I’m all about choices. Ask my kids. They will tell you that the phrases they heard way too many times growing up included “Life is a series of choices.” and “Make good choices!” (borrowed from Aunt Karen). They know that I am all about choices.
Financial independence means, to me, that time in your life in which you feel as if you get to make choices about your lifestyle and work based more on your heart’s desire than your financial obligations. Sometimes that is framed by retirement or backing off of the traditional work week. Of course, if you have a career that you love, you certainly can have achieved financial independence and keep doing that thing you do. Choices, right?
So, when it comes to financial independence, how do you know if you’re there, on the path, or way off toward outer space? It’s not just about how much money you have available; you also have to tie to the obligations side of the equation. The ability to make choices about how much time of your life you allocate to working for pay vs. creating for your own satisfaction vs. being a water aerobics athlete all comes together in assets and expenses. How long do those assets need to support those expenses?
You Can Do This
Jumping into the financial independence pool can seem a little overwhelming. Taking the first step is really knowing – getting clear on your estimated expenses. How much do you need to live on? Be real with yourself….don’t do some base addition relying on only paying the mortgage, eating bologna every day at home and keeping the thermostat at 62 degrees in the winter (unless you really like a cool house).
There are many ways to estimate your expected expenses. Some like to estimate categories of spending such as gas vs. groceries vs. eating out, some take 80 or 85% of your current salary, etc. I like one based on current expenses and lifestyle. It’s easy to add up those pieces that stay pretty much the same, like a mortgage payment and auto insurance, and then layer in the average of all the monthly expenses.
I’m also not a big believer in trying to categorize everything down to the “Groceries / Health Food / Wine / Really Healthy Red Wine” level because, in real life, our expenses chart up and down each month. Money comes in, it goes out. Sometimes you buy the wine, sometimes the car needs tires, sometimes there are concerts.
Fred and Wilma’s Monthly Expenses
Fred and Wilma have been thinking a lot about financial independence lately. Pebbles has completed her masters program in contemporary rock and roll studies and is no longer financially dependent on the folks. Fred wants to spend less time at the quarry and to try his hand at creating petroglyphs and Wilma is looking forward to spending more time traveling.
Let’s work with Fred and Wilma and get a handle on the expense side with a high level approach. We’ll start with a basic approach – what would Fred and Wilma need each month right now?
Breakdown – Categories of Expenses
Category 1 – Expenses from the Checkbook
Total your fixed monthly expenses – if you have a mortgage, car payments, loan or credit payments, utilities, anything you can’t put on your credit card.
Category 2 – Annual and Semi Annual Expenses – Calculate the Monthly Amount
Total your annual and semi-annual expenses and find their monthly total. This may include items like if you pay your life insurance once a year, or your real estate taxes twice a year, or your annual car registration fee. I think this category is really easy to underestimate – people seem to be surprised every year when that pesky auto registration comes up again!
Category 3 – Monthly Average Credit Card
Pay everything else by credit card and pay off the card at the end of the month. Never carry a balance on this one or it will skew your number. After three or four months, take the average.
Category 4 – Health Insurance
If you think you will need to purchase this separately, allocate an estimate based on open market rates. This one may be tricky – a lot is in flux right now in the health insurance arena.
Category 5 – Extras and Miscellaneous
This is your category for the unique expenses for which you need to account. For example, if you make monthly treks to Colorado and take a lot of cash, perhaps you need a special category for that amount. Yes, my unique expense is concert tickets.
Subtotal of Expenses: $6,500
Throw in another 10 to 15% of the sub-total for unknown….because life is full of surprises.
Subtotal of Expenses plus Contingency: $7,475
Federal and State Taxes
Take your current effective tax rate for both Federal and State taxes. This is a very rough estimate and it’s fine to go high. Use whatever percentage seems reasonable to you. This is NOT tax advice.
Fred and Wilma’s Estimated Monthly Expenses: $8,970
Yabba dabba doo! Fred and Wilma estimate that they would need around $8,970 a month for their expenses (today’s dollars). Notice that this doesn’t include a category for “retirement savings” since they will be shifting into living on some of those monies.
Quite frankly, Fred and Wilma were a little surprised by that number. It is higher than they would like it to be. There are more choices they can make to reduce that estimate but let’s save that for another post.
Here is a link to a workbook so you can identify your expected monthly expenses: Expense Workbook
Of course there are other choices!
You can use a spreadsheet and put your own categories and items together and decide where you are in terms of monthly expenses. That is the point, after all. Knowing. There is an incredibly vibrant community of writers on the web that have brilliant ideas about financial independence. Some focus quite a bit on early, or extremely early, retirement. Others tune their message toward the more technical capabilities of making a higher return on one form of assets over another. I just think people should think about it and make their own good choices.
Jumping in and taking the first step – knowing your expenses – is a great way to get a handle on where you are in your path toward financial independence.
Keep the Conversation Going
What works for you when calculating your average monthly expenses? Are you surprised at the amount you came up with? Please share your thoughts in the comments below.
Resources and Links
Here are some other monthly expense calculators for you to peruse:
Financial Mentor Expense Calculator This calculator lets you put in your own categories to build your monthly expense.
Take Charge America This calculator has categories built in.
Photo Credit: TM & © 2010 Cartoon Network
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