Let’s focus on the 5 most important numbers you need to understand to improve financial wellness. These numbers will help you decide where to make adjustments and how to prioritize your goals.
#1) Total Monthly Net Income – Net income means the amount of income available after deductions, taxes & insurance is withheld. This number represents your portion – what you currently have at your disposal for expenses, obligations, entertainment and future needs.
- If you receive a bi-weekly paycheck, multiply your check by 26 (total annual pay dates) and then divide by 12 (months).
- If you are paid bi-monthly, multiply your check by 2.
- If you are self-employed, deduct estimated taxes, Social Security and insurance first – then estimate average monthly income.
- If you receive any other type of income, determine how much is available for you to use after any taxes or required deductions need to be made.
#2) Total Monthly Living Expenses – This includes debts, obligations, recurring bills and basic necessities. For this calculation use the average of any bills that fluctuate throughout the year. Only use the minimum monthly payment required for any outstanding debts. The goal is to calculate the absolute minimum required to meet your current monthly living expenses.
- If you share expenses with others, calculate your monthly living expenses two different ways. First, only include your portion of the expenses.
- Next, include the entire portion of any expense you would be required to pay if the other person(s) couldn’t pay their part. This gives you a realistic view of your living costs.
#3) Total Monthly Living Expenses as a Percent of Total Monthly Net Income – In other words, how much of your income is needed to keep up with current obligations. Divide your Expenses by your Net Income, then multiply by 100. This will show your percentage.
- Keeping Living Expenses under 70% of your Net Income is a good place to aim for. This can reduce anxiety and stress over cash flow.
- It’s not about chasing a perfect number, but understanding the dynamics behind the numbers.
- Lower Expenses means More Discretionary Income to set aside for the activities and experiences you want in your life.
#4) Total Monthly Debt to Income Ratio – This helps gauge how much of your current Income is needed to cover debt obligations. Lenders use this ratio to determine how much debt your Income can support. That’s why sales people tend to ask what kind of “monthly” payment you want. Divide the total amount of your minimum monthly debt payments by your monthly Gross Income (Gross Income is before any taxes or deductions).
- A DTI Ratio under 35% is a healthy level. Most Lenders consider anything over 40% as a red flag and can have a negative impact on your Credit Score.
- For Student Loan Debt calculate 5% of the outstanding balance, then divide by 12 to get the minimum monthly payment. Use this number or your actual payment, whichever is higher.
- If your Housing Expenses (Mortgage+Insurance+Taxes/Rent+ Insurance) is under 28% of your Gross Monthly Income – your chances of missing a payment or getting behind is significantly lower.
#5) Discretionary Income – This is the Total Net Income left over each month that you can put towards building the future you want. Pay off debt. Invest. Make a donation. Take a class. Travel.
- If your Short-Term Savings is less than 3 months of your Total Monthly Expenses, that is a good place to start. Set aside at least 5% of each paycheck until you build up your “get out of town” fund.
- If your DTI Ratio is high or you want to reduce your debt, begin paying extra each month to pay it off quicker. Usually the best strategy is to pay off the highest interest first, then the lowest balance. Keep increasing the amount you pay on any remaining debt payments as others are paid off.
- If your Long-Term Savings hasn’t been a priority, it’s never too late to start saving for future needs and expenses. A 401(k) or IRA/Roth IRA is the best place to start.
The best place to start is becoming aware. Know your numbers. Seek to understand the steps that got you to today. Identify options, alternatives and long term sustainable solutions. Remove any guilt, shame or embarrassment from the equation. Focus your limited time, energy and money on crafting a life you love.
image from pixabay – Geralt