You know what’s interesting about a lake that’s frozen over? There’s no way to simply look at it and tell if the ice is safe based on its appearance, the temperature, how long it’s been there, or how thick the ice is.
You know what’s interesting about finances? You can fool yourself and others into thinking your financial situation is stronger than it really is – but in reality, your ice is ready to crack!
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Testing The Ice So You Don’t Fall Through
There are ways to test how stable you are financially. Just like the strength of a frozen lake is affected by multiple factors, these financial ratios and guidelines won’t always account for other factors of your personal financial life. They’re still good measures of strength, but they’re just one part of your overall financial health.
Debt To Income Ratio
Gather your debt obligations, including your mortgage, car payment, student loan payment, minimum credit card payment, or other debts you owe monthly on. Divide that number by your monthly income (pre-tax income). This is your debt to income ratio.
Most financial professionals will tell you a healthy ratio is below 36%. If you’re treading on a 40%-50%+ debt to income ratio, you should reevaluate your debt situation and find ways to reduce your obligations.
Credit Score
In general, a good FICO score is anything above 760. If you’re nowhere close, don’t worry just yet. There are ways to improve your credit score. It takes time, but building a good foundation of credit will be helpful in obtaining the best rates for home mortgages and can even affect your ability get a job! (Yes, many employers will screen your credit score before they hire you.)
Overspending
If you feel like the crack in the monthly budget just keeps getting bigger and bigger, it might be time to rethink your spending habits. Read Dave Ramsey’s book Total Money Makeover and you’ll start to see how people drastically improved their financial strength by making uncommon and even ‘weird’ (as Dave would say) spending cuts.
If you need help with overspending, try using the envelope system to guide you through. It’s one of the best ways to really ‘assign your dollars a home’ each month.
Retirement Savings
There isn’t a magic number or percentage to show you how much you should be saving and how much you need at retirement. The biggest problem I see with people saving for retirement is that they don’t consider how much a small increase will strengthen their retirement balance at retirement.
Assuming an 8% return, your retirement account can grow by nearly $25,000 after 25 years with every increase of $25 per month to your account. Just think, for every $25 you set aside now, your account will be $25,000 larger than it would be if you hadn’t increased your contribution.
That’s only $12.50 per paycheck. If you can steadily increase your savings by $12.50 every other month, you’ll be well on your way to catch up with your retirement savings.
Surviving The Financial Freeze
The first tip that’s often given for someone who has fallen through ice is: DON’T PANIC. The same is true if you’re realizing that you need to strengthen your financial position. I’m not saying that you should be nonchalant about your situation, but panicking leads to irrational decisions. Your decision to improve your finances needs to be deliberate – not irrational.
Have you ever fallen through the ice…financially? What did you do to get back on track? What do you wish you did to keep from falling in the first place?
I have read posts at your blog before and keep coming back, not just for the information, but for the quality of your writing, as well, which is very high,
I find the subject of this post very interesting. I am a financial coach; my specialty is working with people who are living paycheck to paycheck to help them stop doing so. Based on my work in that regard, it is my opinion that the real way to “test the ice” is to answer one simple question:
How long could you sustain your lifestyle if you lost your job?
Living p2p is only a symptom of the underlying issue — that real issue being over-spending which I define as spending more than you earn and spending so much that you are not saving “enough.”
The money to sustain your lifestyle will come from savings — and this fall-back plan cannot include any funds in a tax-deferred qualified retirement plan. Your 401k plan is not emergency money!
To a very large extent, it is my opinion that prudent personal financial management should be about building financial viability — extending the length of time you could go without a paycheck until, at some point, you achieve financial independence and you no longer need a paycheck, at all!
I absolutely agree with you! The p2p lifestyle is a miserable life – and it can happen whether you make 25k or 125k!
Thanks for the encouragement; it’s always good to hear a nice writing compliment…especially if you’re a blogger :)
Tim
Tim,
I can’t say that I have ever fallen through the ice, but I have been on thin ice several times. Ironically, many times those who are on thin ice (myself included) are the last ones to find out…often after the ice breaks. Hopefully, these signs will alert some readers who need to be alerted. Good post!
Thanks Joe! Yeah, if you’re not watching you can find yourself in situations that stretch you financially. It’s always good to look for the symptoms…and hopefully it will help some people to get back on track.
One of my favorite quotes is “when the tide goes out, you see who’s been swimming with no trunks on.” I think it’s absoletly fitting for your post. I’m now debt free and pretty committed to saving and investing so I haven’t swam sans trunks in a while. Sure feels good.
Borrowing money (from whereever) when you face a minor financial emergency is a pretty good indicator you’re living too close to the edge. More money and lower expenses always helps thicken the ice. You just have to devise a plan to address both components, and then execute it.
Love that quote. haha – may have to be the name of my next post. “When the tide goes out, you see who’s been swimming with no trunks on”.