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Budgeting 101: The First steps to Financial Independence

David Bialecki
Mar 6, 2018
3 min read

All of us want to stop working at some point of our lives. For most, the sooner the better. In order to do this, we need to replace our income with something else. Assuming your last name isn’t Rockefeller or heir to a trust fund, that would be either a side-hustle or investment income.

However, we need a starting point.

Net Worth

First, we must determine our net worth. This is simply your assets minus your liabilities, or everything you own minus everything you owe. We need to take this a step further. We want our financial net worth. This only includes income-producing assets, mainly your investments. What good is including your home? You’d have to sell it to generate cash flow. In addition, you’d still need a place to live. Therefore, going forward, whenever we mention net worth, we are referring to our financial net worth.

Net worth is not the same as net income. If you make $1 million and you spend $1 million, guess what? You’re broke. Your net worth is zero! Becoming financially independent isn’t about how much you make. It’s about how much you keep.

Budget

The starting point of any money management plan is your budget. A budget is nothing more than a glorified income statement. You must know where your money is coming from (inflows) and where it is going (outflows). Start by listing all sources of income, preferably recurring income. Leave out one-time receipts (gifts from parents, etc.). Next, list all details of disbursements (food, shelter, transportation, savings), down to the last penny. If you come up with a negative balance, you’re spending more than you make. I’m old school and still use Microsoft Excel. For you modern types, there are apps on budgeting like Mint or You Need a Budget.

Strive for the following distribution of your income: 3-5% insurance, 10-17% saving, 18-25% taxes, and 53-69% standard of living. Be sure to distinguish between needs and wants. Yes, you need a car for transportation and a house to live in. But you want a BMW or a 4,000 square foot mansion. Remember, frugality and cheapness are not the same. Being frugal means making every penny count. Being cheap is leaving a $2 tip on a $100 meal.

Helpful Tips

The following tips should help creating and maintaining a budget as easy and painless as possible:

Save money automatically; at least 10% into your 401K/IRA and non-taxable accounts. If you don’t you’ll always find a reason not to
Clip coupons, never go grocery shopping when hungry, buy generic brands when possible, and brown-bag your lunch to save on food costs
Use the 24 hour rule when making (online) purchases: leave item in your shopping cart for a day. Many times, you’ll decide you really don’t want it, BEFORE you buy it! The ease of technology and the use of “plastic cards” makes it easy to buy stuff. How many times have you asked yourself “why did I by this piece of junk?”
Cut bad habits like smoking, gambling, drinking, and other vices
Don’t bother trying to keep up with the Joneses. Chances are, they are trying to keep up with other Joneses
It’s OK to spend on a guilty pleasure once-in-a-while. Just make sure it’s a reward for reaching some financial goal
Don’t be anyone’s sugar daddy. If you don’t know what that is, Goggle it
Never depend on one source of income (Warren Buffet)
Keep a 3-6 month emergency fund
Don’t go all-in on making a major change. Take baby steps. Otherwise, you could end up like most dieters, worse off than when you started because you get discouraged and give up. It takes 4 weeks to make something a habit. Keep this in mind when making any major change, whether it’s your finances or any part of your life