The Two Most Important Documents You Need to Start Your Retirement Planning Process
The first step in the retirement planning process is to assess your current financial condition. The two most important documents that help you do this are your statement of net worth and your personal income statement.
Statement of Net Worth
The statement of net worth provides a snapshot of your current financial situation. Net worth is defined as the measure of your wealth. It is calculated by adding all of the assets you own, and subtracting all of the amounts you owe.
How to Create Your Statement of Net Worth
In order to develop this statement, you will need to list all of the things you own and all of the amounts you owe.
The things you own section would list all of your assets including: checking and savings accounts, investment accounts, retirement accounts, stock options, valuables, cars, collectibles, your home, etc. Some values will be easily determinable. Balances in savings or checking accounts, investment or retirement accounts are listed on your monthly statement. Other items like the value of your home, car, collectibles may be a little more difficult to ascertain. Do some research to estimate the values, and be realistic.
For the amounts owed section, include all of your obligations and liabilities including: credit cards, personal loans, student loans, car loans, mortgages, and any other balances. All of these accounts should have monthly statements available. Use the balances as of the date of your personal statement of net worth for all of the amounts reported.
When compiling the information, you may discover that some things will need to entered as both something you own and owe. For example, you may own your home, but it has a mortgage. In this situation you would put the home in the assets section and the loan in the liabilities section.
Once you have all of these items listed, simple arithmetic will get you to your net worth. Identifying your net worth is critical because this will be the metric by which you measure your progress. The retirement planning process will consist of growing, protecting, and ultimately giving away your net worth in a thoughtful and strategic fashion.
Personal Income Statement
A personal income statement tracks amounts earned and spent over a specific period of time. If you are consistently spending more than you earn, your net worth will be shrinking. If you earn more than you spend, your net worth with be growing. Gaining an understanding of your spending habits related to your income is critically important in the early stages of the retirement planning process.
How to Develop Your Personal Income Statement
The complexity associated with developing your personal income statement will largely depend upon the number of accounts and transactions you have. If you have numerous bank and credit card accounts, be prepared to roll-up your sleeves and spend some time. If you have only one or two checking and credit card accounts, the process will be much easier.
Start with the big items first - like your wages (For this exercise, I would recommend using your net pay amount and not the gross salary amount. The net pay amount will be the amount that gets deposited into your bank account after the related taxes and withholdings are paid.), housing payments, car payments, etc. List all of your income items on the top half of the page, and all of the expenses on the bottom half.
With respect to credit card activity, it is important to itemize the actual expenses. Just having a “credit card expense” line item will not provide much insight into the amounts being spent. Itemize each transaction so you can see exactly how each dollar was spent.
There are “free” technology solutions that can help you automatically generate a monthly personal income statement. But with any of these “free” online services, beware that you are the product. Giving these apps access to your financial information will only mean you will be placed on email and ad campaign lists. If you value your privacy, using a good-old-fashioned spreadsheet may just do the trick. You can download a CSV file from most financial institutions these days and save it in your favorite spreadsheet format. This will save you both time and keystrokes when doing the data entry.
Once you have completed this process for a month, take a moment to assess the results. Was your spending in line with what you thought? Do you see any expenses that you might be able to trim? Let the data guide your decisions, and use this information to strategically plan your spending on a go-forward basis.
How These Statements Work Together
The personal income statement will show how much you have either saved or lost in any given month. If you have saved, you will notice that the balance in your checking account will have likely grown. If you were to redo your personal statement of net worth after that month, you will see that your net worth increased.
The statement of net worth provides the answer to the “what” question. “What is my net worth?” The personal income statement provides the answer to the “why” question. “Why did my net worth go up last year?” Once you observe how spending habits affect your overall net worth, you will begin to understand how your daily actions can affect your retirement plan.
Conclusion
Planning for retirement requires a starting point, and the best starting point is to get your arms around your current financial condition. The personal statement of net worth and the personal income statement illustrate your financial position today, and will inform how you can improve it in the future. More importantly, when used together, these statements will help illustrate how your daily spending activities can affect your long-term retirement plan. With this knowledge, you will be empowered to take control of your retirement plan.
About the author:
JP Geisbauer is a Certified Public Accountant and a Certified Financial Planner ®. He is the founder of Centerpoint Financial Management, LLC, a retirement planning, investment management, and tax planning firm located in Irvine, CA. If you have specific questions regarding your situation, please schedule a complimentary 30-minute call here.
Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, please consult with your financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.