Your Financial Checkup Part 2

Ok, last week we started our annual financial checkup by listing our liquid assets and our total liabilities and calculating our net worth. An eye opening experience for all I’m sure. If you haven’t started, I suggest you read last week’s posts and work through the process.

This week I want to move to the next step, creating an income statement. For many this too will be a real eye opener. This is an important step, maybe the most important; as you examine where you are at financially and how much money it takes to keep you at your current standard of living.

The process is simple. You list all of your sources of income in one column and all of your expenses in another column. Hopefully, when you do the math, you have a surplus left over that you are putting away for a rainy day. You may wonder why I believe this step to be the most important part of our check up. Let me explain.

Most people look at net worth as a measure of wealth. Most financial planners do as well, but the reality is that most of your net worth is tied up in assets that are not readily available should a need arise. In other words, they are not liquid assets. That is why I recommended leaving the value of your house out of our calculations. Most people believe that to be financially independent, you need to have a high net worth. Usually a million dollars is considered as the threshold for folks aspiring to wealth.

Well, I’m here to tell you that net worth does not make a person rich. Net income does. If you calculate that you need $4,000 per month to meet all of your obligations and your current family income is only $3,500 per month, you are in trouble, and you are not financially secure. If you are earning $4,500 per month, you are in a position to put away most of the extra and build your savings (something that we Americans haven’t been doing for the past five years).

Now, here’s the secret to financial freedom. If you are able to reduce your monthly expenses, say by paying off your credit card bills, your car payments, and maybe even reducing your mortgage payment, and at the same time, you increase the amount of your passive or investment income, you can lessen your dependence on your income from your job.

Let’s say that after reducing expense, your monthly total drops to $2,000 and over the years, you’ve purchased a couple of small houses which you rent out and now how a positive cash flow of $1,000 per month. If you are a saver and have investments earning you another $500 per month, you are only $500 away from financial freedom, the freedom to retire, to volunteer, or to work part time in a job of your choosing. As you can see, looking at your net income and in particular, your passive net income, can really open the door for other opportunities in your life.

Of course, the other big reason for building a passive income stream is because of the unstable job markets. This past year has seen some of the largest mass layoffs by large corporations in history. Along with the job market troubles, we all need to understand that the pension plans that cover millions of employees and recent retirees are failing and the Pension Benefit Guarantee Corporation just reported a deficit of better than $23 billion. The airline industry alone has pension liabilities of over $280 billion.

The old saying “Never put all of your eggs in one basket” couldn’t be truer today with regard to your income and your retirement accounts. If you are counting on Social Security or your company pension plan to provide you with a comfortable retirement, you are in for a rude awakening when you turn 65.

So with your financial checkup complete, you now have a clear picture of where you are and where you need to be. If you haven’t already started diversifying your income sources, now is the time. Start small, but get started today.