Stage 2: Creating a Solid Plan to Control Spending and Create a Path Towards Creating Wealth
By: I Love Making Money
Tags: Budgeting, Financial Planning, Saving, Best Practices, Budgeting Tips

Step 1: Determine Your True Net Income

Let’s do a little exercise. Don’t skip this: It’s incredibly important, and it will change how you think about money — your money — forever.

We’ll start with a simple premise. You know what you make.

You know your hourly rate or your weekly or monthly salary. When you fill out your taxes you know your gross income for the year. And when you receive your paycheck, you definitely know how much cash you get.

The cash you get on payday is your net income — that’s the number that matters the most, at least for our purposes.

You probably don’t give your income a second thought, other than probably to wish there was more of it. That’s a major problem: If you truly understand what you earn, you can better evaluate what you spend — and you can make better decisions about where and how you spend your hard-earned money. If you don’t clearly understand what your true income is, you can easily fall into the mistake of spending more money on some items then you really want to… or ever should.

So let’s dig deeper into your income. Follow along on this worksheet; fill in your pay figures for the sample figures provided. This is a very simple math exercise that will definitely change your behaviors.

Say our sample person (we’ll call her Jane) makes $50,000 per year. (Last year the total per capita — meaning per person, not per family — personal income in the United States was just over $38,000. If she earns $50,000, she’s making well over the average. Well done Jane!)

Yearly Income Jane Your Actual Income

$50,000 ________________

Now divide $50,000 by 2,080 to determine your hourly rate. If you’re paid by the hour, you already know your hourly rate, so you can skip this step. (2,080 is the number of hours you work in a year if you work 40-hour weeks; 40 times 52 equals 2,080.)

Hourly Rate Jane Your Hourly Rate

$50,000 / 2080 = $24.04 ________________

So, Jane’s rate is just over $24. (What’s yours?) That means every hour she works, she earns $24, right? Oops. Not so fast.

Let’s look at her deductions. Let’s say she’s enrolled in a 401(k) plan and she contributes 5% of her income each pay period. (Enrolling in a 401(k) plan is an excellent idea, by the way. If you’re currently not contributing to your work’s 401(k), we’ll show you how to start putting away some of the money you save after you work through the System. 401(k) plans are arguably the best investment available for the average American.)

5% of $24/hour is $1.20, so she now has $22.80 left in net income. That’s okay — the 401(k) is a great investment in her future and is well worth it.

Let’s keep going. We’ll assume Jane is paid every week, so she makes $961.54 per week (gross). [You get the weekly amount by dividing the annual income by the number of work hours in a year — then multiply by the number of hours in a normal workweek — 40. For Jane, that’s $50,000 divided by 2,080 = $24.0384615. Multiply that hourly rate by 40 hours a week — and you’ve got $961.538462. That rounds up to $961.54 per week.)

You can fill in this chart using your weekly, bi-weekly, or monthly pay stub, depending on how you’re paid. Here are some of the more common income deductions (that you may not feel are so well worth it). Check out your pay stub to see exactly what your deductions are.

Jane Yours

Gross Income $961.54 ________________

401(k) deduction $48.08 ________________

Federal taxes $137.02 ________________

State taxes $50.34 ________________

Social Security $56.63 ________________

Health insurance $85 ________________

Miscellaneous $0 ________________

Net Income $580.01 ________________

Use your pay stub to fill in your own deductions and calculate your own net income. Then divide your net income by the hours in that pay period. So, if you are paid:

Weekly Divide by 40

Bi-weekly (every two weeks) Divide by 80

Bi-monthly (twice a month) Divide by 86.67 (2,080 / 24 pay periods)

Monthly Divide by 173.33

Jane’s Net Income Divided by Equals Her Hourly Rate

$580.01 / 40 = $14.50

Net Income Divided by Equals Your Hourly Rate

__________ / __________ = $__________

So: After all your deductions, what is your net — again, the amount you actually bring home — hourly income? In the example above, after taking out all of her paycheck deductions, Jane’s $24.04 per hour rate is, in reality, $14.50 in actual, spendable dollars.

That means her take-home pay is only 60% of her gross income, which by the way is about what the average American brings home.

You might have realized that you could simply divide your net pay by your hours per pay period; the reason we worked through the complete example is so you will have a good feel for where a major chunk of your hard-earned money goes. While you can’t control taxes (not completely, anyway), feeling a lack of control in that area should double your motivation to control the things you can control.

Why is your net income important to know? The goal is for you to understand your true income so you can make decisions based on that number. Here’s a simple example:

· In her mind, Jane makes $24 an hour. (Feel free to substitute your own number.)

· She hires a lawn service to cut her grass. They charge her $25. (In most areas that’s probably a low figure for a professional lawn care service.)

· She could do it herself — after all, it only takes 45 minutes — but it’s a hassle and after all, she’s way too busy. Plus she makes $24 an hour… so paying someone else to take care of it sounds pretty good, all things considered.

· Now let’s evaluate the cost of having someone else cut her grass using her true hourly income. She really brings home $14.50. That’s the cash she gets, in her pocketbook, for an hour’s work. She’ll have to work 1.7 hours to make the $25 to pay the lawn service. Hmmm….Should she put in 1.7 hours of work at her job, or maybe or 45 minutes of work at home, on her own terms?

· Which makes the most sense now?

Or look at it another way. If you’re Jane and you work eight hours a day at her net hourly rate, you bring home $116.00. Not bad… but do you really want to spend, each day, $3.50 on a cappuccino, $10 eating lunch out, $4 on cigarettes… and maybe even a couple of dollars on lottery tickets? Should over 15% of your pay be spent on those items? If you look at how you spend your money from that perspective… it doesn’t sound so wise.

Your time has value. Your “work time” has value — in terms of what you’re paid — and your “free time” (away from work) has personal value. Understanding what you truly make per hour while you’re working can help you better evaluate what you’re willing to do — and willing to spend. Don’t over-estimate your true hourly income — your real, spendable hourly income is all that matters when you evaluate an expense or a purchase.

Related Articles: How to Build a 50/30/20 Budget

Before we move on, take a second to determine your actual monthly income on a weekly and monthly basis. We’ll use those figures later. Simply multiply your hourly income by 40 to get your weekly income.

For example, if you bring home $14.50 an hour, like Jane, your weekly spendable income is $580. Multiply your weekly income by 4.25 — that’s how many weeks are in the “average” month — to calculate your monthly income. (52 divided by 12 = 4.25.) In this example, while your gross is $4,086 per month, you actually bring home $2,465 per month. That’s what you get to spend.

Write those two figures in here:

Weekly Income ____________ Monthly Income ____________

Depressed? Don’t be. Things will get better: I Promise.

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