This is an excellent time to look at your financial situation and start developing financial goals for 2022. Assessing short-term and long-term monetary goals gives you control over your financial future. There are several steps to take to easily examine your financial well-being.
1. Know Your Net Worth
Take everything you own and subtract what you owe. This total is your net worth. The goal is to have a positive net worth. In other words, your total assets must be greater than your liabilities. If you owe more than your assets, you have a negative net worth. If you own more than your debt, you have a positive net worth.
Video of the Day
If your debt increases but your assets remain the same, it will affect your net worth negatively. Assessing your net worth and how it may change is imperative to financial success. AARP has a net worth calculator available to help.
2. Identify Your Assets
What do you own that can be considered an asset? Some examples of assets are retirement accounts, bank accounts, home and the cash value of life insurance. Add the value of all your assets. Then, estimate what you think your annual asset growth will be. Do you anticipate your assets increasing? If they're decreasing, how can you change that trend?
3. Calculate Your Debt
Debt that you may have could include mortgage, car loans, student loans and credit card debt. Add the amount of debt together. Then, determine your annual liability growth. Do you see your debt increasing or diminishing? If it's increasing, take steps to reverse it and don't let debt sneak up on you. Controlling your debt contributes to financial health.
Consider also: Financial Lit: What is Net Worth?
4. Track Your Debt-to-Income Ratio
Your monthly debt payments divided by your gross monthly income determine your debt-to-income ratio. It's a clear picture of how much debt is eating away at your monthly income. Knowing your debt-to-income ratio will help you make financial plans.
If you plan to make a large purchase, like a home, your debt-to-income ratio can make or break you. It's one of the first items lenders look at along with your credit score. A 36 percent or less debt-to-income ratio is where you should be. It shows a mortgage company you should be able to make monthly payments.
Monitor your credit report to keep an eye on your debt-to-income ratio.
Consider also: 5 Signs You're Spending Too Much
5. Determine Your Spending Habits
Examine your expenses to see where the income is going every month. Do you have high credit card balances that are eating up income? What are your miscellaneous spending habits? The cost of those daily lattes adds up. So, trimming your daily or weekly miscellaneous spending habits can have a meaningful influence on your balance sheet and financial health.
Once you have determined your spending habits, make a budget and stick to it. One important element of a budget plan is to build an emergency reserve savings account. If something unexpected happens, the emergency savings money will help cover that event and not cause a major interruption to your monthly cash flow. By controlling your spending habits, you take a step toward financial freedom.
Consider also: What are the Different Types of Budgeting?
6. Analyze Your Investment Strategy
Look at your current investment strategy and determine if it's performing. Will it meet your financial goals? If you don't have an investment strategy, it's time to develop one.
A great way to start an investment strategy is through an individual retirement account. Mutual funds or purchasing real estate will also go a long way in helping with your retirement savings.
Long-term investing is different than saving for the short-term and requires a meaningful commitment on your part.
7. Examine Your Housing Circumstances
Housing accounts for 30 to 40 percent of most Americans' monthly gross income. That's a significant amount of your paycheck. Do you rent or own? If you rent, have you considered buying a home?
The average yearly rent increase is between 3 percent and 5 percent. That increase is a direct increase to your annual debt without increasing your assets. But if you own, a fixed mortgage remains the same monthly and yearly. Other benefits include being able to deduct the interest you pay on your federal tax filing, and real estate historically increases in value over time, contributing to your net worth.
Examine your housing situation and determine if purchasing a home is a realistic goal.
- AARP: Net Worth
- Consumer Financial Protection Bureau: What is a Debt-to-Income Ratio? Why is the 43% Debt-to-Income Ratio Important?
- Bankrate: Debt-to-Income Ratio Calculator
- Capital One: What is a Good Debt-to-Income Ratio?
- U.S. Bureau of Labor Statistics: Consumer Expenditures Midyear Update – July 2019 through June 2020 Average
- Chase: How Much of Your Monthly Income Should Go to Rent
- Millionacres: What is the Average Rent Increase Per Year