Master Your Money – Part 2

With our Master Your Money series, we want to empower people with basic financial knowledge so that they can live the life they want.

In the first part of this series, we shared share five myths of the financial world. Many people have fallen prey to these myths, and billions of dollars have died as a result.

In this second part of the series, we want to start the process of helping you make a good financial plan.

You’ve no doubt asked yourself “how much money do i need to save for retirement?”. This article will help you answer that question.

In order to do this, you’ll need to accept the following premise.

No one actually wants money. Rather, we all want what money can provide.

Precisely what is sought is different for everyone, but it all falls under the six basic human needs of certainty/comfort, uncertainty/variety, significance, love/connection, growth, and contribution.

Once you know where you want to go, you can calculate the precise amount of money you need to have.

In most cases, the number will probably turn out to be less than you would expect. Let’s consider an example, and imagine that you want to fly on a private jet – and never on a commercial plane again.

How much do you think this will cost? Write down the number for reference.

Now let’s compare your number to reality.

To buy a private jet it will cost you about $70 million. Then you have to add in the cost for fuel, maintenance, and crew. Is $70 million higher or lower than the number you had?

Now let’s reframe the problem. Instead of buying your own private jet, you could just charter someone else’s private jet. This will still allow you to never fly commercial again. This will cost you about $5,000/hour to rent the same jet. During your lifetime this will likely cost you much less than $70 million.

You can see that even with a crazy goal of never flying commercial again, you can often get what you want for a fraction of what you thought it would take. Once you define what you want from the money, rather than the money itself, you’ll realize your goals are much more attainable than you thought.

Now let’s put a process around what we’ve just talked about so that you can clearly identify how much money you will need to meet your goals.

The point of this exercise it to determine how much money you need to spend on a monthly basis, and then calculate the nest egg you will need in order to generate investment returns for your lifestyle.

1. Determine a number for “financial security”

If you can save enough so that the monthly returns on your investment will pay for your monthly housing, food, utilities, transportation, and any insurance, then you’ve covered about 70% of the average American’s total monthly costs.

Typically, people who are able to hit this level can choose a job they love instead of the high-paying one that they absolutely hate. This will allow you to take risks that you’ve always wanted to take but couldn’t because you didn’t have enough in the bank to feel safe taking them.

You can’t retire if you’re living in this tier, but you can feel secure about providing for your family.

Action: Fire up a spreadsheet and determine how much you spend a month on: housing + utilities + food + transportation + insurance.

Here is an example of some monthly costs.

Housing: $1000

Utilities: $250

Food: $300

Transportation: $600

Insurance: $300

Total = $2,450 / month

This means that if our nest egg can earn us returns of $2,450 / month then we have reached the level of “financial security”. Let’s keep the $2,450 number in the back of our minds, and we will show you how to calculate the nest egg you need based on that amount.

2. Find your number for “financial vitality”

Now that you know how much you need for financial security, let’s get into the fun stuff.

To have financial vitality, you will need to cover half of your monthly clothing, entertainment, and minor luxury costs (eg. golf dues, manicures, eating out).

The reason we use 50% of these costs is that all of this money is discretionary spending and can be cut back if needed.

Living in this tier means that you can live very comfortably, but will still have to work some sort of job.

Action: Add additional rows to your spreadsheet and determine what your number for financial vitality is.

Here is an example of some monthly costs in this category.

Gym membership: $50

Salon Services: $100

Eating Out: $100

Golf: $200

Movies: $100

Financial vitality Subtotal: $550 x 50% = $275

Total = $2,450 (from “financial security”) + $275 = $2,725

Our nest egg will now have to produce monthly returns of $2,725 if we want to live in the “financial vitality” tier.

3. Figure out what you need for “financial freedom”

Now this is exciting. You need to add up the rest of your actual or desired spending – including things that are purely a dream. This can include things such as driving a luxury car, having the house you want, and going on amazing vacations.

Having financial freedom means that you can live the life you want without having to work ever again!

Action: Add additional rows to your spreadsheet and determine what your number for financial freedom is.

Here is an example of some monthly costs in this category.

Luxury car payments: $900

Vacations: $1000

Household cleaning services: $200

Charities: $100

Kid’s education fund: $200

Financial freedom Subtotal: $2,400

Total = $2,725 (from “financial vitality”) + $2400 = $5,125

Our nest egg will now have to produce monthly returns of $5,125 if we want to live in the “financial freedom” tier.

You’ll notice that our monthly costs in this tier have almost doubled from the financial vitality tier. Most people will have to work very hard at saving up enough of a nest egg to generate returns that will keep them in this tier, but it can be done if you are committed to it.

4. Determine the size of your nest egg

Now that we know how much monthly income our nest egg has to generate we can make some rough calculations to see how big it should be. Keep in mind that this is the money that your investments are generating, and doesn’t take into account any of the money you earn from a job (if you’re still working).

First, let”s look at the financial security tier. We will need $2,450 per month from our nest egg. The results of our research suggests that it is reasonable to assume a 4% per year return on your investments, and this number already accounts for inflation.

$2,450 per month works out to $29,400 a year. This means that you will need a $735,000 nest egg earning 4% per year in our example.

But wait, you have to remember that the tax man always comes calling. Everyone’s tax situation will be different but let’s assume you will get taxed 30% on your investment earnings.

After accounting for a 30% tax rate, the nest egg now needs to be $1,050,000.

Let’s apply the same logic to the financial vitality and financial security tiers.

For financial vitality, our example nest egg will need to be $1,167,857.

For financial freedom, our example nest egg will need to be $2,196,428.

Yikes! These are some pretty big numbers. Is it possible to save up this much money?

In the final portion of our three part series, we will show you how to build your nest egg.

We are not financial advisors, and no content on this site should not be taken as financial advice. No guarantee can be made if you invest based on the information provided on this blog. We make no warranty of any kind regarding the blog and/or any content, data, materials, information, products or services provided on the blog.