Forecasts are at the heart of how you'll plan your path to financial independence. You create a forecast by providing some basic information such as take home pay, mortgage payoff date and retirement account balances. That's all it takes and you'll instantly get back a detailed plan that shows your progress on a yearly basis up to and beyond financial independence.
Each forecast includes a graph and table which shows your path to financial independence.
There are roughly 10 fields that you'll be asked to provide when creating a forecast.
The forecast graph is a straight-forward way to visualize how your nest egg will grow. It's a great way to see the trend your forecast puts you on.
The forecast table is a year-by-year detailed breakdown of your money. The table includes a lot of information in an easy to understand explaination of what's happening with finances.
You'll notice that certain columns may contain a subtext and green () or red arrow (). Each of these represent an increase or decrease for that column by the dollar amount next to the arrow. The label following the dollar amount indicates where the money came from. It might be from interest or payroll contributions.
The more familiar you get with the forecast table, the more you'll feel in control of your path to financial independence. You can easily add up the numbers to understand how your money is growing and the impact of both decreasing expenses and increasing income. This should equip you to decide what steps to take to reach your goals.
The calculations used in your forecast make several assumptions that are important to understand.
Your forecast indicates financial independence based on how well your net worth will cover your expenses for that year.
You'll need a net worth of
$36,000 ÷ .04 which is
$900,000 to be financially independent. This means with a net worth of
$900,000 you can safely withdraw
$36,000 each year for 30 years before running out of money.
Nothing is guaranteed so make sure you factor in whatever buffer makes you feel comfortable into your forecast.
Your take home pay is your most valuable asset in building wealth. Unfortunately, deductions and taxes are used for other important purposes, so we exclude them. Any 401k contribution or employer match is calculated separately so it's okay to leave them out of your income.
Both your expenses and debts work against you but in different ways. Predictability in your expenses is very important if you want to make a plan of any kind. Once you determine an appropriate budget then provide your monthly living expenses. This should include food, rent (but not mortgage), entertainment, etc.
Your income minus your expenses is considered a surplus. Your surplus is divided up in the following manner.
If you are married, you can technically put up to $12,000 into a Roth IRA but the differences are negligible enough that we do not need to worry too much about it. One reason we fund your Roth IRA is because you're able to withdraw money without penalty using Rule 72(t).
Our calculation treats your mortgage as a fixed term liability and your home's equity is not factored into your net worth. Since your mortgage is a predictable expense which lasts a fixed period of time we only need to know your total monthly cost and how long you'll be paying it.
If you're not making any extra payments, you can find both your monthly payments and your payoff date on your mortgage statement. Be sure to include taxes and insurance if they are not part of your monthly payment and make sure to average it out as monthly.
If you do make additional payments, use a mortgage amortization calculator to see the year it will be paid off.
Our calculation assumes that your consumer debt total will have an average interest rate of 8%. Interest rates aren't what make or break a forecast and paying off your debt as soon as possible makes the interest rate less important.
We assume that 75% of your monthly debt payment goes toward principal. Extra money (your surplus) first goes to pay off any remaining balance. Once your debt is paid off, the money which used to go toward payments is freed up.
The return rate you specify will be applied to all of your pre-tax and post-tax investments. Our calculation factors in a 3% rate of inflation automatically so you should not factor it in yourself. If the interest gained in your investment accounts don't add up, then reduce your interest rate by 3% and calculate it again.
The withdrawal rate is the percent of your nest egg that you're comfortable taking out for living expenses. If your withdrawal rate is too high, you will take too much out of your nest egg and will run out of money. In order to avoid running out of money you should pick a Safe Withdrawal Rate. Use 4% (or .04 in the form) if you're unsure.