I adopted a 9-week old puppy in 2020 during the pandemic. Yes, I was one of those people.. But don’t worry! This story has a happy ending and a very joyful, five and a half year old dog.
There was so much to know about food, sleep training, socializing, potty-training, crate-training.. not to mention the rumination around pet insurance. The research and deliberation was endless. I couldn’t help but wonder why it all felt so complicated. It all felt so important, but were there some concrete things I could focus on above all else that would get me well on my way to providing her the best possible life?
Luckily there are guidelines, metrics, KPIs, numbers (whatever you want to call them) that can help you better understand your personal finances. The list below is not comprehensive, but it is safe to say that if you know these numbers, you will have a really solid understanding of your finances without the overwhelm!
So here we go…
#1 Your take home pay
Your take home pay, net income, or income after taxes is an incredibly important number and is necessary in calculating some of the numbers below. Your take home pay is quite simply what you get paid after all taxes, automatic investments, and payments (like health insurance) are taken out by your employer. If you are self-employed, like me, my take home pay is whatever I get paid x .75 (just to be cautious!) so that I am automatically setting aside money for my quarterly taxes.
This number is incredibly important to know and I would guess most people do not know it. So start here!
I did not know my take home pay for years and purposely avoided this number. But it was only possible for me to build confidence with money by looking at the real numbers head on and I am so glad I did.
#2 Your fixed costs and your fixed cost ratio
Fixed costs are the expenses you have each month that you must pay. This includes your rent or mortgage, utilities, health insurance (and pet insurance!), minimum debt payments, etc.
Knowing this number will help you create your emergency fund goal. Let’s say your fixed costs each month are $4,000. To build a 3 month emergency fund, you would need $4,000 x 3 months = $12,000 saved.
This number will also help you find your fixed cost ratio, which is simply the proportion of your after tax income (the number we talked about above) that you use toward fixed expenses. Let’s say your take home pay is $8,000. And your fixed costs are $4,000. That would mean your fixed cost ratio is 50% ($4,000/$8,000 = 1/2 or 50%).
There is a pretty standard recommendation that your fixed costs sit around 50%.
#3 Debt totals and interest rates
Debt can be a pandora’s box type of topic and it deserves a post in and of itself because there are many different kinds of debt (mortgage, student loan, credit card, personal loan, auto loan, etc) and each kind affects you differently in both magnitude and direction.
To simplify, write down all your sources of debt, the principal (how much you owe), and the interest rate on that debt. Once you have a simple chart (columns: debt type, principal amount, and interest rate) you can see where your debt is and how much it is affecting your finances each month. Typically, credit cards have the highest interest rates so plan to tackle that debt first and ferociously (as quickly as possible!).
My brother still makes fun of me for just paying the minimums on my credit card (for a short period!). Even though I could afford to pay the balance in full, I didn’t… mostly because I had the option not to and I didn’t understand the crazy interest rate applied to my balance. Long story short, pay off your credit card in full each month.
Overall, this number, or set of numbers, will help you get organized around how to pay off your debt and when.
#4 Variable/fun costs and ratio
Similarly to the fixed cost ratio (above) figure out what you spend each month on discretionary or fun purchases. My friend calls this her WAM — her walking around money. This number generally will hang out around 20-30% of your take home pay.
I used to struggle in this category in the sense that it was hard for me to spend money on fun things for myself. I have gotten much better about it over the years and it is because I know how much I can spend without sacrificing on my other goals.
#5 Saving and Investing rates
Saving and investing ARE NOT THE SAME THING, but they are often lumped together, which I find frustrating and needlessly confusing.
Saving is typically for things like emergency funds or goals that you would like to achieve in 5 years or less. Investing is meant for goals related to longer time horizons like retirement. A good rule of thumb is that you should have 10% of your take home pay going to each category. There are exceptions so make sure to understand when to prioritize saving over investing and vica versa. 10% to each is at least a good rule of thumb.
I went from being scared to invest 4% of my income to investing almost 20%!
Get yourself a fun coffee drink and spend some time figuring out these numbers. Maybe do this exercise with a friend so you’re not doing this alone. Make it fun, however that looks to you. And once you are done, I hope you feel awesome because you invested in yourself and now you have the information you need to make better choices now and in the future.
What do you think of this list? What would you add? Which one is tripping you up or challenging to calculate?
With confidence,
Your personal finance friend