Thursday, July 10, 2008

Tracking Progress Toward Financial Independence

The ultimate goal for me and almost every personal finance blogger out there is to become financially independent. But what does that mean exactly? In the simplest sense this means when one no longer has to actively work to earn income to support one's lifestyle, i.e. regular expenses. It's the point when all one's passive income from investments such as interest, rental income, stock dividends, et al. reach or surpass one's regular expenses.

So far I've done well with tracking my monthly budget and net worth, but I haven't really taken a look at the (albeit long, long, long term) view of reaching this goal of financial freedom. Jonathan over at My Money Blog had a nice post recently about this very topic. He presents a graph that shows a simple but informative picture of one's financial progress:

The graph shows a monthly picture of one's income, expenses, and investment income. This is a great graph because you can visually track changes in your regular income, see your spending habits in your expense line, and watch as your investment income grows. What you are shooting for is the crossover point when that green line hits the red - that's when your passive income equals your expenses!

The key here is that you are tracking investment income, not total investment assets. This of course can fluctuate quite a bit depending on the risks associated with one's portfolio.

I decided to do this for my own finances over the last six months (since I started this blog and revamped my financial life). The result is, well, interesting:

Kind of crazy, isn't it? The income line is screwy for a couple reasons: January included my (substantial) Christmas gifts which really kick-started my saving and investing. March included a big check from my aunt which was subsequently used for my tickets to Europe, hence the spike in income and spending there. As you can see, June was bad with my taking on debt to help cover my trip to Europe. Right now the investment income line is laughably flat, as I'm only making something like $5-6 per month.

In the short term this graph will be useful as I try to increase my active income and concurrently decrease my spending. I'd like to get that red line to a lower, more even amount. February here represents my "ideal" month, at least according to my old income level. I kept my consumption down and stayed within my budget. This is the model I'd like to keep moving forward. For the foreseeable future this should be doable because there aren't any major events coming up (that I know about at least - life throws stuff at you all the time!).

So the short term key is to maximize that active income and minimize expenses, all the while building up my investment portfolio and watching that yellow line grow, ever so slowly, into something resembling a slope which is increasing at an increasing rate!

That's the plan at least. We'll see what happens.

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