How can you play a game and not keep score? Be it video games or competitive sports such as tennis, golf, football, or soccer there is a score kept determining the winner. Unfortunately personal finance is another score keeping activity. In personal finance, it applies to everyone, however, and not just those who voluntarily chose to play a game or sport.
To succeed at the game of money, you need to keep track of your net after-tax cash flow and keep it positive or at least break even at all ages. Financial security is achieved with positive cash flow and the resultant accumulation of financial assets.
To help you in your journey to financial security and success, there are several financial measures that reflect whether you are on track or not. It is a good financial habit to calculate and analyze these measures at least every six months. I suggest you keep a written score sheet that shows your updated results so that you can track your progress.
Here are some key personal finance scorecard measures that people use to manage their financial lives:
Credit Scores
Your credit score is a numerical rating that generally ranges from 300 to 850. Your scores will vary based on the credit bureau method used. These scores represents how safe it is to loan you money, based on a variety of factors that we have discussed in prior posts. Credit scores are the most talked about measure when discussing personal finance. It’s important to know and manage your credit scores because they are how you get access to more and better credit. Gaining access to credit when needed is key to financial success.
Emergency Fund Amount
If you had a $1,000 emergency expense such as an uncovered medical bill, would you have to borrow money to pay it? How long can you survive on savings if lose your job? Emergency funds exist to cover life’s unexpected events. As we have discussed in several prior posts, establishing and maintaining your emergency fund is a must do at all ages. Tracking your progress towards having at least six months of living expenses in your fund should be a top priority.
Debt-to-Income Ratio
Your debt-to-income ratio is how much money you must pay on debt each month compared with how much money you bring in, expressed as a percentage. For example, if you get $6,000 a month and have minimum payments on your mortgage, car loan, and credit cards totaling $2,000, your debt-to-income ratio is 33%. This number is important for getting more credit because lenders look at it when deciding whether to approve you and how much interest to charge. It’s also essential for you because it gives you a general gauge of easily you can repay your debts and what margin of safety you have.
Monthly Cash Income
Positive monthly cash flow is the key to everything in personal finance. You need to manage both your income and outflows.
First you need to look at your monthly income. That’s from your main job, your side gig, your partner’s job, alimony, interest and dividend payments or rent payments — money from every source comes in between the first and last days of the month, that’s your monthly income.
Next you need to look at all your cash outflows for living expenses and debt service. You need to add up all the money you spent on everything during the past month. Whatever money went out between the first and last days of the month, that’s your monthly spending.
Many people focus on increasing their cash income, but they can get in trouble if they don’t watch their expenses. Since spending is easier to change in the short term than income, it’s crucial to observe this metric.
Annual Savings Percentage
As we have discussed in numerous posts, you need to save at least 10% of your pre-tax annual income and more if you can. This number is how much of your gross monthly income goes toward savings. It tells you a lot about how much extra money you have compared with your spending for essential living expenses. You need to look at all the different savings amounts you make each year including retirement (e.g., 401k contributions and employer matching funds), emergency fund additions, vacation fund, college savings, increases in cash value life insurance and any other accounts you have. Hitting your savings percentage consistently year in year out will allow you to meet your long-term goals.
Financial Freedom Score
Another measure I like to keep is what I refer to as the financial freedom or "Can I Quit" score. It is meant to determine if you can quit your job and look to do something you find more meaningful. If you quit working today, how long could you keep going before you had to earn money again? How many months of cash do you have on hand? That number of months is your score. You could also view this as another way to gauge your progress toward doing whatever better fulfills you. For example, suppose you have $75,000 in cash and your monthly expenses are $5,000. Your score would be 15 or 15 months until you run out of cash. The freedom score is a number but also can be a strong motivator. Taking a break to do what you really want to do or to try another job or profession may be just what you need psychologically in life.
Summary
Just like any sport, in personal finance, you must have positive scores to become or maintain your financial success. To know where you stand you must keep track of your cash flow, debt obligations and accumulated assets. I believe you need to develop and monitor a few key financial scorecard measures that allow you to stay on track. You cannot manage what you can’t measure. Positive after-tax cash flow is the key to building wealth and financial security. If you measure it, you can make it grow for you and your household.
At the FinancialVerse, we work to make personal finance understandable for people of all ages. Our easy-to-read books provide you with ideas on how to better manage your money and work to achieve financial security.