It’s almost tax time again and most people who haven’t filed already are in the midst of organizing their receipts and sorting through W2s and 1099s. For far too many tax season is an upside surprise when they tally up how much money they actually made. That number comes as a surprise because they’ve gone through the year feeling broke, curtailing entertainment expenses and eating out, while staring at credit card balances that never seem to quite go away. Tax time is when many ask how they could make so much money and yet be so poor?
For the majority this state of endless poverty is self-imposed and stems from a lack of systematic analysis of their own personal finances. Even saying the words “systematic analysis” makes people’s eyes glaze over and feel defeated before they even get started. Just the terms are intimidating, reeking of math, science and hard stuff. Besides, let’s face another hard fact: personal finance is not terribly interesting. It’s boring and it’s hard, two good reasons to avoid it.
What if a systematic analysis of your finances wasn’t that difficult? What if you could answer a few simple questions and have a really good idea where you stand financially? These questions are simple but that doesn’t mean they’re easy. Answering some of them may take a little work.
The Amount In Your Emergency Fund
Without an emergency fund you’re one disaster away from debt or financial ruin. A $1,000 is the minimum, $3,000 is better and anything over $8,000 is overkill. That’s enough money to cover major car repairs, replacement of your homes central HVAC system and even some major medical bills.
How Much You Make
This is pretty easy for anyone working a single day job at a fixed salary but few Americans have just one job these days and not all jobs pay the same. If one of your jobs has income from tips, what you make in a given year can vary widely. It’s important to track what you make because tip income tends to be cyclic.
How Much You Spend Every Month
This is the hard one for most people. Tracking what they spend in a given month, down to the penny is very difficult. It’s hard because getting cash back at the store means recording that latte after working out at the club. Every penny means every penny. You’ll never be able to get a handle on spending until you know exactly where every dime of your money is going.
How Much You Owe
Everything counts in this column as well. This isn’t just a list of debts; it also includes any contract expenses that are deducted from your checking account, like club dues, child support, alimony, legal judgments and phone contracts. If you can end it on short notice, then include it with the expenses listed above, otherwise it’s a debt.
What To Do With The Numbers
Once you have those numbers you can do some simple but powerful number crunching. An example is your debt to income ratio, also called your DTI. Divide the amount of your monthly debt service payments by your monthly income. If you make $4,000 a month and have $2,000 a month in debt service payments, your debt to income ratio is 0.5, which would be quite high. That means half of what you bring in every month goes to debt. Ideally that number should be under .36 for all debt service.
Once you have the numbers you do simple projections on loan payoffs and have a good idea when you’ll have extra money. Without those numbers you’re like a person stumbling around in the dark and expecting something good to happen.