish a budget
- Track spending categories and find ways to reduce spending
- Calculate your savings rate
- Understand where you want to go
- Are you saving for something?
- When do you want to retire?
- Map out how you will get there
- How will you make that happen? What does your savings rate need to be? If you need to fast track, review earning and investing options.
Check out the real estate investing category to learn how to fast track your wealth building.
Now, all you need to do is take action.
I’ve included a number of links to related blog posts. Since there are a lot of steps involved in creating your financial plan, be sure to review the posts listed so that you can complete each step before moving on to the next one. Here’s a list of the links I mentioned before, in the order you may need them: