As a New Year turns the corner, it is common to reflect on the previous year, and take an accounting of where you are compared to where you want to be. This is the perfect time to set concrete goals that will lead to progression towards your long term financial goals. This process begins with having a clear understanding of where you are today.
There is a temptation to avoid this step, since it is usually seen as a reminder that you are “failing” and not where you want to be. However, knowing where you are starting will give you a clear view of where you need to go and how to get there. Let go of any financial past failings and move on with a plan for your future. After all, things might not be as bad as you imagine, or they could be a whole lot worse. You will never know until you take a few minutes to reflect.
Here are 7 Tips that will help you see your finances clearly.
- Have you missed any payments in the last 12 months? Missed payments often result in late fees and could also include a negative report on your credit file, impacting your credit score. Late payments are a sign that you are living beyond your means and most likely using credit card to supplement your income. This is one of the first key signs of financial trouble.
Solution: Create a budget. Track expenses for 30 days so you can see where money is going or carefully review your debit and credit purchases. Then establish a budget that will keep costs under control.
- Were you able to save money regularly? Setting aside a little each pay period into an emergency fund will help you to stay within your budget by providing a resource for unexpected expenses. Even $10 a week adds up to $520 a year. That money can be found by bringing lunch one day a week or cutting back on incidentals like gourmet coffee or drinks when you eat out.
Solution: Automate your savings. Have an automatic transfer from checking to savings each pay period for a small amount. Some banks offer savings accounts that round up purchases, which is another way to increase savings without feeling any “pain” from cutbacks in spending.
- Did you contribute to your retirement accounts? Having high interest rate debt can cause you to forgo retirement investing because you don’t feel like you can afford to put money in retirement. However, retirement funding through a 401K or traditional IRA reduces taxable income, which means you are able to put more away faster while minimizing the impact on your take home pay.
Solution: Take advantage of any work programs. Set an amount you feel you can live with and then increase contributions by 1% each year. You will hardly notice the additional amount coming out of your account, yet retirement balances can grow exponentially. If you don’t have a workplace plan, use part of your tax refund to make a contribution to an IRA. This may actually increase your refund amount and contributions can be made up until April 15, the following year enabling you to select a contribution amount after taxes have been completed.
- Have you monitored your credit this year? With identity theft on the rise it is not a good idea to wait for your bank or credit card company to catch fraud. Have a system in place to track everyday expenses so you can spot unauthorized purchases on accounts quickly. It is also a good practice to track your credit score and credit report to keep an eye out for unexpected charges or suspicious accounts.
Solution: Obtain a copy of your credit file from each of the credit bureaus once a year (Experian, Equifax, and Trans Union). You can get one report every 4 months or all at once. Credit scores can often be tracked through an existing credit card account.
- Do you know your Debt-to-Income ratio? This ratio compares the amount of debt you have in relation to your income and gives you a view of your overall financial health. Housing payments should be no more than 30% of your income and other debt (credit cards, car payments, student loans) should be no more than 20% of income. This will leave 50% for food, gas, insurance, savings and other expenses. Lenders set acceptable debt-to-income ratios, including housing at around 43% for total debt payments. When debts are too high you may be unable to get financing, are more likely to make late payments, and more likely to increase debt each month.
Solution: Gather bills and list all debts and then divide it by your income. For example: if you have $3,500 in debt payments and you earn $7,000 a month, your debt to income ratio is 50%. If these numbers are high, it is time to follow a strict budget to reduce spending to improve your financial health.
- Did your total debt increase or decrease in the last 12 months? Debt reduction is generally a slow process and it may be hard to tell what direction you are going. One of the most common New Year’s Resolutions is getting rid of debt. Yet success cannot be achieved until you measure it and take deliberate steps to debt reduction. If your debt is increasing, this can signal an impending debt crisis, even if you are not struggling to make payments today.
Solution: Get statements from the past January and compare them with current bills from this December. Those who receive online statements can generally look up statements for a 3 to 5-year period of time in a matter of minutes. A simple graph or spreadsheet will give you a clear debt picture and what direction you are headed.
- Is your net worth growing or shrinking? Net worth considers both debt and assets in determining whether you are truly better off this year than you were last year. A quick review of statements for debt, mortgages, student loans, savings accounts, investments, and retirement accounts will enable you to see where you stand financially. This overall picture will help you evaluate not only a debt reduction strategy, but your general financial health. Are you on track for retirement, or becoming debt free? Comparing the mortgage debt to your home’s value will help you see any equity growth you have gained over the course of the year.
Knowing where you stand financially is a starting point to better debt management. As you set goals for the New Year, take a few minutes and clearly learn where you are now. It may be that you are better off than you thought, or it could be a wakeup call to address your financial shortfalls before they get out of control.