Every journey has a starting point. It is essential to understand what your starting financial health is. However, we don’t need to make this super complicated either.
Like stepping on a scale to measure your weight, you’ll want numbers for where you started. Then, you can show exactly how well you did when you achieved your goals. I really wish I had better numbers from when my wife and I first started.
Why You Should Measure Your Financial Health
Let’s be honest; we all want to know we’re doing “better” than the “average Joe” out there. I know this because over 70 percent of people I surveyed said they’d rather make $50,000 while everyone else made $25,000 versus the choice of making $100,000 if everyone else was making $200,000.
Why? People wanted to know they were doing better than everyone else. Despite the obvious fact that they’d still have double the money in the second scenario. Fascinating. However, there’s really only one person you should compare yourself to – your past self.
Tracking Helps You Measure Progress
One of the main advantages of tracking your financial numbers is helping you measure progress. We want to ensure that any financial changes we make have a positive outcome over time. This lets you know you’re making real measurable progress toward your goals.
Clarify Goals and Plan More Strategically
Knowing exactly where you stand helps you clarify goals and make sure they’re achievable. More importantly, it helps you uncover what it takes to make your dreams a reality. In other words, accurate data helps you turn a wish into a well-planned roadmap to success.
Tell a Better Success Story Later to Help Others
It might seem a little self-serving, but having actual numbers will help you show your success later. This is just as helpful to others as it is for you. People love to see how other people like them achieve financial success.
That’s a big reason why I started this blog. I wanted to highlight stories from people just like me. I didn’t start with a big, six-figure salary, but I’m steadily building momentum on our wealth-building journey.
What to Measure
I know what you’re saying. Okay, got it, measure your financial health. But what exactly should you be measuring?
I feel you should measure your savings rate, net worth, debt-to-income ratio (DTI), and liquidity ratio (cash on hand). I’ll give an honorable mention to your credit score, but fixing the first three will help you raise your credit score. You can track many other ratios and metrics, but I feel these are the most important.
Savings Rate
Your savings rate is an often overlooked yet vitally important number. Your savings rate is the ratio of how much you saved versus how much you made. In other words, your savings rate is how much money you have left over each month.
I’ve listened to tons of stories on Millionaires Unveiled about how people became millionaires. Many of the people who achieved the million-dollar milestone got one thing right – a high savings rate. Some of these people made huge mistakes along the way, but their savings rate made their success inevitable.
Developing an Above Average Savings Rate
Surprisingly, it takes very little to achieve an above-average savings rate. The national average savings rate is less than 5%. Can you live on 95% of what you live on now? Yeah, I thought so.
However, being a tad above average may not be enough to meet your goals. You need to increase your savings over time until you can achieve your financial goals. Many people use the 50/30/20 rule where 20% of your income is set aside for savings. This is a good target to aim for, but it’s not the only thing that matters.
Net Worth
Knowing your net worth gives a good understanding of your overall financial health. Like a compass, it points to whether your financial health is moving in the right direction. A decrease in your net worth while you’re in the accumulation phase of your life isn’t a good sign.
In theory, your net worth will increase until you retire and then level off to a plateau before declining toward the end of your life. Until you hit your “FI number,” you want your net worth to increase. It will often continue to increase unless you change your spending habits.
Calculating Your Net Worth
Luckily, calculating your net worth is fairly straightforward. You take everything you own and subtract everything you owe. This may even be a negative number if you have a lot of debt.
Ideally, you want a positive net worth that increases over time. I have a free net worth tracker in Excel that you can download here. It’s the same one I use.
Debt to Income Ratio
Your Debt-to-income ratio, or DTI, measures your annual debt payments divided by your annual salary. If you make $50,000 per year and your total debt payments total $25,000 for the year, then your DTI is 0.50 or 50%.
Ideally, you want to have a DTI of 16% or lower. Once you reach 36% or higher, you’re starting to get a critical level of debt. Once you’re at 50% or more, you’re at serious risk of bankruptcy.
Consider this a test to see if you’re carrying too much debt. I prefer no debt with a DTI of zero (0%). However, this will change a bit when we buy another house.
Liquidity Ratio
Your liquidity ratio is a simple measure of how long you can go without a paycheck. To calculate this, you take your total cash on hand and divide it by your monthly expenses. If you have $5,000 in monthly expenses and $20,000 in cash on hand, you have a liquidity ratio of 4.
Another way to say this is that you have four months of living expenses. The higher the liquidity ratio, the more protected you are from a loss of income or financial emergency. Most experts say you should have a liquidity ratio of 3 or higher. I think six or more (6 months of expenses or more) is better.
The main goal is to make sure to have a solid emergency fund. Think of your liquidity ratio and emergency savings as an indication of your ability to weather financial “storms” as they come.
How Often to Measure
I recommend reviewing all your accounts at least annually. I wouldn’t update things more than quarterly since things won’t change that much. I rerun our numbers in preparation for Money Day each year with my wife.
When to Measure More Often
It’s perfectly okay to measure more often if you want to. This might be useful if you’re working toward a shorter-term goal, like seeing progress regularly, or are afraid of losing momentum. It’s your personal finances, so create whatever schedule works best for you.
You’re Not Alone – Help is Available
I also recommend getting help. You can get free financial counseling on post if you’re still on active duty. You can find links to these on my resources page. You’ll also be able to download my free templates and Get Started Checklist™.
Final Points and Thoughts
I want to leave you with one main thing: don’t complicate gathering this data. The harder you make this, the less likely you are to do it. If you want to use an app or something else to help automate this process, that’s perfectly fine.
Remember, these are just numbers, not representations of who you are. They’re meaningless outside the context of your personal goals. In other words, your net worth is NOT your self-worth.
The most important things in your life might not have anything to do with money. I’m actually working on an article talking about how I’m refining my methods to track non-financial goals right now. To get notified when I release my upcoming article on “Metrics that Matter,” subscribe to my newsletter below.