According to the recently released National Financial Capability Study, Americans are feeling much better about their current personal finances. I’m a ‘glass half full’ kinda guy myself so I’m glad folks are feeling more optimistic about their money. Unfortunately, I’ve noticed that along with this new-found optimism, savings rates are beginning to fall after rising steadily since the financial crisis of 2008. I thought it would be instructive to offer a short quiz that you could take that would allow you to self-analyze just how confident you should be about your current financial situation. Answer these six ‘Yes or No’ questions and tally your score to see where you stand:
- Do you have a minimum of three months’ worth of net paychecks in the bank? In my experience, true and well-founded financial confidence comes from having ‘money in the bank’. Most families pretty much spend their whole net paycheck every month so having three months in the bank would be a minimum. The more uncertain you are about job security, the more cushion you’ll want…up to twelve months’ worth of income if you’d anticipate re-employment would be difficult.
- Are you currently contributing to your employer’s retirement plan? You only get to answer ‘yes’ to this question if you are contributing an amount that fully catches the company’s matching contribution. To knowingly contribute less than a full matching contribution would be like walking past a $5 bill on the ground simply because you don’t want to bend over!
- Are you paying your credit card bill off in full every month? Carrying a balance on your credit card from month-to-month is a sure sign that you do not have your financial house in order. After all, most credit cards charge interest rates of 11% to 18% or more. In this low interest rate environment, paying a high, non-deductible interest rate is simply poor money management.
- Are your total debt payments less than 30% of take-home pay? Add up all of your monthly debt payments, including home mortgage and car payments, and determine what percentage they are of your net paycheck. Less than twenty percent should allow you to meet other financial objectives such as saving for retirement or college funding. Your ultimate goal is to be debt-free by retirement including mortgage debt.
- Are you investing a minimum of 10% of your gross income? Here I’m talking about your gross income, not your net paycheck, but it does include money you are investing through your employer’s retirement plan. If your answer to this question is ‘no’, rest assured, you are not on the path to financial freedom. This assumes you began investing in your twenties. If you didn’t start investing until your thirties or forties, you’ll need to up your percentage to fifteen percent or more.
Is your net worth on track? In order to become financially independent by retirement, you’ll need to build your investment net worth over time. Investment net worth includes only assets you can use to produce cash flow during retirement, so it typically wouldn’t include assets such as your home. Here’s your target investment net worth guideline:
20 X Annual Income at retirement
15 X Annual Income if you are 5 years away from retirement
10 X Annual Income if you are 10 years away from retirement
5 X Annual Income if you are 20 years away from retirement
1 X Annual Income if you are 30 years away from retirement
.5 X Annual Income if you are 35 years away from retirement
For example, if your current income is $100,000 and you are twenty years away from retiring, to be on track, your investment net worth needs to be approximately $500,000. These numbers are exclusive of Social Security.
Now add up the number of ‘Yes’ answers. If you scored six out of six, consider yourself a ‘Financial Wiz’. If you scored five, you do indeed have reason to be optimistic about your financial progress. If you scored four, you’re doing a lot of things right but it’s time to refocus your efforts. If you scored three or less, there’s still hope but you face financial doom unless you get dead serious about changing your money habits. Remember that there is always a solution to solving financial problems. You just have to ask the right questions of the right people and be willing to do whatever it takes to get the results you desire.