Many people struggle to assess their financial health effectively. To gain a clearer picture, consider these five key numbers. While you may know your weight and pre-tax income, understanding your financial situation requires more than those figures.
Even if you view yourself as responsible with money, several other numbers can reveal whether you’re genuinely managing your finances, facing difficulties, or heading toward trouble. Think of these as grades on a “money report card” that help you stay on track.
Here are five vital personal numbers to understand and easy steps to calculate them:
1. Your “overhead” ratio
Your overhead ratio compares your essential expenses to your income. It shows how much of your income goes toward necessary costs. A high overhead ratio can hinder your ability to save.
To calculate your overhead ratio, add up all necessary monthly expenses, including rent, utilities, commuting costs, taxes, insurance, food, and minimum loan payments. Also include all essential obligations.
Next, could you compare this total to your monthly income? For example, if your expenses are $1,800 and your income is $2,000, you spend 90% on essentials.
Spend too much on necessary expenses. You might not be able to save the recommended percentage of your income for retirement, leaving you with little for discretionary spending and potentially leading to debt. Financial experts recommend keeping essential expenses at 50% of your income. The 50/30/20 budget method suggests using 50% for necessities, 30% for wants, and 20% for savings.
2. Your debt balance
Please take a look at the total amount you owe across all debts. In 2010, American households estimated they owed around $440 billion in credit card debt, representing only 60% of the actual figure reported by lenders. Similarly, households underestimated student loan debt.
To determine your total debt, log into your online accounts for student loans, auto loans, credit cards, and other obligations. Add up your outstanding balances and double-check your credit report for accuracy, which you can access for free at AnnualCreditReport.com.
Knowing your debt balance allows you to set realistic financial goals, such as avoiding carrying debt into retirement. A debt repayment calculator can help you explore how to pay off your debt faster.
3. Your debt-to-income ratio
Calculate your debt-to-income ratio by adding your total minimum monthly debt payments and dividing that sum by your monthly income. If your total debt payments amount to $500 and your income is $2,000, your debt-to-income ratio is 25%.
This number is crucial because a high debt-to-income ratio indicates that a significant portion of your income goes toward debt payments, leaving less available for other financial goals.
Be mindful of this ratio if you plan to apply for a mortgage. The Consumer Financial Protection Bureau suggests that your monthly debt, including mortgage payment, property taxes, and insurance, shouldn’t exceed 43% of your income. This percentage acts as a guideline for safer loans, but aiming for a lower ratio works in your favor. A debt-to-income ratio of 20% or below is considered excellent.
4. Your net worth
Your net worth reflects your wealth. Calculate it by adding the values of all your assets, such as your house, car, furniture, and jewelry, and subtracting your debts, like mortgage and student loans.
While your net worth may start as unfavorable when you’re young due to high college loans and limited assets, you should aim for growth over time. Achieving a positive net worth by retirement age is essential for financial security.
Assess your net worth relative to your age. According to Thomas J. Stanley in “The Millionaire Next Door,” multiply your age by your pre-tax annual household income (excluding inheritances) and divide by ten. This figure, minus any inherited wealth, indicates the net worth you should aim for.
5. Your credit score
Finally, keep track of your credit score. Knowing this number helps you understand your creditworthiness when applying for loans or credit. Regularly monitoring your score allows you to spot inaccuracies and improve your financial health.
By tracking these five numbers, you can gain valuable insights into your financial situation and make informed decisions to live your best life.
