The Exchange

7 Signs You’re a Paradigm of Financial Health

Set up an emergency fund. Diversify your portfolio. Reduce your debt load. Bring your lunch to work once in a while. So goes the conventional finance wisdom consumers have heard so often that they tune it out.

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You can be taking homemade turkey sandwiches to work everyday, clipping coupons and maxing out your 401(k) plan, but still not really be in tip-top financial shape.

Last month we wrote about the tell-tale signs you’re living above your means (your mortgage payment is more than one week’s salary was one example). On the other side of that equation, how do you know if you’re really on the right track money-wise?

We spoke with a few certified financial planners to get their thoughts on what kinds of benchmarks people can use to gauge their financial health. One caveat: It’s important to note that everyone’s situation is unique and it’s not very useful to apply a blanket rule across all age groups. (Also note this list is by no means exhaustive. There are surely other ways to measure fiscal fitness. Feel free to add your own thoughts in the comment section below.)

With that in mind, here are some ways to measure if you’re financially ahead of the game.

1. By age 40, you’ve accumulated 1 to 3 times your annual income.

Many financial advisers use age-based targets for determining how much workers should save to be ready to retire. Fidelity Investments, for example, released a set of guidelines last year that said employees should have the equivalent of their annual salary in savings by age 35 in order to reach the first benchmark on the way to the retirement finish line.

Erin Baehr, a CFP in Stroudsburg, Pa., ascribes to similar guidelines. According to a strategy recommended by the Alliance of Cambridge Advisors, a group of fee-only financial planners of which Baehr is a member, someone between 30 and 40 is in the “early accumulation phase” and their net worth should be 1 to 3 times their annual income.

At that point, “you’ve most likely bought your first house, you’ve got good savings habits, you’re minimizing consumer debt. You’re at the point in your career where you’re able to accumulate savings,” says Baehr. When you get to three times your income, you’re in the rapid accumulation phase. (Note that net worth here includes equity in your house.)

2. If you’re part of a dual-income couple, you can cover your fixed expenses with one income.

If you can pay for all your fixed costs – mortgage, cellphone bill, insurance payments, child care, etc. – with using just your or your spouse’s income, you’re in excellent shape, says Baehr. The second income can be used for discretionary expenses, like vacations, dinners out, summer camp and savings.

Granted, when you’re starting out in your 20s and 30s, often both spouses are working to cover the bills, so it’s harder to set aside one person’s income for savings or costs that might be deemed “extra,” Baehr says.

3. You live in your 30s like you did in your 20s, 40s like you did in your 30s, your 50s like you did in your 40s, and so on.

The standard advice to save 10% of your income is good but there’s a problem, says Michael Kitces, a certified financial planner and partner and director of research at Pinnacle Advisory Group in Columbia, Md. When your income keeps rising, saving just 10% “doesn’t really get you to your goal because your standard of living is rising too fast for your prior savings to keep up,” he says.

The whole “save-a-percentage-of-income” approach assumes level income and level spending, says Kitces. For instance, if you start out saving 10% of your $40,000 salary in your 20s, but get some big promotions and suddenly are making $100,000 a year in your 30s, saving 10% on $40,000 the prior decade barely makes a dent in setting up a retirement for what’s now a $100,000 standard of living. But if you save nothing when you’re making $40,000 in your 20s, and live on $60,000 a year in your 30s (while earning $100,000 a year), you’d be saving a lot of money. And you’d still be living a better lifestyle than you used to, and you only have to save enough to support a $60,000-a-year retirement.

“This is why so many baby boomers are in trouble. Now they’re in their peak earnings years, but saving 10% per year now doesn’t help at all, because they were saving far less in the past when income was lower,” he says.

4. You have only one car payment at a time, or better yet, you save in a car replacement account each month instead of making a payment.

Of course having no payments is ideal. But by keeping to one payment per month, you minimize the risk of being stuck in a cash flow crunch if you get hit with an unexpected medical expense or get laid off.

“Most of the people I see who are successfully ready to retire, almost all of them have a car replacement account,” says Baehr, where instead of making a payment, you’re setting money aside in an account so you have enough money to buy a new car when you need it.

5. Your home’s value is 2 to 2.5 times your income and your mortgage is no more than 80% of the value.

This is the standard loan-to-value (LTV) ratio – the percentage of the property’s value that is mortgaged – financial advisers recommend for home buyers. For instance, if your income is $100,000, your home’s value shouldn’t exceed $250,000. The LTV ratio is used by mortgage lenders to gauge a borrower’s risk: the higher the LTV ratio, the riskier the loan is considered and the higher the interest rate, and vice versa.

The calculation, though, is only a general guideline. Baehr acknowledges that in some pricey housing markets – in New York, New Jersey and California, for example -- it can be difficult to stay in that range.

6. You have a will.

Estate planning isn’t just for wealthy people. You’re steps ahead of the game if you have a will and durable power of attorney for finances and health care in place after turning 18, the age at which you’re considered an adult by law. And if you have children under 18, “ensuring you have guardianship provisions in place for them from day one will set you ahead of most people,” says Mary Beth Storjohann, a CFP at Hoyle Cohen, a wealth advisory firm in San Diego. As much as no one likes thinking about it, that means figuring out who’ll be responsible for the care of your children along with who would manage any funds left behind for their benefit, should something happen to you, she says.

7. You give at least 5% of your income to charity.

Charitable giving indicates a healthy relationship to money. It means you have margin in your life, in your finances, and you’re not living right up to the edge,” Baehr says. It’s the same indication as having a solid amount of savings, but “I feel that donating helps you remember others have greater needs than yours,” she says.

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