Think you’re financially healthy? Here’s 10 simple questions that will determine if you truly are financially fit:
1. Do you pay yourself first?
A phrase widely used by financial advisors, “Pay yourself first” was originally coined by George S. Clason in his book, Richest Man in Babylon. Although many of us have heard of it, few of us actually do it. For you newbies out there, paying yourself first means that before you pay your bills, before you buy those nicknacks that you’ve been yearning for, and if possible before you pay taxes (as with a 401K), set aside a certain amount of money for savings, retirement or investing.
A great way to do this is to set up a savings, investment or retirement account that will directly route it from your paycheck or checking account every month. For example, in what took only 10 minutes, I set up a high-yielding savings account that automatically withdraws a little bit from my checking account each week. The best part about this is that you quickly adapt your spending habits to the money being taken out until you forget about it completely. And what’s most important is it doesn’t require the self discipline of physically taking out a certain amount each pay period and depositing it into your other account (which is why so few of us do this).
2. Do you save at least 10% of your income?
This goes hand-in-hand with paying yourself first. At first you may think that you can’t possibly afford to put 10% of your money away in savings, and honestly that may be the case. However, by determining your Latte Factor, you will notice that there are a lot of little places where you can save money instead of nickel & dimeing it away.
If you just can’t miss your morning double nonfat latte and 10% of your income seems way out of your range, you can use this simple savings progression to work up to that amount.
Anytime you use cash to buy that latte or anything else for that matter, take the coins that are left over and at the end of the day put them in a jar. If you frequently buy snacks and other sundries, by the end of the month, you’ll easily have around $30 in that little jar. That’s $360.00 at the end of the year (hey it’s more money than you had before).
If you prefer to use a debit card instead of cash, don’t despair, many banks offer a “keep the change” program, where they’ll round up all purchases made on that card to the nearest dollar, take the difference and put it in your savings account.
After doing this for a while, perhaps you’re ready to move on to the next level. Just as you’ve been saving the change that’s left over from the dollar, anytime you break a bill larger than a dollar, take the dollar bills that are left over and put them in the jar along with the change. At the end of the month deposit it in your savings account. You’ll be amazed at how fast you can build up your savings.
When you get used to this, you can then move up to $5.00 bills and so on until, before you know it, you’re saving 10% of your income.
Remember, after only 10 months of saving 10% of your income, you’ll have saved a months salary, 1/3 of the way to the next step:
3. Have you set aside a separate emergency fund to cover at least 3-months worth of expenses?
It’s a known fact that Murphy will rear his ugly head at times we least expect him. Murphy’s Law can come in the form of a market crash, a layoff or downsizing, even an injury. Having an emergency fund set aside for these moments will help you soften the blow. And having enough to cover at least 3-months worth of expenses will pull you through almost anything that he can throw at you.
4. Do you know the exact amount of your debts, as well as the interest rates?
Just as financial integrity is an important aspect of your business dealings with others, so is it equally important with yourself. If you’re not honest about your current debt situation, then it’s likely you’ll continue in the same pattern.
Knowing the exact amount of money you owe on various credit cards, as well as the interest rates associated with those amounts, will help to keep your debts at the forefront of your mind. I know, it’s so much easier to ignore it and hope that it’ll go away…it won’t.
Those who are financially fit, always know exactly how much they owe and at what rate. By recognizing it, they make it a priority to get rid of it.
5. Do you accelerate the payments of your debts?
You wouldn’t pay $7,000 for an item that only costs $2,000 would you? Of course not. But that is exactly what you’d be doing if you buy something with a credit card with the average 18% interest rate and then only pay the minimum payment.
Financially fit people learn that sometimes it’s absolutely necessary to borrow money, such as with a home or a car. But whenever they do, they always accelerate their payments.
To see the power of this at work, take this example:
Let’s say you take out a $200,000 mortgage to buy a house. This you do at a fixed 10% rate for 30 years. This would be a monthly payment of $1,755.14. At that rate, in 30 years you would have paid a total of $631,850.40, that’s more than 3 times the amount of the house! Now, what if you paid $2,000 dollars instead of 1,755.14? Just by coming up with an extra $244.86 a month you would have paid the mortgage off in 18 years instead of 30 and saving around $200,000!
The power of compound interest can work for or against you. By accelerating the payments of all your debts, you minimize the effects of compounding interest.
6. Do you have financial goals?
As the axiom goes, “If you fail to plan, you plan to fail.” This is very true in the financial sense as well. How are you ever going to get there if you have no idea where there is? Start making some financial goals, some short (within a year), medium (1-5 years) and long term (over 5 years).
One of my main goals is to be financially independent within 10 years (9 years as of 2007). I have many mid- and even more short-term goals that will help me get there. What I’ve noticed is, my long-term goal(s) stay pretty constant, but as I become more financially literate and learn other things along the way, oftentimes my short-term and sometimes even my mid-term goals will change.
So know where you want to go, but stay flexible along the journey.
7. Do you have a record keeping system?
I know, keeping track of all that paper work is too much of a pain. However, as it is with physical fitness, so it is with financial fitness – no pain, no gain.
This is a very important part of your financial growth. Regularly keeping track of where your money is coming from and more importantly where it’s going, will be a rude awakening for many of us. Remember, it’s not always the size of your income that will determine where you’ll be in 20-30 years, it’s how you spend it.
In the book, The Millionaire Next Door, Tom Stanley found a common thread in his interviews with hundreds of millionaires: They are keenly aware of everything they spend. They’re not wasteful, they live in modest homes, drive older cars, and consider themselves very frugal.
The fact is, the average American works a total of around 90,000 hours in his or her life and at the end, has nothing to show for it. This is because they nickel & dime it away. Keeping financial records will help keep you honest.
8. Do you live within a budget?
Ugh…the very word ‘budget’ makes people cringe, but it’s really not that hard to set up and follow. Here are five easy steps to creating a budget:
- Determine your Monthly Income: This is the easiest part. Just figure out the amount you take home, after taxes. If you’re income changes because of commissions, tips, or overtime pay, just figure out what the average amount is. Also include any freelance work, alimony or child support, interest & dividends, social security etc.
- Determine your Total Monthly Expenses:For most people, this one is a bit more difficult. However if you have a record-keeping system, then this should be a peace of cake. Not only does this include your monthly bills like your rent or mortgage, groceries, utilities and such, but also the Twinkie that you buy every morning at the mini-mart.
An easy way of determining this is to get or make a receipt for every single thing you spend, from your bills to those bon bons, and put it in a shoe box at the end of the day. When you’ve reached a months time, take all those receipts out and add ‘em up.
- Categorize your Expenses: The next step is to take those same receipts out of the shoe box and separate them into three piles. 1. Fixed Expenses (rent, mortgage, loans, 10% savings ) 2. Variable Expenses (utilities, phone, gas, groceries) and 3. Discretionary Expenses (entertainment, gifts, dry cleaning, donations, health & beauty).
- Evaluate you Expenses: This is where you determine what’s important and what’s not. If you are already making more than you spend, then you’re in good shape and you’re probably already living within a budget. If you’re living paycheck to paycheck, then start cutting a bit off the discretionary so that you can achieve a positive cash flow. And finally, if you’re the type that spends more than you make, then this is especially important for you. Figure out exactly what you need to give up in order to make some positive ground.
- Stay within your Budget: After finishing the previous steps, you now have a budget! The next step is to show some discipline and stick to it.
9. Do you know your net worth?
This is a simple process of taking your total assets and subtracting it by your total liabilities. However what most people are not clear on is what the definition of their assets and liabilities are. I subscribe to the definition that an asset is anything that can put money into your pocket whereas a liability is anything that takes money away.
Examples of your assets would be:
1. Liquid Assets – cash, checking/savings accounts, savings bonds, money-market funds, the cash value on your life insurance.
2. Paper Assets – certificates of deposit, stocks, bonds, mutual funds, insurance annuities.
3. Retirement Plans – vested company pension, IRAs/SEPs/KEOGHs, 401k, 403b etc.
4. Personal Assets – rental property, businesses and passive income generating sources.
On the flip side, your primary residence mortgage, home equity loan, rental property mortgage, credit card balances, car loans, education loans and other outstanding debts are examples of your liabilities.
If you noticed, your primary residence is not listed as an asset. I tend not to think of your home as an asset because, not only does it take money out of your pocket but most people wouldn’t be willing to sell it to pay for their daily expenses anyways. Basically things you really could and would sell.
10. Do you put your eggs in different baskets?
Those who are fit financially, understand the importance of diversification. Now, I’m not talking about the Wall Street mantra of “diversify, diversify, diversify.” The stock market is only part of it. It’s important to spread your investments throughout many different vehicles. The stock market (paper assets), real estate, money-market accounts, treasury bonds etc. Relying only one one form of investment could be the recipe to disaster. How do you know that when you’re required by the government to start withdrawing from your IRA or 401k (at 70.5 years old), that the market won’t have hit rock bottom at that time?
Part of planning for the future is planning for worst. By learning to spread the wealth, you’ll be better prepared to meet the worst, and survive.