Article 7 min read

Your New Years Audit: A Guide to Creating a Strong Financial Plan

New Years

Before the new year its a good time to take stock of your financial health for the coming year. With the last paychecks of the year coming in, you can get a clear idea of how you did over the last 12 months. I specify looking at the last paycheck because it acts as a sum of our entire financial life on one sheet of paper. If you are self-employed try taking a look at your full year numbers instead of the last paycheck.

Once I have these numbers in my hand, I begin trying to see if I completed everything I wanted to. Did I stick to my budget? Did I save for large purchases in the future? I try to get a clear picture of what went well and what I could improve. Even if everything went perfect, conducting an audit gives me piece of mind that I am on track for my financial goals. Below are some of the specific steps I take to stay on track for the upcoming year.

Automate your saving

Automating your savings is the easiest way to make investing and saving easy. The idea is to put your investing and saving on autopilot. That way the only money that ever touches your checking account is money to use for expenses. I am a fan of automation because I never think about the money that is going to my rainy day fund, retirement, etc. I never see it unless I go looking for it, so I'm not tempted to touch it or change my savings plan.

If this all sounds complex, it isn't. Effectively you divert your money into different accounts every pay day automatically. Most employers offer this through their payroll system. You can direct deposit the percentages you want to go into your different accounts. If your employer doesn't offer this, most accounts offer auto-withdrawal. Select the amount and cadence (weekly, bi-weekly, etc.) and it will automatically come out of your account.

Below is an example breakdown of a possible bi-weekly paycheck:

Gross Income $2,500
Pre-Tax Retirement (401k Fidelity) $500
Net Income $2000
Taxes (25%) ($500)
Roth IRA (Vanguard) $250
Savings Account $500
Checking Account $750

In this example you can see that the money is automatically diverted into the accounts the person wants. The only amount of money they will likely see on a daily basis is the $750 that hits their checking account every paycheck. Everything else is automatically diverted to Fidelity, Vanguard, or their savings account so you don't have to remember to transfer it out.

Check your pre-tax contributions

At the end of the year I like to take stock on how much I was able to contribute pre-tax in the last year. At the beginning of each year I try to estimate what percentage of my income it will take to max out my tax advantaged accounts. One year, I realized I got my percentage wrong and came up short. My employer didn't offer any one time deposits so I wasn't able to maximize my 401k for that year. Big bummer.

Now, I double check my math at the beginning of every year. That way, I should hopefully not make that mistake again. If your front load (contribute a high amount at the beginning of the year) your contributions, this probably doesn't apply. For those of us contributing over the course of the year, you can do a rough percentage calculation like this:

Target pre-tax amount / salary = % needed to contribute

You should now have the percentage you need to reach your pre-tax number. For those of us trying to max our 401k, this is now $19,000 so you percentage might be higher than before. To showcase the massive potential of maxing out your 401k, I put together a compound interest graph.

Compound interest graph

Starting amount: $0 | Additional yearly: $19,000 | Growth Rate: 7.0%

Value after 10 years: $280,888.4

If you did nothing else but max your 401k pre-tax, you would have nearly $300,000 after 10 years. Over $90,000 of that is purely in interest from your investments. Getting the math right on your contributions is key for seeing this type of growth on your path to retirement.

Create a new budget

For a lot of us, our budget going to change much year to year. We already know what our budget is per month and relatively good at sticking to it. There are some life changes that might change your budget though:

  • New job
  • Salary increase
  • Having a child
  • New, large life expenses (saving for house, car, etc.)

Any one of these could drastically change your budget in the new year. A higher salary could mean you can now FIRE faster. A kid on the way means new expenses to take note of. Think forward for the next year on what might be coming and try to predict what your budget might be.

When I'm doing an audit, I try to be realistic with last years budget. I compare my theoretical budget to your actual numbers to see how I did. Did I go out to eat more than planned? Did I spend more than I thought?  Even if you have a rock solid budget that hasn't changed for years, there still could be room for improvement. Try taking a look at actual vs planned and see how you fared over the last 12 months.

Travel globe

Estimate your travel

Alright, this one isn't absolutely necessary for some of us. I mention it because travel seems to be a common interest in the FIRE community. Travel makes up a large portion of my yearly budget so I need to plan ahead. I suspect a large number of us in the FIRE community set a large percentage of our budget towards travel.

To estimate my travel plans for the year I sit down with my (digital) calendar. I pencil in what plans I already have, where I want to go, and "bucket list" trips. The trips I already have planned are normally for events that were planned far in the future. My "want to go" list is a rough list of places I have seen around the web that look cool to go to. Bucket list are long trips that need a lot of time and planning to go on. Bucket list trips are often the most expensive.

To budget for these, I do a rough estimate of each trip. I try to go on some sort of trip every two months. This makes for a  planned total of ~6 trips a year, but the reality is more around 4 or 5. If I've already paid for the trip I write down what I have spent already. My "want to go" trips I look at flight costs, hotel costs, etc. and jot down a rough estimate of what I think that trip would cost. Bucket list trips I do the same, but add 20-30% on top of my estimate. On bucket list trips I want to be able to do all excursions, restaurants, etc. so I bake in extra costs.

Once you have an idea of your travel plans, add up your list and see if the numbers fit in your budget. If the numbers are high, you might have to reconsider a trip or two. There also might be some areas where you could save, like staying in hostel vs hotel. Remember, none of this is concrete. It should be more of a guide to plan some of these larger expenses earlier in the year. You can always adjust as the year goes forward.

Think towards the future

As we think on a the scale of the year, I like to think ahead on the scale of 5 to 10 years. What large expenses do I want to start saving for? Where do I (hopefully) see myself in that time frame? If you find yourself thinking about large items like a house or children it can be a good time to start planning. I think a lot of millennials like myself want to start saving for a house. Try to guesstimate what a down payment looks like and set aside a little each month. Even saving $20-50 at a time can become massive sums in the future.

This list is by no means comprehensive. Instead, use it as a guide to get you thinking about were you want to be at the end of the next year. A little bit of planning goes a long way and you can improve your financial future by being proactive.