Understanding a few basic numbers can give you a good picture of your financial health and help you plan your future. You may have seen these terms mentioned in personal finance articles and in the news. Learn what these numbers mean and how to use them to improve your money situation.
1. Net Worth
Net worth is the most important measure of your overall financial health. The calculation of net worth is simple — in short, subtract everything you owe from everything you have:
Net Worth = Total Assets – Total Liabilities
Assets include all property you own (including cars, a home, etc.), savings, investments, and the money in your checking account.
Liabilities include credit card debt, student loan balances, mortgage balance, auto loan balances, and other debt. It is possible to have negative net worth if your liabilities exceed your assets — this is a common situation for new college graduates who have student loan debt and few assets, for example.
There are two ways to improve your net worth: Increase your assets, or reduce your debt. Do both simultaneously, and you’ll be on your way to improving your financial health quickly.
2. Home Equity
Home equity is a measure of how much of your home you own based on its current value, including improvements and appreciation. Here’s how to calculate your home equity:
Home Equity = Current Market Value of Your Home – Mortgage Balance
You can see that the calculation of home equity does not include the price you paid for your house. Home equity depends only on the current market value of your home — in other words, how much would it sell for today?
As with net worth, home equity can also be negative in some situations. If your home value declines to less than your mortgage balance, you have negative home equity. This is also known as an “underwater mortgage.”
A great way to increase home equity is by doing your own home improvement projects and repairs that increase the value of your home by more than the cost of doing the improvements.
3. Gross Income
Gross income is your total income before taxes and withholdings. If you are an employee, taxes and withholdings are taken out before you get each paycheck. You can find your gross income on your paystub.
Most salary offers and salary statistics are given in terms of gross income. This is also the number that you report on income tax forms. Gross income can be confusing for budget planning, since you’ll never really have this much money to spend. Use your net income instead.
4. Net Income
Your net income is how much money you get after taxes and withholdings are taken out. This is an important number because this is how much money you have available to work with to pay bills and to save and invest.
5. Market Salary
Market salary is how much you are worth in the labor market, depending largely upon your length of job experience, education, and location. Your market salary may not be equal to your actual salary if you are overpaid or underpaid. You can find your estimated market salary on survey websites (such as Salary.com).
It is useful to know your market salary to bargain for a raise or to know when it would be worthwhile to look for a higher paying job.
6. Monthly Expenses (Burn Rate)
Monthly expenses (burn rate) is one of the most important financial numbers, and one that you have a lot of control over. This is the total of your expenses over a month, including housing, food, clothing, and transportation.
Your burn rate is the amount you are actually spending each month, and there is always room to reduce this number to leave you with more money available to pay down debt or invest.
7. Investment Balance
Good for you if you are regularly contributing to investment accounts. Your investment balance is an important number since this will largely determine if and when you will be able to retire. Check it regularly to determine whether your investment strategy is meeting expectations.
8. Dow Jones Industrial Average (DJIA)
The Dow Jones Industrial Average is the stock market value that is most often reported in the news. This is calculated based on the value of a handful of large company stock prices and is currently around 18,000. The DJIA provides a general indication of the stock market’s overall valuation and performance, and may give you a rough indication of how your stock portfolio is performing (assuming it’s broadly diversified).
9. Cash Balance
Net worth does not reflect how much of your assets are liquid. For example, if all of your assets were invested in land holdings, you might have a hard time getting cash in a timely manner to buy food or pay your real estate taxes. Access to cash and other liquid assets (assets that can be sold rapidly to get cash) is important to be able to pay expenses.
When I ran a small business, I learned that the three most important rules for success were:
Never run out of cash;
Never run out of cash; and
Never run out of cash.
These three rules apply to personal finance, as well. Make sure to have some cash available at all times to cover expenses that come up.
10. Emergency Fund Balance
Building an emergency fund is a step that many financial planners recommend for people trying to get out of debt. Putting cash into an emergency fund provides a cushion against using credit cards to cover unexpected bills. This practice also establishes the habit of saving money from every paycheck instead of spending it all.
How much money do you have available to handle an emergency without running up debt? Experts recommend a minimum of three to six months worth of living expenses.
11. Credit Card Balance and Interest Rate
Many households carry a credit card balance. It is important to keep track of all debt, but credit card debt is especially important, since it usually carries the highest interest rates of any debt, and since it is easy to increase your debt without noticing.
If you are paying a high interest rate on your credit card debt, save money by making a balance transfer to a card with a lower interest rate. Try to reduce expenses so you will be able to pay off credit card balances faster. (See also:Best 0% Balance Transfer Credit Cards)
12. Monthly Nut
I encountered this unusual term in an entrepreneurship course back in my college days. Your monthly nut is the minimum amount of money you would need to make it through a month. Your monthly nut includes basic housing, minimal food, and other essential expenses after unnecessary spending is eliminated.
Your monthly nut is an important number to understand when you are planning to use as much of your income as possible to meet a goal, such as starting a business or getting out of debt as quickly as possible.
13. Inflation Rate
If you want to have enough money to buy the things you need in the future and throughout retirement, you’ll need to account for the effects of inflation. Prices tend to rise over time, reducing the purchasing power of money in the future. Historical average for inflation rate is around 3%, but inflation rates in recent decades have varied from over 10% down to the current inflation rate of nearly 0%.
For retirement planning, you will want to estimate your expenses, and then scale the expenses up based on the expected effect of inflation over the years.