I am pleased to bring you another installment of my popular blog series "Empowering Women Through Finances". This week we are on Step 2 of 6, and in case you missed my previous blogs you can check out the kick off blog here and Step 1 here. If you read my previous blogs then you know that it's important for woman to realize they do have different barriers to achieving financial independence than men do and have different motivations for being financially independent. In Step 1 we learned that you need to have goals and I explained how to clarify the goals that you want to achieve in life. Now that we've got that out of the way, it's time to move to:
STEP 2 - TAKE CONTROL OF YOUR CASH FLOW
At this point, you know what you want. For example, maybe what you want most is to retire and not have to work at all. Just as important, you also want to make sure your children (or grandchildren) go to college and secure their own financial future. Finally, you want to know you’ll have the money and protection you need to handle any unexpected expenses or health problems.
All worthy goals. And all of them cost money.
One key aspect of financial independence is being able to support yourself financially. To do that, and to actually afford the goals you’ve set for yourself, requires that you first take control of your cash flow.
To put it simply, cash flow is the total amount of money you have coming in and going out. It goes without saying, then, (or at least it should go without saying) that if you have more money going out than coming in, you have a problem. You won’t be able to reach your goals and you certainly won’t be financially independent. What you probably will be is in debt.
Sadly, too many people don’t pay attention to their cash flow. But women seeking financial independence can’t make that mistake.
There are a number of factors to consider when it comes to controlling your cash flow, but there are two in particular that should be at the top of every list:
Income and Expenses
Why are these two words so important? It all comes down to this simple rule: You cannot be financially independent unless your income is more than your expenses. It sounds like a no-brainer, and it is. Yet I can’t count the number of people I meet every week who have no idea what their income will be after retirement … never mind if it will be more than their expenses. These people want to be independent, but they don’t know if they really can.
Of course, cash flow is about more than just being able to pay the bills. Go back to the answers you wrote down a few minutes ago. Here again is why income is so important. All your goals are likely to cost money! So to control your cash flow, start by calculating your expected income and expenses. Stay with me, because we’re about to do some basic arithmetic. (It’s worth it, I promise you!)
First, sit down and calculate what your income and expenses are right now. To do that, here are some questions you need to answer.
- What is your monthly income after taxes?
- How much do you pay in monthly utilities?
- How much debt do you have, and what are your monthly payments like? Remember, this can include mortgage payments, car payments, credit card payments, etc.
- How much do you spend on automobile insurance, home insurance, gas, and other regular expenses? Don’t forget to consider any out-of-pocket medical costs.
Step A: Once you’ve tallied those numbers, subtract your expenses from your income. Whatever number you get is what you have available to put toward your financial goals.
But that’s just your current cash flow. Now let’s look at your expected cash flow. For example, let’s calculate how your expenses are likely to change after retirement. See if you can answer these questions:
- What expenses will you have to pay out of pocket that currently come out of your paycheck? An example is health insurance. If you receive health insurance from your employer, your expenses for this could go up after you stop working.
- What expenses do you currently have that will decrease after retirement? For instance, if you stop commuting to work on a daily basis, your transportation expenses will probably go down.
- What is your current tax bracket? Will it change after you retire and start earning less income?
Next comes one of the most important—and hardest—questions to answer.
- What will your health care expenses be after retirement?
No one knows what their future health will be like, but some research suggests that a 65-year-old couple who retired in 2012 will ultimately end up paying $240,000 in health care costs. The study cited assumes that the husband will live 17 years and the wife 20, and have no employer-provided health care coverage. That equates to paying a little more than $14,000 a year over 17 years, and $12,000 a year over 20. And that’s for a couple! For single women, of course, paying for health care can be even more difficult.
Of course, those figures could increase if you have any existing health conditions, like diabetes. But whatever your number is, how much of it will you have to pay out of pocket? That’s an important question to consider too, because you may not have the same coverage you did while you were working. Another study suggests that most people “severely overestimate the percentage of health care costs covered by Medicare.” 2
Here comes the home stretch. Finish these final steps:
Step B: Take your existing expenses, then add the amount of expenses that will go up after retirement. Next, subtract the amount of expenses that will go down. Hold on to that number for a moment.
Step C: Calculate the amount of income you expect to receive from any retirement accounts you have, like your 401(k), IRA/Roth IRA, etc. (More on these below.) Then subtract the tax you’ll owe on these accounts once you start using them. Any withdrawals you make from accounts that were funded with pre-tax dollars, like a regular IRA, will be taxed as income.
Take the final number from Step C and combine it with the original amount from Step A. Then compare it to the number from Step B. Steps A and C combined is your income after retirement. Step B is your expenses. Which number is higher?
Keep in mind that every number you reach from this exercise is just a loose estimate. Too loose, in fact, to make financial decisions by. But at the very least, this should get you thinking. By understanding what your cash flow is now, and what it’s likely to be in the future, you will know whether changes need to be made. And that’s what taking control of your cash flow is all about!
We covered a lot today in this blog but I'm confident that education is key to financial independence. My team and I are always here to answer questions and provide free Income/Expense worksheets for individuals to use.
 Paul Sullivan, “Planning For Retirement? Don’t Forget Health Care Costs,” NY Times, October 5, 2012. http://www.nytimes.com/2012/10/06/your-money/planning-for-retirement-dont-forget-health-care-costs.html?pagewanted=all&_r=0