As a financial planner who works with many people in their 30s to 40s, one of the most common questions I get asked is, “Where do I even start”? Young professionals have a lot going on in their lives: student loans, marriage, home purchases, job changes or promotions, kids, and daycare expenses.
Where do you start when it comes to making personal finance a priority? I think the best place to start is by knowing and keeping track of these five personal finance numbers.
This one seems simple enough, right? Take-home pay is the amount of income that hits your bank account after taxes, employee benefits, and retirement plan contributions. This number is the starting point to build a monthly cash flow plan. It can also be used to analyze how much individual expenses are taking up your take-home pay.
For example, John has a $600 monthly car payment and his monthly take-home pay is $3,000. In this example, John spends 20% of his take-home pay on his car. This can be a pretty insightful way to see if your dollars are aligned with what you value most.
The other reason it is important to track take-home pay is to combat lifestyle creep. As you receive raises and promotions, your take-home pay will increase. If you do not save or invest part of this increase, it will go towards increasing the lifestyle you are used to living. This can be a detriment to your financial future. Lifestyle creep is expected, and you should reward yourself for all your hard work, but it should be done in a way that is controlled and fully thought through.
Fixed expenses are monthly bills that do not change from month-to-month. These are items such as mortgage/rent, car payment, student loan payment, and insurance payments. Fixed expenses are so much more important than variable expenses.
One of the biggest mistakes I see young professionals make is that they focus on cutting back their variable expenses, like eating out less, but ignore their fixed expenses. Fixed expenses are constant every month and typically last for an extended period. Focusing on your fixed expenses and comparing them to your take-home pay to them will have a much greater financial impact than doing your best to eat out less. If you could reduce your monthly rent by $300 ($3,600 per year), what would you do with that money?
An emergency fund is typically a savings account with the sole purpose of being used in case an unforeseen large expense occurs or in case of a job loss. Examples of an emergency could be major car repairs or a pipe bursting in your house.
Typically, you would want to keep between three to six months of expenses in this account. This is another common issue that I see young professionals make – they either have too little in an emergency fund or they have too much.
Making big life transitions like purchasing a house or beginning to invest without having a proper emergency fund in place can be risky. If you purchase a home before having a fully funded emergency fund you are very susceptible to consumer debt, such as credit cards, when issues with your home occur.
If you begin to invest before having an established emergency fund you could be faced with taxes or penalties to withdraw those funds if the cash is needed to cover an emergency. On the other hand, having too much cash in an emergency fund can also be an issue. As young professionals with a long time horizon we need to put our money to work! Having too much cash in the bank earning little to no interest is an issue because that cash is losing value everyday to inflation.
Keeping track of how much money you are either contributing towards retirement savings or debt paydown is extremely important. This is where you put those hard-earned dollars to work so that one day they’ll work for you and you won’t have to.
The best way to keep track of this is to compare the monthly dollar amount going to your employer-sponsored retirement plan (401k, 403b, etc.) plus any debt payments, to your gross monthly income.
If you make $6,000 before taxes, benefits, and retirement contributions each month, and you put $300 into 401(k) plus make $300 in student loan payments, then your retirement savings and debt paydown rate would be 10%. This means 10% of your gross income each month is going towards bettering your financial future. Having a monthly goal for this rate, and finding a balance between retirement savings and debt paydown, is crucial to any young professional’s financial plan.
Net worth is one of the most important metrics to track in your financial plan. It is a wholistic snapshot of all things financial. Net worth = Assets – Liabilities.
Assets are items that you own such as bank accounts, cars, houses, and any investment accounts. Liabilities are items that you owe such as student loans, car loans, and mortgages. Your net worth increases through retirement savings, paying down debt, and assets appreciating in value.
I would recommend you update your net worth at a minimum annually. Not only is it a great metric to see your financial progress but it also forces you to get organized through logging into your retirement accounts or checking the balances of your student loans. Organization is always the starting point before you can make an educated decision.
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