With the New Year just around the corner, many of us will vow to make 2016 the year we finally get our finances in order. But in order to be successful, experts agree that we must first understand a few basic numbers. Knowing these figures will help us make the right decisions for a financially fit future.
Debt is the cancer that consumes your financial well being from the inside out.
Your Gross and Net Income
To budget your way to financial success, you must first understand how much you actually bring home. Your gross income is the amount your employer pays you before deductions are taken out of your paycheck. Your net income is the amount you have left over after all deductions are subtracted from your gross income.
Just because you earn a $45,000 yearly salary doesn’t mean you’re able to spend $45,000 a year. Local, state, and federal taxes, as well as social security and health insurance contributions, take a significant bite out of your take home pay.
Failure to appreciate the difference between net and gross income has led many people to spend more money than they actually take in. But, by understanding exactly how much you bring home, you can determine how much you can actually afford to spend.
Your Burn Rate
We get in trouble for failing to appreciate how much we actually bring home. But, we can also find ourselves in hot water when we don’t know how much we actually spend each month. Our burn rate (or monthly expenditures) is the amount of money we spend each month on everything from our mortgage to our trips to the movies.
Calculating exactly what we spend and where we spend it allows us to accomplish two things. First, we can determine if we are actually spending less than we’re bringing in. Second, we can identify areas where we can trim the fat on expenses, putting more money into our pockets.
Your Personal Savings Rate
A part of all you earn is yours to keep, and if you cannot save money, the seeds of greatness are not in you. -W. Clement Stone
In order to invest for the future you must save a portion of every paycheck. The personal savings rate is defined as the amount of money you’ve saved as a percentage of your disposable income (money left over after all the bills have been paid). According to the US Bureau of Economic Analysis, over the past few years the personal savings rate has hovered around 5%.
Yet, many financial analysts warn that this rate is too low, providing inadequate funds for retirement, an emergency fund, and other savings needs. They frequently suggest that you direct between 10% to 15% of your disposable income toward savings.
Your Debt-to-Income Ratio
Debt is the cancer that consumes your financial well-being from the inside out. But, you’ll never gain control over your debt until your determine precisely how much you owe.
Your debt-to-income ratio indicates how much debt you owe relative to the amount of money you earn. It is the total of your monthly debt payments divided by your monthly gross income.
Make a list of all of your monthly debt obligations, or more easily, obtain a copy of your credit report which conveniently lists them. Divide this figure by your gross monthly income to determine your debt-to-income ratio. Generally you want the ratio less than 35%, meaning less than 35% of your gross income is going toward paying off debt.
Your Net Worth
How will you know if all your hard work and financial sacrifice is actually paying off? Unless you have a way to track your progress, there’s really no way to know where you stand. You need a measuring stick, and that measuring stick is your net worth.
Your net worth is the sum of all of your assets minus the sum of all your debt. Assets are things of value like your automobiles, home, savings and checking accounts, and investment accounts.
Many of us have a negative net worth, meaning we owe more money than the value of things we own. This is OK. The key point is to make the right decisions that ensure your net worth increases over time. Review your net worth periodically so that you can track your progress and make adjustments to your financial life as needed.
BMWK, do you know your five numbers?