Give Yourself a Financial Check-Up

A financial check-up is as important as an annual physical with your doctor. Like a medical exam, a review of your finances can identify strategies to improve “financial fitness” and screen for potential problems, such as lack of a will or a high debt-to-income ratio. This article will discuss eight ways to assess the strengths and weaknesses of your financial situation.

Check-up Method #1 is financial quizzes. Rutgers Cooperative Extension’s Financial Fitness Quiz is available online at www.rce.rutgers.edu/money/ffquiz.asp. The quiz consists of 20 questions about various financial practices. Those with a low score indicate areas for improvement.

Check-Up Method #2 is financial goals. Goals should be SMART, which is an acronym for specific, measurable, attainable, realistic, and time-related. Annual progress benchmarks should be established and investments should be matched to the time frame for financial goals.

Check-Up Method #3 is a net worth statement. Net worth is assets (what you own) minus debts (what you owe). Assets have three categories: liquid (e.g., bank accounts), tangible (personal property such as a house and car), and investment (e.g., mutual funds and 401(k) plan). Short-term debts are those that you expect to repay within a year (example: credit cards) and long-term debts, like a mortgage, last longer.

Check-Up Method #4 is the “Wealth Test.” This formula, from the book The Millionaire Next Door, can be used to assess one’s personal progress based on two key factors: age and pre-tax (gross) income. Simply multiply these two figures together and divide by 10. This tells you what your net worth should be. Obviously, the higher the number relative to this benchmark, the better.

Check-Up Method #5 is an income and expense statement that analyzes past spending patterns. There are four components that are totaled for a month: income, fixed expenses (e.g., rent), variable expenses (e.g., food), and 1/12 the annual cost of irregular expenses (e.g., quarterly property taxes, school tuition, and vacations). For the latter, list all expenses that come irregularly throughout the year. Then total each expense and divide by 12. Treat these expenses are monthly “bills” and set money aside for them.

Check-Up Method #6 is one’s liquidity ratio, a measure of the adequacy of emergency savings. It is calculated by dividing liquid assets (from a net worth statement) by monthly expenses (from an income and expense statement). The ratio should be 3:1 or better.

Check-Up Method #7 is a credit card check-up. Areas to consider are strategies to pay a lower interest rate (e.g., refinancing), whether certain credit cards could be cancelled, a recent review of your credit file for errors and evidence of identity theft, and obtaining your credit score.

Check-Up Method #8 is a tax check-up. Analyze your marginal tax bracket, whether or not you are maximizing contributions to tax-deferred employer savings plans and individual retirement accounts (IRAs), and other tax-reduction strategies such as deductions, credits, and long-term capital gains tax rates on assets held more than a year.

The next time you’re scheduling a medical check-up, take time to assess your finances also. For resources to analyze your finances, visit the Rutgers Cooperative Extension personal finance Web site at www.rce.rutgers.edu/money2000.