Four financial numbers you really need to know
“Simplicity is ultimately a matter of focus.” – Ann Voskamp
One of the many things I love about my job is that it gives me the opportunity to sit down with a wide variety of people to discuss their financial goals and answer questions they might have. One thing that I notice during these meetings is that there’s a general lack of confidence among people when it comes to managing money and selecting their own investments. Interestingly, this lack of confidence doesn’t seem to be impacted by a person’s educational background, management level or age.
I believe that part of this lack of confidence comes from the fact that money management isn’t taught in schools or universities. In theory, the school curriculum is supposed to equip students with the skills and knowledge necessary to navigate life in the adult world and to prepare our young people to be active, contributing members of society. Yet it doesn’t even include the basics of financial literacy. With credit so readily available and acceptable, this lack of knowledge and understanding puts people at a real disadvantage.
This general uncertainty and lack of information about money are amplified by the fact that the financial services industry does an excellent job of making the everyday person feel as though they’re not qualified to manage their money effectively. This just isn’t true. In the same way that learning to cook is less about trying to be a gourmet chef and more about mastering a few basic dishes, so money management boils down to a few simple principles: Pay yourself first. Spend less than you earn. Track your spending. Put your money to work. Rather than getting caught up in trying to figure out the intricacies of RRSPs, TFSAs, ETFs, etc. focus on mastering these foundational elements and the rest will take care of itself.
One idea that Jim has written about before is the idea of personal benchmarking and I think this is a critical element in tracking your personal progress. Just as tracking your progress in a new fitness regime means monitoring elements such as your strength levels, weight, and body size so keeping track of your finances means monitoring your situation to ensure you’re moving in a positive direction.
Related article: How am I doing financially?
When tracking my own financial progress from year to year, there are four financial numbers that I focus on in particular. They’re easy to calculate using information that’s readily available (mostly from your T4 slip and bank/investment statements) and it takes very little time:
Your net worth
To calculate your net worth you take the value of everything you own and subtract the value of everything you owe. (Assets – Liabilities). This simple calculation is a great benchmark to track from year to year because it clearly shows you if you’re making progress in building wealth and creating financial security.
Related article: Calculating your net worth
Your net income
Thanks to taxes and other deductions there’s often a dramatic difference between our gross income and the amount we actually take home each paycheque. Too often we focus on the gross amount rather than the net and this can lead to an over-inflated view of how much we actually have available to spend. Basing your lifestyle on the $75,000 you make gross rather than the $50,000-$55,000 you take home (depending on which province you live in and your benefit premiums) gives you a distorted view of your financial situation and may leave you wondering where on earth all your money goes. Focusing on your net income figure allows you to make real plans for your money and helps you track whether your financial situation is improving year by year.
Related article: Planning with Gross Income can be Misleading
Your savings rate
Taking the amount that you save each year and dividing it by your gross income gives you your savings rate. The savings rate in Canada has been less than 5% for a long time which is a big problem when you consider that experts have long recommended saving 10% of our gross income for retirement. It’s an even bigger problem when you factor in saving for other goals. Simply put, if you’re not saving then you’re not building a “buffer zone” to protect yourself against an unexpected drop in income or increase in interest rates. This makes you vulnerable. Putting a spotlight on your savings rate and doing what you can to maintain or increase it each year will help you stay out of debt and build a solid financial foundation.
Related article: Principles of Saving Money
Your credit score
Your credit score is a reflection of how much debt you are currently carrying, how much you have available and your payment history. Creditors use your score as an indicator of whether you can handle new debts and how likely you are to default on loans. A low credit score makes it hard to access credit and can mean that you pay higher interest rates than someone with a higher score. Keeping track of your credit score and monitoring the information in your credit report helps you stay on top of your finances and detect any errors or any issues relating to identity theft. You can order a free copy of your credit report once a year by mail from Equifax and Trans Union. Equifax also allows you to access your credit score online for an additional charge.
Taking a look at each of these financial numbers at the start of each year gives you a candid snapshot of your personal financial situation and allows you to identify any areas that you especially need to focus on over the next 12 months. It also lets you see your progress from year to year which can be a great motivator. I’ve found that these four numbers work well for me. Which numbers do you monitor to keep track of your financial progress?
Great points. I agree that most adults are illiterate when it comes to finances because we learn nothing about it in school and it’s a somewhat taboo subject. It amazes me how disconnected people can be with their financial lives, when it’s really so simple to keep track of finances and drastically improve your life just by implementing simple changes.
I totally disagree with the paragraph on net income. I base all calculations on gross income. I include income tax as an expense (the same as rent, food, etc. It gives a more accurate picture. Besides, it avoids being blind sided by a huge tax bill on filing, or getting a huge refund, which most people consider free money and spend it.
We are retired and have all our RRSP’s,TFSA’s and cash in saving accounts. The financial person at our bank said we should put it all in GIC’s connected to the market. He also suggested we put it in mutual funds. We listened to that advise in 2008 and did not do well. We have always saved before we spent. We don’t want to deal with anyone at our bank, but think it may be a good idea to speak with a financial planner. Any thoughts