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Before you ever get your personal finances in order and start on the road to financial health and security, the place to start is to figure out your personal finance basics: the numbers! There are just so many numbers and terms out there, it’s easy to get lost trying to figure out what you really need to know. What numbers are the most important? Where do they come from and how can you change and improve them? Why is it so important to know and understand them in the first place? It’s really a numbers game of personal finances!
Personal Finance Basics: The Numbers
1. Know your Real Income (Spendable Income)
It sounds so darn simple, doesn’t it? If I asked you how much you make from your job, you probably know exactly what that number is. But your income is not your salary. Knowing your actual take-home, spendable income is the foundation for accurate budgeting. When you know how much you bring home from your job and any side hustles or passive income streams, you can then determine how much you can spend. You can also make well-informed decisions to prepare for your future.
How do you calculate your spendable income after taxes and other deductions that you must have before you actually get your hands on any money?
To calculate your take-home pay, determine your taxes, retirement contributions, health insurance deductions, and so forth and subtract them from your gross pay. You can use an online calculator to figure out your take-home pay. Once you come up with your number, multiply the amount of each check by the number of paychecks per year (say 26 or 52). Then divide that number by 12 months to come up with your monthly spendable income.
If there are additional amounts of income such as interest or investment income, add that to you total. Now you have a real number to work with.
2. Know your Real Expenses
It’s so easy to spend your money. With groceries, utility bills, housing and car expenses, your money can easily and quickly disappear. But when you keep track of your expenses, you’ll know exactly how much you spend, where you spend it, what you spend it on, and how much you have left over for other things in your life. It’s not that difficult to look at all of your regular bills and add them up.
Be sure to include things you pay monthly, quarterly, semiannually, and annually in the totals and then break that down into a monthly number. For example, I pay my car insurance every 6 months, but I know what that comes down to on a monthly basis so I have it ready when the bill is due. In addition to knowing your income, determining your expenses is a key part of maintaining a budget and a financially sound life.
I highly recommend tracking your expenses on a regular basis using an app or software tool, a spreadsheet, or even pen and paper. Personal Capital offers free financial tools to track your expenses, cash flow, net worth, and more. It can be a real eye-opening experience to see where your money is actually going.
3. Know your Real Debt
Many people don’t know how much they regularly spend every month, but even worse is not knowing what your real debt actually is. It may be too scary for them to look at those numbers or they may have so many loans and debts that they don’t add them up. You must make time to figure out that amount.
Add up all credit card debt, car loans, student loans, personal loans, mortgages, and so forth. Once you know what you really owe and can put that into perspective with what you can spend, you can take action that starts to reduce that debt number down. It may be a wake up call that tells you that you can no longer rely on credit to get you through the month!
4. Know your Net Worth
Your net worth is how much money or value you have to your name. To calculate your net worth, add up everything you have of value (e.g., cash, savings, investments, accounts, property, cars, etc.) and subtract all your liabilities (e.g., loans, credit card balances and any other additional debts).
It can be scary to look at the number, especially if your net worth is negative, but this is important for future financial planning. If your net worth is negative you are in the position of emergency action and the time to take that action is right now! If you find yourself in the positive, then keep doing the things that are getting you there to keep it going!
5. Know your Saving Rate
A saving rate is the percentage of your gross income (of your pay and other income before any deductions) that you don’t spend. In other words, it’s how much your household saves every month. The saving rate in the U.S. is currently below 5% and while no perfect percentage exists, financial advisors typically suggest setting aside 10-15% of your income towards saving for your retirement. That is true when you are just starting out in the workforce and may also be true even if you are older and contemplating retirement in a short period of time. Saving for retirement is and must be a real priority.
How do you determine your saving rate? First, add up all your income sources before taxes. Don’t forget any investment income, side income, or employer contributions to retirement accounts. Then, add up the amount of all the money that you don’t spend every month. That may be money in your checking or savings accounts, investment accounts, or cash.
Divide the amount of money that you didn’t spend by your total monthly income and multiply that amount by 100. This will give you your saving rate.
If you find your saving rate below 10%, consider increasing the rate. Even a small or incremental change makes a big difference. If you’re saving more than 15%, that’s great! Challenge yourself to find ways to increase that percentage if you can. Some frugal households manage a saving rate of over 50%!
6. Know your Credit Score
A credit score is the number that represents your creditworthiness to companies which do business with you. The score is based on multiple factors including how long you’ve had credit history, whether you pay your credit cards on time, and how much credit you utilize.
A variety of credit score scales exist. Credit scores typically range from 300 to 850 with higher numbers being better. In general, scores above 700 are considered good to excellent. If your score is low, there are steps you can take to improve your credit.
When you have a high credit score, you’ll find more doors open to you. You may qualify for lower interest rates on loans, which is important if you’re making a large purchase like a house or car. You may qualify for credit cards with lower rates and better perks. Your score can also affect job offers and rental opportunities. So, how do you find out your credit score?
Check with your bank or your credit card company because many offer free access to your credit scores just for being a customer. You can also research and join a reputable website such as Credit Karma or WalletHub which provide an estimated credit score for free.
All three major credit bureaus provide a free credit report annually. A credit report is different from a credit score. Viewing your credit report regularly is a great way to check on your credit health and ensure there’s no fraudulent activity in your name. It’s advisable to obtain one report every six months.
There are just so many numbers and terms thrown about when discussing personal finance basics that they can leave your head spinning. Start with these six numbers above as a foundation for understanding your financial health. Once you know these, you’ll be in better shape to make inroads to reduce your debt and increase your wealth and net worth. Use all of this info to properly plan your financial goals!
Do you know your financial numbers? What are your thoughts on them? Do any of them surprise you? Are there other numbers that you think are necessary to know in order to plan for a successful financial future?