What It Is, How To Calculate It, And Why It Matters

You might not be there yet, but there will come a time when people start asking you, “So, when do you plan to retire?” That well-meaning question can often trigger an intense onset of panic for those who haven’t strategically planned out retirement and what really is needed in order to enter into it.

Unfortunately, too many individuals are operating on auto-pilot – getting up, going to work, paying bills, booking a vacation here or there, and addressing financial needs as they arise. The problem is these individuals are likely not aware of how the day-to-day is impacting their financial future.

Panicked by the question, “When are you going to be done working?” individuals start trying to uncover the answer to that question. They try to calculate their net worth – not knowing if what they’re adding up is accurate or not. One might start listing those items considered “assets” versus the debt owed in life. What many find as they start listing these “assets,” the debt column seems to surpass those items. Credit cards, mortgages, car loans, student loans, etc.

As overwhelming and discouraging as the thought or reality might be, it’s critical to have an income spread gut-check with yourself so that you know what your financial present and future looks like.

Calculate for Your Future

Planning for financial freedom requires number work. To do that accurately, you need to first start with your total monthly income. First, you add up your total income sources. If you have a spouse/partner, you do add in their income amounts as well. The total income should include all sources including wages, tips, commissions, bonuses, interest, dividends, net profits from businesses and properties, alimony, IRA, pensions, veteran’s benefits, unemployment benefits, royalties, etc.

There are a few things to consider when compiling your total income list. If you have a business that flows onto your return, include that information as well. Also include net profits from rental profits. Why do I say net profit from rental profits? It’s because we care about what actually hits your account. If you have incoming rent of $1,000 per month, but you have a property manager taking 10 percent of it, plus you have some repairs and other miscellaneous charges, you’re only netting $500. Remember that we are calculating this by the month. If you get something quarterly, divide it by three. If you get something annually, divide it by twelve.

Next, you need to get honest with your monthly expenses. When calculating expenses, many people tend to overlook some of the things they spend money on. Remember that the more accurate you can be, the better. Don’t forget to include everything, no matter how small it seems. From living expenses like rent, utilities, groceries, insurance, medical and taxes, to the other day-to-day expenses like phone bills, internet, gym memberships, hobbies, etc. There is an exhaustive list of things we spend money on that results in the fat we accumulate that must be thinned out where possible.

What can you cut out that isn’t a need? Could you cut out your cable bill? Could you cut out going to the movies or clubs? I understand that you may not want to cut these expenses. But could you do without them if you had to in a pinch? Are they ongoing expenses that you don’t really need? Are some of them services you forgot you are paying for? Look back at your list of expenses and put an asterisk next to the ones that might be fat. You could now subtract the fat from your monthly expense total. Your wants minus your fat equals your need. This is your income spread.

The reason this is important is that it’s going to show you what we could do if you wanted to. If you’re willing to live off of what you need instead of what you want for a while, you may be able to quickly change the amount of your money available for investment opportunities and end up living a life long-term that you didn’t think was possible. But for now we’re just doing an income statement, so subtract your expenses from your income.

It is critical to calculate an accurate number for yourself in order to set a goal. It’s like trying to lose weight. You need to understand your current weight and the weight you want to achieve. You have to set goals that are quantifiable. Hopefully it’s a positive number. If it’s a negative number, then you have some work to do. If it’s a positive number, it immediately creates some hope for you. Your future depends on your ability to honestly and accurately view your situation.