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The Top 7 Questions You Should be Able to Answer About Your Finances

For many Americans, money is a taboo subject – right up there with sex, politics, or religion as topics to be avoided in polite company. The discomfort surrounding money leads to financial ignorance where grown adults don’t know the basics of their own finances and are afraid to ask. Unfortunately, when it comes to money and your finances, what you don’t know can hurt you.

Ignoring money matters doesn’t make them go away. At best, not knowing your own finances leads to missed opportunities. At worst, financial ignorance can cost you thousands or even lead to ruin.

It's never too late to get a handle on your finances. All you need is a few hours and a spreadsheet or pen and paper to answer these 7 important questions about your finances detailed below.  Doing so will get you well down the path towards a more secure future for you and your family.

1. What is your income after taxes and benefits?

First, you need to know what money you have coming in and how much of that money is actually available for use. How you calculate your income after taxes and benefits will depend on the source:

  • Wages and Salaries (W2): This is income from a traditional employer-employee relationship where you are paid an hourly rate or yearly salary for work completed. You can look at recent paystub to see your income (typically for a 2 week or bimonthly period) after taxes and benefit deductions for health insurance. Multiply this number by 26 (if your pay period is 2-weeks) or 2(if your pay period is bimonthly). Add in post-tax bonuses and reliable overtime not reflected on the paystub to determine your yearly income from this source. Repeat for all wage and salary work you do.
  • Self-Employment (1099) Income: Next, add in income from self-employment income. This can include contract work, freelancing, side hustles, and farm income. For 1099 income, first deduct appropriate business expenses from your gross income from that line of business – office supplies, electronics, travel costs, etc. Then deduct taxes. If you held the same business last year, pull your 1040 Schedule C from last year’s taxes to make the calculation easier. Repeat for all self-employment income sources.
  • Government Transfer Payments: Government transfer payments come from your local, state, or federal government with no goods or services exchanged. In the United States, payments from Social Security, unemployment benefits, and welfare payments are some of the most common government transfer payments. Some government benefits are taxable so use the post-tax number for your calculation.  
  • Investment Income: Investment income  is money earned from an increase in the value of investments, such as stocks, bonds, and funds. The income may also come from interest payments, dividends, or capital gains gained upon the sale of a security or other assets. Subtract any administrative fees paid and taxes due. Investment income can be trickier to calculate. Your Financial Advisor can help you find the right number to use for your income calculation, particularly if you hold a complex portfolio or many different investments.
  • Other Income: Any other income that you have coming in on a regular basis. 

Add all your sources of income together to find your yearly income after taxes and benefits. Divide by 12 to calculate your monthly income.

2. What are your expenses?

Now that you know what you have coming in, it's time to figure out how much is going out. Sit down with recent credit card and bank statements and loan statements for your mortgage, student loans, car payments, or other loans. Create a list of monthly expenses, dividing expenses in to three categories:

  • Fixed expenses: This includes your mortgage or rent, loan payments, and insurance payments that were not deducted from your paycheck in your income calculation.  Fixed expenses are largely set and would take a large lifestyle change to adjust, such as downsizing your house.
  • Flexible expenses: Flexible expenses are necessary expenses that vary from month to month, including utilities, groceries, toiletries, childcare, basic clothing, and healthcare costs. These expenses can often be adjusted somewhat by lifestyle changes like lowering the heat a few degrees.
  • Discretionary expenses: These are nice-to-have but not strictly necessary items such as dining out, entertainment costs, travel, extracurricular activities for children, etc.

Add in irregular expenses like holiday gifts, vehicle maintenance, vet bills, and vacations by dividing the yearly cost by 12 and adding to your monthly expenses.

Ideally, your income from step 1 will be greater than your monthly expenses calculated in step 2. If not, you’ll need to increase your income, reduce your expenses, or a combination of both to get into better balance. 

Regardless of how much your income exceeds your expenses, it’s still very helpful to do an expense check-in once or twice a year to go over expenses that can be reduced (by shopping around for car insurance) or eliminated (by cancelling that subscription service you haven’t used in months).

3. What is your net worth?

Your net worth is simply your total assets minus your liabilities. Assets include:

  • Cash value of liquid accounts such as checking and saving accounts, money market accounts, certificates of deposit, treasury bills, and physical cash.
  • Investments such as annuities, bonds, mutual funds, pensions, retirement accounts (IRA, 401k, 403b), stocks, cash value of life insurance, etc.
  • Real or personal property including real estate owned, vehicles, and household items (antiques, art, furnishings, jewelry, technology, etc.)

Add up all of your assets, using the most realistic values you can find, such as the Kelly Blue Book value for a car.

Liabilities are easier to calculate as there are hard numbers to work with. There are two types of liabilities:

  • Secured debt - Debt held against an asset, such as mortgages, car loans, home equity loans, etc. 
  • Unsecured debt – This includes credit card debt, student or personal loans, medical bills, outstanding taxes or other debt or bills owed

Add the value of your secured and unsecured debt to find your total liabilities.  

Subtract your liabilities from your assets to determine your net worth. If the number is greater than zero, you have a positive net worth. If the number is in the red, you have a negative net worth. Tracking your net worth over time can provide a good big-picture view of your financial trajectory.

4. What are your financial goals?

Where do you see yourself in 2 years? 10? 40? If you don’t know where you want to go, it’s hard to get there. Make a list of personal, big-picture objectives such as:

  • Short term goals: <2 years - Think travel, saving for a vehicle down payment, planning a wedding or other big event, home improvement/renovation, paying down debt, adding an income stream, going back to school, or building an emergency fund.
  • Medium term goals: 2-5 years - Saving for a down payment on a home, purchasing a vehicle in cash, taking a bucket list vacation, paying private school tuition, launching a company, or starting a family.
  • Long term goals: 5+ years - Retirement, putting your kids through college, purchasing a vacation home, etc.

Your goals will be highly personalized to you. Maybe you want to retire in 10 years, splitting your time between homes in Florida and NYC, or maybe you're working towards purchasing your first home where you can raise your family.  No matter what your goals, it is critical to make the effort to think about them in advance, and write them down and revise them from time to time.

5. Are you on track to meet your financial goals?

Now that you’ve articulated what your goals are, you can make an action plan on how to achieve them 

Want to put your child through college? Calculate four years of tuition and room and board at an appropriate school (less any expected financial aid) and make a plan to get to that necessary amount. You may want to open a 529 account or adjust your contributions to an existing plan 

Hoping to retire in 2031? Take a hard look at your investments, retirement accounts, and expected Social Security income to see if you are on track to retire comfortably at that time. Increase your retirement savings and adjust your investments as needed.  

A trusted financial advisor can help make sure you are on track to meet all your goals – big and small. Your financial advisor will work with your goals so that your Bora Bora trip this year doesn’t derail your home purchase down the road.  A great investment person can also help you harness the power of investment compounding so that you can achieve your goals sooner and with less effort than if you were dependent solely on your ability to save the necessary amounts.

6. Are you prepared for a financial emergency? What would happen if something happened to you?

Are you ready if a hurricane damages your house? What if a global pandemic puts you suddenly out of work? If you or your spouse passed away tomorrow, would your family be left wanting?  

A little advance planning can go a long way to mitigate the effects of a financial emergency:

  • Build Your Emergency Fund: Experts recommend having a minimum of 3-6 months of expenses available in a liquid account. If you have a stable, salaried job in a common field, 3 months may be sufficient. If your income is more varied or you work in a specialized field with fewer job openings, 6 months may provide better peace of mind. If your job is even more tenuous, you may want to build up a reserve in excess of 6 months of expenses in the short-term. Having an emergency fund keeps an an unexpected setback to your income or expenses from derailing your finances or causing undue stress.
  • Insurance: Carrying the right kinds and amounts of insurance is essential. Life insurance can ensure a surviving spouse will be able to continue living comfortably in the family home. Disability insurance (short and long term) helps replace income if a breadwinner is injured. Car insurance keeps a negligent driver or careless mistake from being financially devastating. Health insurance helps you get the care you need to live a healthy life.  Home owners insurance protects your home and physical property from damage due to fire, natural disaster or theft.  A risk review looks at whether you have the right amounts and types of insurance in place to protect you against high severity but low probability risks.
  • Living Will and Advance Care Directive: Leave instructions for your medical care in the event that you cannot make decisions for yourself. Having these documents in place saves your loved ones from the heart-wrenching decisions of trying to guess if you would want to be resuscitated or kept on a ventilator.
  • Update (or Create) Your Will: Having a legal will makes the time after your death easier for your family and gives your heirs faster access to needed assets. You can spell out how assets are distributed (including in ways that will reduce taxes for your surviving family members). If you have children or other dependents, your will should include who will care for them so that decision falls to you and not the court system.  If your assets are sufficiently valuable, an estate attorney and your financial advisor can also help you craft your will and your entire estate plan to take advantage of legal strategies to reduce the estate tax and income tax burden on your heirs.
  • Keep Records: Keeping updated records of your assets and liabilities will make it easier to file an insurance claim after something happens that causes damage. Electronic records backed up to the cloud or a fire and water proof box will keep your records accessible if a natural disaster hits your house.

No one can eliminate the possibility of a financial emergency but taking the steps above can make the emergency much easier to handle so that you can move on with your life.

7. How often do you track and review your finances? Are there any steps you should be taking to maximize your options?

Knowing what your current finances are is essential to reach your financial goals. Schedule a routine (minimum yearly) financial review. Update your account records, review your income and expenses, check that your will is still up-to-date, and review your goals and adjust your plans as needed. If you are in a marriage or partnership, both partners should understand the broad picture of what your finances are and what you are working towards. If you experience a major life event like a birth, death, job loss, or new job, take a moment to review your finances and adjust as needed.  

A trusted third-party, like a financial advisor at Ridgewood Investments, can help you choose the right investments to stay on track to reach your financial goals and make sure you aren’t forgetting anything in your financial plan.  As a comprehensive advisor, offering investment guidance and deep financial planning capabilities, Ridgewood Investments has all the skills in house to help you answer the above important questions and take action accordingly.  For our highest wealth clients, we also offer Multi Family Office solutions which enable an even greater level of guidance and outsourcing when appropriate.

When you know where your money is and where it’s going, and have put in the effort to make sure it is optimized as much as possible, you can focus on the parts of life that money can’t buy without financial worries or unpleasant surprises.  The result can be priceless in the form of peace of mind and security for your family and loved ones.

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For more on how Financial Advisors like our team at Ridgewood Investments are positioning their clients for success, check out my article: "How Great Advisors Are Positioning Clients to Survive and Thrive Through this Crisis".

High Net Worth Financial Advisor New Jersey

About the Author

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.