Are you trying to check your financial health? It’s not as simple as how much money you have in the bank. You could have thousands of pounds in the bank and still be off-track if you have bad money management skills.
To gauge your financial well-being, you need to work through a number of ratios and figures. essentially, they boiled down to these five:
1. Credit Score
Credit scores are becoming more important by the day. Credit scores in essence are a gauge of your financial health. Businesses including banks, mobile phone firms, car finance companies etc scrutinise your credit score before deciding whether or not to offer you there products.
I have a friend who has a well-paying job and has a few thousand quid in his existing bank account. You would think that he was in good financial health but due to a past incident where he let his broadband bill accrue over the years ( as he had moved house and the bill went to the wrong address), he now has a bad credit score. I couldn’t believe it when he told me he couldn’t open a current account with a bank nor could he take out a mobile phone contract. Ridiculous i know!
The three major credit score companies in the UK are Experian, Equifax and Callcredit.
For Experian and Equifax, you can get your free credit report with the 30 day trial by contacting them directly.
Callcredit is much newer and less widely known and you can get free access at any time to your credit report and score at the moment.
2. Emergency Fund
An emergency fund inessential for every adult and you never know when you will be hit with a financial disaster. You emergency fund will come to your aid in time of financial need such as you getting laid of work or you need to pay medical bills.
To see if you have a sufficient amount saved in an emergency fund, ask yourself this question, How many months could I survive on my savings?
I would recommend that you have at least 8 month worth of savings in your emergency fund.
Most people don’t have anything saved up for a rainy day and that is worrying. The major problem from not having an emergency fund is that if you are laid off, you will find it hard to adjust to a lower standard of living. With no money coming in and no savings, many would turn to payday lenders of high interest rate lenders out of desperation in order to pay there bills. This will only lead to a spiral of more debt and even more worrying. If you have sufficient savings, you could use it to pay the bills and concentrate all your efforts on finding a new job.
3) Savings for Retirement
There is no universal, correct monetary amounts you ned to put aside for retirement. This is due to different people having different expenses and are accustomed to different lifestyles. The most commonly used rule of thumb projects that the average retiree will need to save 11 times his or her salary at retirement age in order to be reasonably confident of having enough funds. This number may seem daunting but if you take baby steps and just put aside 15% of your salary from young age into an investments and savings account, it is achievable.
Most people take the view that retirement is far away and it is not worth saving for it now. But if you listen to people in retirement today, most will tell you that their one big regret is not saving more. So get into the habit of saving 15% of your income and put it into tax shelters accounts like. SIPPs and ISAs.
4) Rate of Return
Saving money is good enough, but if you are getting a 0% return on your money, then you are actually losing purchasing power by the day due to inflation. This means that money saved today will be worth less in the future i.e. you will be able to purchase less goods with the same amount of money as you are able to do today.
Although the world is currently fending off deflation, central banks in the developed world tend to target an inflation rate of 2% – 3%. Thus, you should aim to have a return of above 3% i.e. your money should grow by at least 3% a year.
You need to think about your money as employees. If you are getting a low rate of return, your employees are not working hard for you. If you get a high rate of return, you have wonderful employees. You should put your money to work as it will grow quicker this way through the power of compounding.
You need to put your money to work in money generating assets that produce dividends, rents and royalties. See how this can be done by reading my article on passive investing.
- If you want to invest in stocks, see the best platforms for you.
- If you want to invest in property, look at Propetymoose, Property Partner and the house crowd.
- If you want to invest in startups, use crowdcube and seedrs.
Many people are afraid of investing for the risk of losing their hard earned money. If you are one of them, read this article.
5) Net Worth
People have many different definitions of net worth but the universally accepted one is :
Net Worth = Assets – Liabilities
- an asset is anything that puts money in your pocket
- a liability is anything that takes away money from your pocket.
The figure you calculate from the above formula will give you an amount in absolute terms, but it is meaningless.
So in conjunction to your Net worth figure, you need to look at your wealth.
As Robert Kiyosaki puts it, “Wealth is the number of days you can survive without working while also maintaining your lifestyle”.
For example, if your monthly expenses are £5,000 and you have £20,000 in savings, your wealth is approximately four months or 120 days.
In this definition of wealth, Kiyosaki excludes most people that derive their primary income form a pay check. The wealthy are described as those with money generating assets. So for example, if you have assets that generate you £40,000 a year and your expenses are only £30,000 a year, you are considered wealthy as your wealth is infinite.
On the other hand, if you earn £80,000 and have expenses of £100,000 a year through your extravagant debt fuelled life style, you are not considered wealthy.
Ultimately, it’s not how much money you make that matters but how much money you keep—and how long that money works for you.