Sometimes it's really hard to know how you're doing at managing your money. There's a lot to keep track of and many milestones to achieve to become financially successful, so it can feel exhausting to try to figure out if you're on track.
The good news is, when you boil down everything down to the basics, many of the most important aspects of your finances can be summed up in a few simple numbers. If you know these numbers, you can track your progress in achieving financial goals, see if you're on pace to become financially independent, and get a pretty good idea of how you're doing with your money.
What are the numbers you need to know? Here are five key metrics that paint a pretty comprehensive picture of your financial situation.
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1. Your credit score
Technically you have many different credit scores, as different lenders and credit-scoring agencies have their own formulas for determining your score. However, the most important two are your FICO score and your VantageScore, as these are the most commonly used. Both FICO and the latest VantageScore model score you between 300 and 850, and the higher your score the better. Both also take similar factors into account, including the amount of debt you have relative to credit available and your payment history record.
Knowing your credit score is important because this score determines if you can borrow, and at what rates. It's also used by many other companies, by landlords when they're deciding whether to rent to you, and by utility and cellphone companies. A good credit score means you've generally been responsible with payments, aren't maxed out on your credit cards, and have a good mix of available credit. A bad credit score suggests you have some work to do when it comes to managing your debt -- and could also make it more difficult and expensive to borrow in the future.
Your credit score can be found using free online websites. Discover, for example, will provide you with your FICO credit score at no cost even if you aren't a cardholder. You should check your score regularly, as this will give you insight into whether you're using credit responsibly.
2. Your debt-to-income ratio
To figure out your debt-to-income ratio, you need to know how much you owe relative to your income. You can find out your DTI by dividing the total amount of monthly debt payments you have by your gross monthly income.
Knowing your DTI is important because this number shows how much debt you have relative to what you earn. It can give you a much more accurate picture of how indebted you are than just looking at your total debt balance alone. After all, if you owe $1,000 but make $1 million a year, you're a lot better off than if you owe $1,000 but make $30,000 annually.
A DTI that's too high doesn't only mean you'll probably struggle to make debt payments and may have too little income left to accomplish other financial goals, but it also means many lenders won't want to give you a loan because they'll worry you've overextended yourself.
The maximum DTI to get a qualified mortgage loan, including your future mortgage payment, is 43%. Many lenders set your DTI even lower, at 36% or below. If your DTI is much higher than that, you need to get serious about either paying down debt ASAP or increasing income or both. Otherwise your debt is likely to have an ongoing adverse impact on your financial life.
3. Your monthly expenses
Knowing your monthly expenses is important for many reasons. First, once you know how much you spend each month, you'll know how long it will take you to achieve financial independence. If your total spending is $5,000 per month, you need to produce at least this much income. If your investments could produce $60,000 in annual income, you'd be financially independent because you wouldn't have to earn a paycheck and could still support your lifestyle.
You also need to know your total monthly expenses so you can determine how much cash should be in your emergency fund. Most experts recommend you have at least three to six months of living expenses saved up for emergencies -- but you can't hit this target until you know what your monthly expenditures are. Finally, when you know your monthly expenses, you can make sure they don't add up to too large a percentage of your income. Ideally, spending on needs and wants shouldn't exceed 80% of monthly income, so you'll have 20% left over to save.
You can figure out your monthly expenses by tracking spending for at least 30 days and seeing where your money goes. If you find your monthly expenses are too high relative to income, look for ways to cut back. And, remember, the lower your essential monthly expenses, the easier it will be for you to become financially independent, because your investments won't need to generate as much income to maintain your lifestyle.
4. Your savings rate
Saving for the future is one of the key steps to achieving financial success. While conventional wisdom suggests you should save at least 10% of income for retirement, this wisdom is likely wrong, and aiming to save 15% to 20% of income is best to ensure you don't end up broke. You should also make sure you're saving for other things, such as emergencies, big purchases, a home down payment, paying for a car in cash, and accomplishing other financial goals.
To find your savings rate, look at how much income you save per month in all your accounts -- including your 401(k), IRA, other brokerage accounts and savings accounts -- and compare it to your total monthly income. The higher your savings rate, the better off you'll be, because you'll be putting more of your money to good use. If your savings rate is below 10% to 15% of your income, you'll need to work on saving more. You can automate transfers of money to retirement and other savings accounts to make sure you're hitting your goals.
5. Your net worth
The last key number to know is your net worth. Net worth equals assets minus liabilities. It represents the wealth you have. Let's take a simple example. If you have a house valued at $200,000, a car valued at $20,000, $5,000 in personal property, $1,000 in savings, and a $150,000 mortgage loan, your net worth equals $200,000 + $20,000 + $5,000 + $1,000 - $150,000. This gives you a net worth of $76,000.
If you have lots of assets and few liabilities, you should have a positive net worth. But if you have lots of debt and few assets, your net worth will be negative. As you start out in life, with student loans and a car loan, it's normal to have a negative net worth. But as you save, invest, pay down debt, and acquire things of value, your net worth should grow. A negative net worth means you have more work to do, while the higher your net worth the better off you are. You can track your net worth over time to gain a very clear picture of how you're doing at building wealth. If it's not increasing, you need to make some big changes.
Do you know your numbers?
Now you know five important numbers that show you how you're doing with debt, how much you need to earn, how prepared you are for the future, and how close you are to financial independence. If you don't already know what your numbers are, you've also got the info to find them.
So sit down today and figure out your credit score, debt-to-income ratio, monthly expenses, savings rate, and net worth. Then keep track of these numbers as you work toward improving your financial situation. If you do, you'll always have a clear idea of how you're doing, and you can make adjustments as needed to ensure you're on track for a secure financial future.
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