The Voyage to Financial Independence

Given that it’s the dead of winter here in Colorado and I’m landlocked in a sea of white snow, I thought conjuring the image of a sailboat, preferably on blue Caribbean waters, would be a pleasant analogy for illustrating a path to financial independence. Imagine that you are the Captain of a sound sailing vessel and her name is You, Inc. Put on your captain’s hat and let’s set sail on a Money Mind voyage…

Identify Your Port of Call

Before setting sail on any voyage, it is necessary to first identify where we are and what provisions we have on hand. We need to pinpoint our exact location and take an inventory of the items we will need on our trip. From a personal finance perspective this is accomplished by creating a personal Net Worth Statement as of a specific point in time (usually at the end of a calendar year, quarter or month). Creating a Net Worth Statement is rather simple. Here’s how to do it. Take out a sheet of paper and draw a vertical line down the middle. The left-hand side will list all of your assets (what you own). The right-hand side will list all of your liabilities (what you owe) and the difference between the two (what you own minus what you owe) equals your Net Worth which is captured as a figure at the bottom of the page on the right-hand side. (Net Worth may be a positive or negative figure.)

First, identify and organize all of your assets – divided into three main categories – Cash Equivalents, Investments, and Use Assets. As you might suspect, the first asset category, Cash Equivalents, includes any actual cash on hand, checking and/or savings accounts, CDs (Certificates of Deposit) or any other similar assets. The second asset category, Investments, includes any investment accounts, such as taxable brokerage accounts, Individual Retirement Accounts (Traditional IRA, Roth IRA, SEP IRA, SIMPLE IRA), employer sponsored retirement accounts (401(k), 403(b), 401(a), 457, etc) and any other financial investments you may have. The third asset category, Use Assets, includes items that are not specifically identifiable as cash equivalents or investments. These include things like a house, vehicles, and other physical property of value. All assets should be listed at fair market value, or what can reasonably be expected if it was sold today. Calculate a sub-total for each of the three categories and an overall total for your assets.

Next, identify all of your liabilities (what you owe). Liabilities are typically separated into two categories – short-term (due in less than one year) and long-term (due in one year or longer). Short-term liabilities include credit card balances and any other near-term obligations. Long-term liabilities include items like auto loans, student loans, mortgages or anything else owed beyond one year from now. Calculate a sub-total for each of the two categories and a total for all liabilities. Now for the fun part! Take the total figure for all of your assets and subtract the figure for all of your liabilities, this is your Net Worth. (Assets – Liabilities = Net Worth). Write this figure at the bottom right side of your page. If assets exceed liabilities, net worth is positive. If assets are less than liabilities, net worth is negative.

Your Net Worth figure is your starting location, your current port of call. Our goal now is to work to improve this figure going forward – whether starting from a negative or positive position – the important factor is that we move forward from here.

Determine Your Current Heading

Unless you were born yesterday, or are 100% financially dependent on someone else, you are likely already sailing along on your financial journey, but have you charted a course and defined a heading? In the financial world, we determine our current heading by creating a Statement of Financial Activity. This document will list all of your financial inflows and outflows during a specific period of time (i.e. monthly, quarterly or yearly). This is where we determine what direction we are going in (forward or backward) and how fast we are getting there.

In order to make forward financial progress we need our income to exceed our expenses. Excess income beyond expenses can be put to work in the form of savings and investments. The wider the (positive) gap between income and expenses, the faster we are moving toward our desired destination. There are many ways to compile or track this information. Personally, I have tracked my income and expenses using Quicken for many years (decades, actually) and it suits me well given my accountant-oriented Money Mind. However, there are many alternative tracking methods available that also work well from the basic DIY pen and notebook format to Do-It-For-Me computer and mobile app software, such as Mint or You Need A Budget (YNAB). Whatever method you choose to track and organize your information, the most important thing is that it gets accomplished and that you use a tracking method you will stick with for the long haul.

You can either choose to start tracking inflows and outflows from a set point going forward, or if you have the information readily available (via statements, etc), you can create your Statement of Financial Activity going back in time. A period of 90 days should suffice to get your current bearing – no need to go back much further – the focus should be from here going forward. Once this is accomplished, you should have a good handle on your current direction and speed.

Identify Your New Destination & Chart Your Course

Now that you have a good understanding of your vessel, its heading and speed, you can identify any desired destination by establishing financial goals. But first, one item every sailor should possess is a life jacket. Every financial voyager should have a savings cushion to weather the inevitable storms ahead. The first goal should be to establish an emergency fund, a savings account with 3-6 months of bare minimum expenditures. This will provide financial security when the seas get rough – when unexpected expenses crop up or there is a temporary loss of income.

Now that we have our life jackets at hand, we can look toward the horizon and determine our destination. Every Captain should have a pre-determined destination and a plan to get there. From a financial perspective, a comfortable retirement and/or financial independence is frequently the number one long-term goal for most people. In order to reach that goal at a reasonable (or early) age, a savings and investment plan must be established.

It is up to each sailor how much to commit to this goal, but the higher the savings percentage, the earlier the retirement porthole opens. In order to reach a comfortable retirement destination, it is usually best to target a minimum of 10-15% of gross income toward this goal. If you start your voyage later in life, you will most likely need to increase this percentage to reach your retirement goals.

While retirement may be our ultimate destination, we all likely have other destinations we may want to reach along the way. These may include the purchase of a home, a vehicle, or college education. Any such goals will require their own savings plans and dedicated funding. It’s a lot to juggle, so be sure that your interim destinations don’t affect you reaching your final destination in good time.

Make Course Corrections as Needed

All long voyages have their share of bad weather that will likely make the journey unique and memorable. Some weather may even require a deviation from the intended route. As these situations unfold it is best not to panic and make your best effort to deal with the circumstances as they occur. Financially speaking, bad weather may come in the form of recessions, job loss, stock or bond market volatility, or any other unexpectedly rough water. Course corrections may be needed to refine goals, timelines and possibly even final destinations.

Life is rarely, if ever, a course set in stone. Rather, it is constantly evolving and we never know what our exact route may be until we’ve actually traveled it. It is best to enjoy the journey along the way while continuing to redirect as needed to achieve our goals.

Plot & Monitor Your Progress

At the outset of this journey you took stock of your possessions and debts. During your financial journey continue to monitor your progress by keeping track of your Net Worth Statement on a regularly scheduled basis. I suggest this be done at the end of each calendar quarter. Have fun with it and graph your net worth over time. (Know that it likely won’t go up in a straight line, it will fluctuate, but the goal is for an upward progression over the long-term.)

The second item to keep a close watch on is your heading and speed using the Statement of Financial Activity – by tracking income and expenses.

TIP: Set your speed on autopilot. One of the best ways to meet your savings goals is to “Pay Yourself First” with automated savings deductions from your paycheck and/or checking account and treat it just as you would a bill you need to pay. This will put your savings on cruise control.

Tracking your income and expenses with some of the tools mentioned previously should be a consistent and regular activity. Review your financial information monthly or quarterly at a minimum, carefully scrutinize all areas and identify opportunities for improvement. This will allow you to make course corrections when necessary or even accelerate your progress.

Your financial voyage can be enjoyable and fun, including bad weather or even an occasional hurricane provided that you know where you are, where you are headed and chart your progress along the way. Much more on these topics will be discussed in greater detail in future posts.

Bon voyage!