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Sticking to a workout plan or diet regimen involves time, discipline, and progress tracking. Sticking to a financial plan is quite similar. However, there are many different measures out there to “track” the success of your financial plan. Finding a measure to determine how well your financial plan is performing can be quite difficult, even overwhelming. This blog seeks to debunk a few commonly used measures of financial health, while at the same time focusing on a few measures that can be a good sign towards ultimate financial freedom.
What you track can really determine how efficiently you use time, and what results come. Here is a video we did on this topic: https://www.youtube.com/watch?v=NNoFaqUo7og
Here are a few common financial health misconceptions:
Many will conflate a credit score in the 800s as a clean bill of financial health. While having a perfect credit score is by no means a financial deterrent, generally speaking, there aren’t too many additional benefits to having an 850-credit score. No products or loans on the market exist for those with a perfect score. Generally, any credit score above 770 receives a clean bill for financial health and most credit offers for house, car purchases, etc.
Learn more about how to utilize credit card points to travel and spend as efficiently as possible:
https://ewa-llc.com/courses/how-to-travel-the-world-for-almost-free
It’s easy to drive past a large home or a fancy car and think that the person living there or driving it is set financially. While that may be the case, simply having a large home or expensive car is not solely indicative of strong financial health. A lot of times, it can mean the opposite. Many Americans default to working in a job they don’t like to buy stuff they don’t need to impress people they don’t like. A good financial plan can flip this default mode into a life by design, and not by default.
For a home payment, a general rule of thumb to keep in mind is to ensure that one’s total monthly housing costs (between mortgage payment, homeowner’s insurance, and property taxes) do not exceed 30% of one’s net take-home pay. In practice, someone could live in a home where their housing payment eats up more than 30% of their take-home pay, potentially putting stress on their other savings goals (retirement, education, etc.).
A common misconception often seen in financial planning is the idea that renting is “throwing money away,” and owning a home outright is the key to financial freedom. While there are certain cases where that could ring true, there are a variety of renting strategies that can lead to successful financial health if you “invest the difference.” Here is a video that explains why renting can sometimes be a better financial choice than buying a home:
https://www.youtube.com/watch?v=3UWerzN864o
Ultimately, here are a few measures of financial health that we believe to be applicable and where to focus:
Having a manageable amount of debt pursuant to one’s income is crucial for sustained financial health. The debt-to-income (DTI) ratio divides monthly debt payments over gross income and is usually one of the first items a lender will request upon any application. Keeping this metric under 30% is generally advisable, provided the type of debt is managed properly.
One of the best steps to keeping a financial plan on track is controlling one’s “money temperature,” or having a clear understanding of monthly cash flow. Ultimately, this doesn’t mean tracking every expense on an Excel sheet. A good strategy to implement to help organize savings and spending is reverse budgeting. On a high level, reverse budgeting divides monthly expenses into two categories: fixed expenses and variable expenses. All fixed expenses should be sent to a fixed checking account and auto-draft at the beginning of every month (mortgage payments, insurance premiums, fixed savings/ investments into the future, etc.). Then, any remaining pay that is “leftover” from paying the fixed expenses can be sent to the variable checking account, meant to be spent to $0 each month. This better allows for guilt-free spending in the variable account, knowing that all obligations are being met out of the fixed account. Reverse budgeting can be a valuable tool to systematize month-to-month operations.
Here is a video that explains reverse budgeting: https://www.youtube.com/watch?v=s768NzYKcu8
Keeping an updated net worth counter has been one of the best ways to track financial health for decades. Tracking how your assets compare to your liabilities can help manage how much debt you may be taking on versus how much your accounts may be growing. Let’s assume a family has $50,000 in cash, $500,000 in investments, and a $1,000,000 home. Further, they owe $500,000 in an outstanding mortgage balance. Their net worth, in this case, would be $1,050,000 (the sum of their assets less the sum of their liabilities). Net worth tracking is relatively easy and is generally a good way to gauge how one’s financial health is trending.
Generally speaking, a higher savings rate will equate to stronger financial health. Consider your savings rate to be the amount you save each month over your monthly income. As an example, if monthly income is $10,000 and monthly savings are $2,000, then one’s savings rate is 20%. A general rule of thumb is to keep this number at 20% or higher, but this rate should ultimately be calibrated specific to one’s personal financial situation.
Even the best-laid financial plans can be thrown off by risk. An individual or family can be doing all the right things from a financial planning standpoint, but if correct risk management planning is not addressed, it could all be for nothing. Ensuring the correct amount and type of life, disability, health, and umbrella insurance plans are put in place is vital to financial health and, ultimately, financial peace of mind.
If you have questions regarding how well your financial plan is on track, please consult with a trusted financial advisor.
In just 15 minutes we can get to know your situation, then connect you with an advisor committed to helping you pursue true wealth.
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Securities and advisory services offered through EWA LLC dba Equilibrium Wealth Advisors (a SEC Registered Investment Advisor).
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
* Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
* The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. You cannot invest directly in this index.
* All indexes referenced are unmanaged. The volatility of indexes could be materially different from that of a client’s portfolio. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. You cannot invest directly in an index.
* The Dow Jones Global ex-U.S. Index covers approximately 95% of the market capitalization of the 45 developed and emerging countries included in the Index.
* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
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* The Bloomberg Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.
* The DJ Equity All REIT Total Return Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* The Dow Jones Industrial Average (DJIA), commonly known as “The Dow,” is an index representing 30 stock of companies maintained and reviewed by the editors of The Wall Street Journal.
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* International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage is often obtainable in commodity trading and can work against you as well as for you. The use of leverage can lead to large losses as well as gains.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
* Past performance does not guarantee future results. Investing involves risk, including loss of principal.
* The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee it is accurate or complete.
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* Asset allocation does not ensure a profit or protect against a loss.
* Consult your financial professional before making any investment decision.
In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.
EWA, LLC dba Equilibrium Wealth Advisors, is an SEC-registered investment advisory firm providing investment advisory and financial planning services to clients.
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In 15 minutes we can get to know you – your situation, goals and needs – then connect you with an advisor committed to helping you pursue true wealth.