How to calculate the exact amount of money you need to achieve financial freedom.

To get started, let’s calculate what your current living expenses are so that we know they are accurate and honest.

First, look at your household living expenses. Start with the basics: food, gas, electricity, insurance, internet, clothing, and rent or mortgage payments. All the essential expenses that you must be able to cover as a minimum. Round all these expenses up to the nearest $10 or $100, or simply add 10 per cent. We do this as a buffer to cover rising expenses.

Then move on to the optionals: gym, additional lifestyle clothing, takeaway and dining out, gifts, hobbies, beauty and self- care services, and social activities. Again, round all these expenses up to the nearest $10 or $100, or simply add 10 per cent.

Simple budgeting with a banana. It’s money made easy.

Then include the average amount that you spend on holidays and weekends away per year. Say you normally go on one international holiday per year at a cost of $7000 including airfares, accommodation and spending money, and you tend to have one domestic holiday per year at a cost of $2000, and then you have two weekends away at an average cost of $500 each. This means that you would spend approximately $10,000 per year on travel and adventures.

The final and most sensible expense to add to your living expenses is a regular investment plan. This is so that you can keep building your passive income, even when you are financially independent and living off this income comfortably. This helps ensure that your financial security continues to grow. This is a set amount of money that you put aside on a regular basis to put towards your building your passive income, even when you are financially independent and living off this income comfortably. This helps ensure that your financial security continues to grow. This is a set amount of money that you put aside on a regular basis to put towards your investment portfolio’s continued growth opportunities.

Ideally I recommend that you factor a minimum 10 per cent of your total living expenses towards new investment into your portfolio, helping your financial security and choice strengthen further.

For example, if you discover that your total rounded-up living expenses come to $50,000 per year, you then need to allocate an extra $5000 per year (10 per cent of $50,000) towards buying and investing in more passive income streams – either building upon your existing investment or adding new ones.

This means that you must allocate at least $420 per month into your budget for regular investing plans. This is not negotiable – it is essential for your long-term financial freedom, and it’s the only rule in this entire book that I strongly recommend you follow.

 

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To make working out your number a lot faster, easier and fun, you can use my Sugar Budget app from the Apple App Store – it will not only prompt you for these expenses, but also give you cash-flow instructions on how to manage your living expenses. Plus, because your budget is on your phone and easily accessible, you can quickly update and check it, which means that you’ll always be on top of your cash flow and living expenses and stop any sneaky new expenses sliding into your budget without your permission.

Alternatively, I have a budget template you can access for free when you subscribe to the SugarMamma.TV website. And of course, there is a wide range of apps available, such as ASIC’s Money Smart Track My Spend, Pocketbook and Money Brilliant, which are also free.

Whether you use the Sugar Budget app, the free budget template or your own budgeting system, your expenses and budget must be written down and written down where you can quickly and easily access them. No more budgets in your head, or on a loose piece of paper. This is time to get serious and really understand the nature of your expenses, goals and values.

But you must check your budget on a regular basis, at least once a month. If you’re in a relationship where you have combined living expenses, you must check them together. New expenses always creep in, which is fine, but you must decide if they can stay and what needs to be adjusted in your budget so that your cash flow remains under control and you aren’t jeopardising your financial goals.

Once you have worked out what it costs you to live – in this example, $55 000 – you then need to factor in tax. So work out how much gross income you need to earn to net $55 000 after tax.

Our tax rates vary each year and are different for each country, so you will need to check your current tax rates (there are lots of tax calculators available for free online) or simply ask your accountant. But income tax has to be paid by everyone, regardless of whether we earned our income via passive income or slogging it out at work. It helps pay for the police that protect us, the hospitals that help us get better, the roads that we drive on, and many other benefits. So we must add income tax on top of this number to give us our final formal number.

So in this example, rounding everything up to be conservative, netting $55,000 per annum after tax would mean that we need to allocate $16 000 p.a. in tax according to the Australian Taxation Office’s income tax calculator at the time of writing. Therefore our number would be $71,000 p.a. ($55,000 + $16,000).

And remember, this is to be passive income – income that you do not need to physically earn. It is simply your money working for you, rather than you working for money. And if you build this passive income properly, on a rock-solid foundation, it should continue – and, even better, keep growing – year on year. So, technically, your passive income will grow to the point it exceeds your living expenses.

Now that is authentic financial freedom.

 

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The next step is to go back and look at your ideal lifestyle and work out how much that will cost, now that you have a grounded idea of what your current lifestyle costs.

We would rather overestimate our living expenses, and have a little extra left over as a pleasant surprise, than fall short and be bitterly disappointed.

Does your ideal lifestyle include more travel? Will you be spending more on education? Will you want more luxury? Or maybe you plan to give more to charity? You need to research what these will cost and add them to your number. It’s not necessary to work it out to the exact dollar, but do some research into the estimated expense and then round it up to the nearest $1000 or even $10,000 to be safe.

Perhaps your ideal lifestyle looks like it will be cheaper than what you currently need to spend. You may want to move to a different town or even country where the cost of living is better value for money and taxes are lower. Or you might realise that you simply don’t need as many expenses in your life as you currently have, or even that you are prepared to let go of some of your expenses and lifestyle if it means you will be financially free sooner. This could mean that your passive income number is much lower and potentially easier and quicker to achieve.

It intrigues me when I do this exercise with clients and see people choosing between certain lifestyles or an earlier retirement. Those ‘essential’ budget requirements, such as designer clothes, expensive restaurants and cars, often can’t compete with the thought of not only retiring earlier but knowing the goal will be easier and more enjoyable to achieve. People start to see what is worth the investment of their effort, and reduce or cut out some of those ‘essentials’.

And then, of course, you may be happy in your job and your life, but would simply like to create passive income to give you the benefit of more time. Perhaps you dream of cutting down to part-time work, studying part time or taking longer and more frequent holidays without creating financial jeopardy in your life.

The important point is to have a number – something concrete that you can set down and actively start working towards with motivation and direction.

We all have different desires, values and sources of inspiration. So listen to what excites you, what feels liberating, what resonates inside you, and honour that. This is your new financial journey, and simply knowing your number is enlightening.

This is an edited extract from Mindful Money: A Real Guide to Building and Managing Financial Independence in a Busy World by Canna Campbell (Viking, RRP $34.99), available now.