Calculating YOUR Freedom Number<\/h2>\n
Calculating your freedom number is easy. It is the average amount you spend on a monthly basis. If you are organized, this will take as little as 10 minutes. If not, you may need to spend a couple of hours pulling together records of your various spending outlets. Either way, the time invested here is well worth it. Here are the steps to calculate:<\/p>\n
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- Figure out how much you spend on a monthly basis. <\/strong><\/em>Look back at all of your spending mediums for the last 12 months\u2014including bank statements, credit card statements, debt payments, charity donations, etc.\u2014and try to remember any cash transactions as well. Note: This is why I try to never use cash. It is untraceable!<\/li>\n
- Put them all into a single spreadsheet. <\/strong><\/em>Aggregate all of the transactions you have made in the last 12 months into a single Excel spreadsheet.<\/li>\n
- Divide by 12. <\/strong><\/em>Take the sum of all of the transactions you have made in the past 12 months and divide it by 12. Assuming no drastic life changes, this is your average monthly spending, otherwise known as your freedom number. Once your passive income surpasses this amount, you are free!<\/li>\n<\/ol>\n
Let me give you an example. Let\u2019s assume John Smith looks back at all of his transactions over the past year and determines that he spends approximately $5,000 each month. Once his passive investments generate $5,000 per month, he is \u201cfree.\u201d<\/p>\n
![\"short-sale\"](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2016\/09\/goals-financial-freedom.jpg\" "\\"\\"")
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\nRelated:<\/strong> How to Achieve Financial Freedom By Calculating Your \u201cRat Race Number\u201d<\/a><\/em><\/p>\nWhy did I put \u201cfree\u201d in quotations marks? Because being free does NOT mean you should quit your job and move to a tropical island with bottomless pi\u00f1a coladas\u2014well, at least not yet!<\/p>\n
Being \u201cfree\u201d means you can live your current lifestyle, exactly how it is, without working. Before elevating your lifestyle, you need to increase your passive income by the amount you desire. If you want to live a lavish lifestyle spending $10,000 a month without working, then you will need to increase your passive income to that amount prior to living that life.<\/p>\n
Keeping your full-time job will likely help you attain this goal quicker by providing a steady paycheck that can be used to invest while also making it easier to obtain a loan.<\/p>\n
Annual Income is Irrelevant<\/h2>\n
Most Americans use \u201cannual income\u201d as a barometer of how successful someone is. Let me break the news to you: Annual income by itself is irrelevant.<\/p>\n
Why? Because annual income is solely an indicator of how much your time is worth. If you are financially free, you do not need to work, and your time is therefore worth an infinite amount.<\/p>\n
The only thing that annual income is good for is giving you additional cash on a regular basis that can be used to invest and increase your passive investments.<\/p>\n
While passive income is the underlying metric to determine freedom, it is driven directly by one\u2019s net worth\u2014though net worth is a misnomer. Real<\/em> net worth is the true metric that should be monitored when considering financial freedom.<\/p>\n
Net Worth vs. Real Net Worth<\/h2>\n
Your net worth is the amount you own (assets) minus the amount you owe (debt and other liabilities). Why is this so important? \u00a0Because you have the ability to earn passive income on your assets while still having to pay your debts.<\/p>\n
As Scott Trench pointed out in his book Set for Life<\/em><\/a>, many Americans\u2019 net worth is tied up in their personal residence, personal vehicle, retirement accounts, etc. These are called \u201cfalse assets.\u201d<\/p>\n
They do not provide you a return that can be deployed in a reasonable amount of time to generate passive income. Since our goal is to have cash-flowing assets and the ability to access this capital well before the age of 60, we will be excluding all \u201cfalse assets\u201d from our calculation.<\/p>\n
And yes, we will be retaining the debt. You are still obligated to pay your debts even if you did not buy real assets for it.<\/p>\n
This will give you your \u201creal net worth\u201d number.<\/p>\n
Here is an example of John Smith\u2019s \u201cnet worth\u201d versus a \u201creal net worth\u201d calculation.<\/p>\n
![\"\"](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2017\/07\/John-Smith-Net-Worth.png\" "\\"\\"")
<\/p>\n![\"\"](\"https:\/\/www.biggerpockets.com\/blog\/wp-content\/uploads\/2017\/07\/John-Smith-Real-Net-Worth.png\" "\\"\\"")
<\/p>\nAs you can see, John Smith received a metaphorical slap in the face after calculating his real net worth. The majority of his assets are \u201cfalse assets.\u201d His 401k and Roth IRA cannot be accessed without penalty until he is 60+.<\/p>\n
He pays insurance, maintenance, and repairs on his personal residence and vehicle while both generate $0 of income. For that reason, these are all removed as assets from his \u201creal net worth\u201d calculation.<\/p>\n
Now that we know the importance of and how to calculate your real<\/em> net worth. What do we need that number to be to be considered “free”?<\/p>\n
4% Rule<\/h2>\n
A common rule of thumb is the 4% rule. This assumes that, on average, you are able to make a 4% annual return on your investments. Now, of course, some years will be lower, and others will be higher. But the average<\/em> rate of return is a conservative 4%.
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\nRelated: <\/strong>Are Your Children Stopping You From Achieving Financial Freedom?<\/a><\/em><\/p>\nLet\u2019s revert back to the John Smith example above. If we take his monthly expenses that we calculated above and multiply it by 12, we will get his annual spending of $60,000. To get to that real net worth number, he divides his annual spend of $60,000 by 4% (or multiply by 25) to discover that with $1.5 million of real net worth, he will be financially free.<\/p>\n
Now, if you are generating more than a 4% return or spend less than $60,000 per year, you may be financially free even before you hit this target. The 4% is just a rule of thumb that takes into consideration fluctuations in the market on a year-over-year basis.<\/p>\n
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<\/p>\nConclusion<\/h2>\n
I can hear everyone now: \u201cOne-point-five million dollars?! I\u2019ll never get there.\u201d<\/p>\n
You\u2019re right\u2014with that attitude, you won\u2019t. You need to shift your thinking. Rather than saying, \u201cI\u2019ll never get there,\u201d you need to say, \u201cHow<\/em> can I get there?\u201d This allows you to think of a means to get there.<\/p>\n
As Set for Life<\/em> points out, you can do this by making more, spending less, and investing the difference wisely. I know I\u2019m touting this book a lot, and I promise, I\u2019m not paid to do so. It\u2019s just a great book. If you haven\u2019t already, the first step would be to read this book!<\/p>\n
See you on the beach!<\/p>\n
- Put them all into a single spreadsheet. <\/strong><\/em>Aggregate all of the transactions you have made in the last 12 months into a single Excel spreadsheet.<\/li>\n
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