How do you know if you're doing well with your finances?
You could be the type of person who saves for retirement, pays off your credit cards and watches your expenses. But are you doing enough? Are you on track to retire comfortably?
In this post, we look at the seven metrics you should measure. Ideally track these numbers every month, but at the very least calculate these once per year.
NOTE: If you're a subscriber to my blog, I email you whenever I write a new post and frequently I include a free spreadsheet or pdf to accompany the post. Just an incentive to subscribe.
1. NET WORTH
Net worth, by definition, is your total assets minus your total liabilities. In other words, what is left over from what you own after you deduct what you owe.
As an example, you own a house worth $250,000 and you have a mortgage of $200,000. If that was your only asset and debt you would have a net worth of $50,000 ($250,000 minus $200,000).
Your goal is to watch this number increase over time by either increasing your assets, decreasing your debt, or both.
Ideally you will put your money in assets that appreciate (go up in value) or produce income instead of assets that depreciate, like most cars. A home can appreciate or could generate income if you rent it out.
For most people, your assets will consist of your home, your autos and your retirement savings.
The goal with debt is to have none, although some people advise to leverage debt. For example, if you can borrow money at 3% but earn a 10% return on it that might be a good use of debt. But for most people the goal should be to get rid of it. The less debt you have, the more money you have to save and the more freedom you have.
Examples of liabilities include; mortgage, car loans, student loans, credit card balances that are not paid off each month.
Track your net worth monthly and compare it over time. There will be months where it will decrease but you should see the overall trend going up. If not, that is a signal that your spending too much, putting your money into the wrong things or taking on too much debt. If you can't track this monthly, shoot for quarterly or annually.
2. INCOME NEEDED TO MAINTAIN YOUR IDEAL LIFESTYLE
If I were to wake you up in the middle of the night, could you tell me how much income you need per year to live your ideal life?
This is not the life where you are living in a mansion, own a private jet, collect antique Ferraris (well unless that is the only life for you).
This is the life you could lead where you would be content; nice house/condo, car, eat out, travel, no debt, no worries.
If you don't have that number handy, jot down what you are spending today for the big categories like housing, transportation, medical, food, and other. Adjust these numbers for your retirement. You may be content to buy a condo on the beach in Grand Cayman with no car. If so, go online and figure out what that cost would be annually.
Many people have expenses decrease in some categories like housing and transportation, but increase in others like medical or travel.
If you'd like a little more information on this topic see my post called "The Secret to Calculating your Freedom Fund".
3. HOW MUCH TO SAVE FOR RETIREMENT
This ties in nicely with your net worth.
Everyone has an idea of what their perfect lifestyle looks like. Some people could be quite happy living off of $30,000 per year, while others require income of $3,000,000 per year.
The less you need to live off of, the less you need to save.
Without getting too complicate, a good rule-of-thumb is to take the annual income needed and multiply it by 25. So, if you could retire nicely on $50,000 per year then you would need to save $1,250,000 to generate the $50,000 per year.
The theory is that on average you should earn 7% on your savings and after you subtract out 3% for inflation, you are left with 4% earnings. If you take out 4% per year (all your net earnings), you are left with your whole savings amount left in tact to earn money in future years.
If you will receive income from things like social security, a pension or a part-time job then you can subtract that from the income needed, which will reduce the amount you need to save.
For example, if we use the $50,000 amount above, and we will receive $20,000 from social security and $25,000 from a pension, we only need to make $5000 per year from our savings ($50,000 minus $20,000 minus $25,000). Using our rule of 25, we only need to save $125,000.
This is why I advocate developing a skill that you love where you can generate some income during retirement. It allows you to not have to tap into your savings as much, and possibly retire earlier.
4. TOTAL DEBT
You will need this number for your net worth calculation (see above), but I like to single it out as it is so crucial.
Debt can kill you several ways:
1. Debt has interest expense. The more expenses you have, the less that goes towards savings.
2. Debt can take away your freedom. If you're burdened with $100K in student loans, a $40K car loan and $25K in credit card debt, then you probably won't be able to take a year off and backpack across Europe. You will need to keep working, unless you have some passive income that allows you to have fun while you earn.
3. Every dollar you use to pay down debt is a dollar you could have put towards retirement. I know many people that pay over $3,000 per month towards their mortgage, car loans and other debts. That's $36,000 per year they could have put in their savings or used to buy rental properties.
Track this monthly and make sure your total debt decreases every single month.
5. CREDIT SCORE
Today, there is no excuse for not knowing your credit score.
Many credit card companies report an estimate for you (like Discover).
Credit Karma offers a free estimated credit score.
You can apply for a free credit score from one of the three major reporting agencies every year at annualcreditreport.com, so three times per year you can check for free.
Shoot for a score over 700, ideally over 750.
Factors that help:
1. Paying your bills on time.
2. Using a small portion of your total available credit (use less than 30%).
Investigate further if your score drops by a significant amount.
6. DEBT TO INCOME RATIO
What percent of your gross income goes towards debt? What should it be?
In a prior section we talked about reducing your debt. This ratio is another way of looking at if you have too much debt.
Take the total amount you pay towards debt each month and divide it by your gross income.
What did you get?
If it is over 36% then you are on the high side.
You should be working on getting this number to zero, but initially get this number to at least below 36% of your gross income.
7. SAVINGS RATE
Many people when they start on their financial journey can't save a penny, or they think they can't.
Saving money is a habit like anything else. Once it is ingrained as a normal part of your life, you won't even have to think about doing it.
The best way to save is to have the money automatically pulled out of your paycheck and placed into your retirement account before you even can touch it.
If you think you can't save any money, then start with an IRA account that allows you to deposit an amount as small as $25 per month. Talk to your HR department to have that amount deposited automatically into your IRA or 401K, rather than going into your checking account where you'll spend it.
If your HR department requires an even percentage then start with 1% and increase it every year. Depending on where you save the money, you may save some money on your payroll taxes and the net decrease in pay won't be that noticeable.
Once a month, track how much money you saved during the month and divide it by your gross income.
Target 10% to 20% for your savings rate. Aggressive savers can sock away over 50% of their income.
There you have it.
Seven numbers to look at to see how you are doing financially.
Are there others? Sure, but these seven will give you a great visual to see if you're staying on track, improving, or falling short of your goals.
Why not start tracking these this month?
If you're a subscriber to my blog you would have received an email for this post with a link to download a companion spreadsheet which will calculate the seven numbers above for you. Most of my posts will have some sort of freebie available to subscribers. I encourage you to join so you don't miss any future posts or bonuses.
Thanks for reading!