Are you getting the right answer to the wrong question? When people find out I used to run a hedge fund, they often ask me, "What is a hot investment right now?" Of course, I don't attempt to answer the question for a lot of reasons, the least being that I would have to ask them a series of probing questions about their finances. Besides, I am not a money manager. Either way, it always occurs to me that they might just be asking the wrong financial question.
I have built my company around the belief that people aren't really interested in money, but rather making their own lives richer, deeper, and more fulfilling. With that in mind, a better question to ask would be, "What are the most important numbers I need to know when it comes to personal finance?" It isn't the hot stock or right mutual fund that will make the biggest difference in their finances or help them attain their financial goals. What they should be looking at are their savings percentage, net worth, and credit score. For someone who is on their way to achieving financial success, each of these numbers will be trending in the same direction -- up.
Want to find out if you are on the right path? Here are three essential questions you should ask yourself:
What percentage of my income am I saving?
The hardest thing about finance is that you can't focus on one thing at a time. If you focus only on eliminating debt, you'll neglect your long-term retirement savings. If you max out your retirement savings while holding on to high-interest debt, you'll get stuck wasting dollars on high interest payments rather than saving more for your future. Your financial decisions don't exist in a vacuum, but people who save a high percentage of their income tend to find it easier to make the moving parts work.
How much should you be saving? Many people follow the rule of thumb to save at least 10 percent of their income for retirement and another 10 percent for other goals, such as an emergency fund. High-percentage savers also save on borrowing costs since they are able to pay cash for things, such as automobiles, rather than getting loans. In fact, one of our financial planners calculated that someone could actually save as much as $185,000 over the next 20 years by simply not having a car payment. Imagine how much your net worth would increase if you could do the same. Find out where you stand by reviewing your current contribution rates to your 401(k) and other retirement plans, as well as your overall savings percentage.
What is my net worth?
Watching your wealth build can be like watching the grass grow; sometimes the mower comes in and cuts everything down. Use an annual personal net worth statement to track the incremental changes to your financial landscape from a helicopter view. That way you can easily determine if you have too much of your net worth in one investment, too much debt, or not enough saved for emergencies.
Imagine being able to review your net worth statements for the past 10 years showing your debt slowly declining as you pay down your mortgage and your assets increasing as you save more. You would have a better perspective on things so that when real estate values fluctuate or the stock market falls you can know when to relax, and when to be concerned.
What is my credit score?
Your credit score is not the "be all and end all" of finance -- it is not an investment and doesn't generate future income -- but it does help reduce costs by lowering the expense of borrowing money. For example, if you have a credit score around 680, you might qualify for a 30-year fixed mortgage around 5% in today's market, but if you have a credit score over 760, you might qualify for a rate around 4.625%. It may not seem like much, but if you were to borrow $250,000 over 30 years, a few tenths of a percent could cost you over $20,000 in additional interest. When you combine that with the savings you might get from better rates on things like credit cards and auto loans, you start to see why a good credit score is important to your financial success.
Paying lower interest rates on debt is not the only benefit of having good credit. Some employers look at an applicant's credit history before considering them for hire, and many auto insurance companies give discounts to customers with high credit scores because having good credit is correlated with lower insurance claims. Having excellent credit can save you a significant amount over your lifetime. Learn how you can improve your credit score at myFICO.com.
It should surprise no one that financial problems are a leading cause of stress, and while studies show stress is a leading cause of illness, new research suggests that there is a link between financial stress and metabolic syndrome. In light of this, it is more important than ever to focus on the right things and to get our financial numbers in order. We want our net worth to go up and our blood pressure to go down -- not the other way around.
Liz Davidson is CEO of Financial Finesse, the leading provider of unbiased financial education for employers nationwide, delivered by on-staff Certified Financial Planner professionals.