I get a lot of emails from people asking me if they are “on track” financially for their age and family situation. The truth is, it isn’t very difficult to determine that all on your own. You could be a 30 year old millionaire, or simply a 30 year old that just recently climbed out of monstrous credit card debt with a net worth of zero, but I’d still say you were “on track”. You simply need to be trending in the right direction. That means you should be paying attention to your finances monthly to see if all of the important financial KPI’s are moving in the right direction. What’s a KPI you ask? That stands for key performance indicator. As a Corporate Finance Manager (day job) this is essentially the basis of my entire job. Our company determines the key performance indicators that are most important to their financial and operational well-being, and we as a financial planning and analysis group need to determine if those metrics are moving in the right direction…and most importantly, why or why not! Now, determining KPI’s from a personal finance perspective versus a large automotive company is very very different. If you want to know how you are trending financially, these are the most important numbers you should be paying attention to each and every month.
If you are an avid reader of this site then you know I talk about net worth more than anything else on here. Plain and simple, it’s the number one indicator of how you are doing financially. In general, you should see this number increasing every month. Net worth is to personal finances that a balance sheet is to a corporation. It’s simply a snapshot in time of your overall financial health. You take all of your assets and subtract all of your liabilities, and thus you are left with your overall net worth. Assets are items like your home value, investments, and cash. Your liabilities are items like your remaining mortgage, credit card debt, home equity loans, etc. It’s really not a very complicated concept, yet if you ask most people what their net worth is they would have no idea. If you don’t want to track your net worth to the penny, then a simple app like Mint or Personal Capital are a pretty easy and graphical way to track it.
Home equity isn’t exactly a new concept. You take the value of your house, subtract how much you owe on it, and voila…you are left with your home equity…or ownership amount within your house. Most people are constantly striving to payoff their mortgage, after all, that is the American Dream. However, people often overlook the journey and only at the destination. A mortgage typically lasts 30 years, but your home equity may become important several times over that 30 year period. Consider that interest rates have been at ALL TIME lows the past few years. Credit card rates haven’t really been getting lower, but home equity rates have been. I know of people who found themselves in financial binds, or even others that just wanted to fund some home improvement updates, that were able to use home equity loans at extremely low rates. The rub is that you need to actually have home equity. The housing bubble exploded and left us with many houses that were underwater on their mortgages, so you can see the importance of owning a large percentage of your house. You should never underestimate the value of cheap credit.
Total “Investment” Balance
In general, I like to know my overall investment balance throughout all my accounts. This is something I usually use Mint to look at quickly from time to time. I don’t necessarily care if it’s my 401k, 403b, IRA, or taxable brokerage account. My only real concern is that overall balance of those accounts combined. Compounded returns count for all of those investment balances, and is the most powerful tool you have to reach retirement. We are told that a 5% lifetime return on our investments is fairly conservative, 6% is somewhat realistic, and 7% – 8% is a relative possibility. Let’s just assume a conservative return on your money for now. If you have a total of $100,000 invested in all of your accounts then you can expect to earn about $5,000 that year off those investments. If you have a total of $300,000 then you can expect to earn $15,000 that year. You can easily see how your overall investment balance seriously contributes to your overall wealth. This is the number I track to see how much longer I have before I can retire!
I understand that income diversification doesn’t necessarily apply to everyone, but it should! I generally look at my monthly earnings and always hope to keep 25% of my overall monthly earnings diversified outside of my day job. While it would be nice to outpace my day job earnings with my online side hustles, it probably isn’t overly realistic for me. But I know with having 25% of my total take home pay coming from sources outside of my day job I am in a good position should I ever lose my job. It happened before and it could always happen again! As we get older and become more expensive to employ, companies tend to go for younger and cheaper. I’ve known this for a long time, and despite only being 34 years old, I am preparing for the day when I become “over the hill” to most employers. I don’t want to find myself reliant on any company to pay my bills. If you currently don’t have any income diversification then you should definitely work on it. Maybe it involves getting a second job as a pizza delivery person, or maybe selling stuff on Etsy, or perhaps you can be successful as a blogger!
Cash Flow and Spending Trends
In my day job, two important things we look at from a company perspective is our monthly cash flow and our monthly spending. Cash is king, always has been and always will be. Your cash flow is a simple calculation as well, how much do you have coming in versus going out. It doesn’t take a rocket scientist to understand that this number should always be positive. However, you would be surprised how few people actually bother to understand this number. This is precisely why people fall into debt so quickly and easily, because they fail to understand the importance of spending less than you earn…it doesn’t get any more simple than that. The easiest way to understand the money going out the door is to look at your monthly spending. This is precisely why I put about 99% of my monthly purchases on a credit card, that and I like getting the rewards points. By putting everything on my credit card I can use my online AMEX account to generate a quick breakdown of my monthly, quarterly, and annual spending. You don’t need to obsess over every little purchase, but it helps if you look at your monthly trends and understand why you have large variances in certain months. Perhaps you ate out a lot more than you realized, or spent a ton more on groceries that month, or maybe it was all of the above. Large corporations hire teams of people to look at these very same trends, so that should drive home just how important they are.
There are a TON more important financial metrics that are key to thoroughly understanding your financial situation, but the 5 listed above are probably the most important to me. These are the numbers I look at each and every month to understand my overall financial situation and how I am progressing. This is why I provide my monthly income reports, and more recently my monthly net worth report.