Understanding cash flow is essential for your financial independence

Achieving financial independence is a common goal and one of the main drivers for investing. The definition of financial independence may be different for each person ranging from flexibility in pursuing career opportunities to phasing into a traditional retirement free from work. Underlying your ability to achieve this goal is clearly understanding your cash flow and spending needs.

Identify your spending needs

There are a couple of different approaches to determine your spending needs with varying levels of complexity and time commitment. The simplest method is to look at your current take-home pay (i.e. what gets deposited in your bank account each week or month) and assume if you can replace this with other sources, you’re able to retire.

This makes a couple of significant assumptions including you’re take-home pay is sufficient to cover your expenses (i.e. you’re not accumulating credit card or other forms of debt) and your spending will be the same when you’re not working. In many cases, you may actually spend less when you’re not working so you may not need to replace all of your current income. Ongoing academic research in this area is of particular interest because spending often fluctuates during different periods of retirement. This makes knowing your current spending even more important as a foundation for future adjustments.

A more accurate method to measure your cash flow is to track your spending over time. While this is more time consuming, the increased accuracy and awareness of how you spend your money can be very helpful.

Check out available expense tracking tools

Fortunately, there are a number of tools available to help with the process of tracking expenses. Gone are the days of manually entering every transaction in a notebook or spreadsheet. Today, most programs for tracking cash flow can link to bank accounts and credit cards to automatically download transactions on a daily basis. One of the oldest programs still around is Quicken (www.quicken.com) which is software that not only helps with tracking cash flow but can also help monitor investments and assist with tax season.

A less robust option (but with no cost) is mint.com which is web-based and helps to automatically categorize repeat expenses. With helpful charts, you can visually see how much of your money gets spent in various categories.

A third option for those who want the greatest amount of flexibility and control is Tiller (www.tillerhq.com) which integrates with Google Sheets. I’ve been experimenting with this last option and while it takes some effort to setup, it allows for a lot of customization (which I find lacking in mint.com).

Ultimately, knowing whether you’re financially on track to achieve financial independence requires some method of tracking your spending. It’s not often at the top of most people’s list of things to do (if it is, I highly recommend Tiller) but it’s worth the effort.

As seen in the Racine Journal Times | July, 2019

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