By guest blogger, Karen Sigmon-Smith
“You cannot manage what you cannot measure.”
This adage is certainly true when it comes to biometrics such as Body Mass Index (BMI), blood pressure, cholesterol, and glucose. Knowing your baseline numbers will help you take steps to live a healthier lifestyle.
The same can be said for your key financial indicators. Keeping tabs on the metrics that matter can help you make smarter decisions about how you manage your money, ultimately leading to optimal financial well-being. Just as physical health check-ups should occur with regularity, financial assessments and check-ins are needed periodically, as well.
You do not have to be a millionaire to track your net worth. In fact, regular monitoring of this key metric is a good practice. Net worth is calculated by subtracting what you owe (liabilities) from you what you own (assets). Knowing your net worth helps you understand your current financial position and serves as a reference point for measuring progress toward financial goals. Over time, your net worth should grow. If an increase is not evident, that may reflect a need for you to save more and spend less.
If you have ever applied for a loan or mortgage, your debt-to-income (DTI) ratio has been calculated to determine your credit worthiness. Lenders use this number to assess your ability to successfully manage additional debt.
To calculate DTI, sum up your total monthly debt payments (i.e. mortgage, auto loan, credit cards, etc.) and divide them by your gross monthly income (the total household earnings before taxes, insurance, and other expenses are deducted). Ideally, your DTI should be less than 36%. A DTI that extends beyond 43% is an indication of dangerously high debt burden and your ability to secure new loans or favorable rates will be significantly hampered.
Another indicator of credit worthiness is your credit score. The most common measure is the FICO (Fair Isaac Corporation) score which indicates the degree of risk involved in lending you money. FICO scores range from 300 to 850; a score of 700 or more indicates good credit. The higher your credit score, the easier it will be to take out a loan and the more favorable the rates.
FICO takes into consideration a variety of factors when calculating a score, including your payment history, the amount of available credit utilized, the length of credit history, and the types of credit used.
Conducting a cash flow analysis will help you determine if you have over-committed yourself financially. To calculate your monthly cash flow, subtract your fixed (mortgage or rent, taxes, insurance, loan and debt payments, utilities, etc.) and variable (food, household expenses, clothing, gas, etc.) expenses from your total household income. The goal should be to have a positive cash flow, meaning you spend less than you earn.
If the cash flow analysis results in a negative calculation, your high debt burden will likely limit your ability to build an emergency fund or save for retirement. The best way to address negative cash flow is to establish a budget and track your spending to regain control of your finances.
Recent studies have uncovered that more than half of American adults could not sustain an unexpected expense of $1,000. This reality only highlights the need that many have to set aside some money in an emergency fund to handle unexpected life events, such as a job loss, hospital stay, or home or car repair.
Typically, this fund should consist of three to six months’ worth of savings to cover any costs beyond your regular expenses. Ideally, your emergency fund should be established in an account that you do not frequently access. If you struggle with debt and cannot imagine having the capacity to set aside that much money right now, aim to save a minimum of $1,000.
By tracking these key metrics, you will be on your way to managing your finances in a way that gives you peace of mind and leads to a healthier you. On the road to financial well-being, however, there will be some roadblocks and detours. Pay careful attention to the five factors that could potentially impact these metrics that matter.
If you can steer clear of these roadblocks, financial wellness will be within your grasp. Just bear in mind the trade-offs that will play a role in your bottom line, as well as in the long-term viability of your financial plan. There may be times when opting for a purchase today will prevent you from saying “yes” to a potentially better opportunity or life-saving investment at some point in the future. Your ability to carefully plan, prioritize, and weigh your options will ensure a smooth journey. Stay the course!