The Key to Understanding Your Finances
Fortunately, understanding your finances is not as daunting as it might sound. It comes down to understanding some key elements, definitions, and numbers that make up the sum total of your financial life.
Here are the things you’ll need to know in order to get a good picture of your fiscal health and help you understand your finances:
Total assets - total liabilities = net worth
This equation calculates a rather important number. Simply put, if you subtract all that you owe from all that you have, you will be left with how much you are worth.
Your assets are your property (cars, homes, etc.) savings, investments, money in your bank account.
Liabilities are credit card debts, mortgage balance, auto loans, student loans, etc.
It is possible to have a negative net worth if your liabilities exceed your assets, and unfortunately, this is more common that you may think. About 25% of American homes have a negative combined net worth.
Home equity is a measure of how much of your home you actually own based on its value, less the balance on your mortgage.
Equity = current market value - mortgage balance
It does not take into account the price you paid for the home but rather the current market value. In other words, if someone were to buy it today, how much would they pay for it?
It is possible to have a negative home equity in the same way as net worth. If the housing market fell, for example, as in 2007, a lot of home equity at the time was “upside-down.” One way to increase the value of your home is by making improvements to the home that increase the value by more than it cost to do the improvements.
Gross Income vs Net Income
Gross income: This is your total income before taxes and withholdings. If you are on a payroll as an employee of a company, your taxes and withholdings are taken out before you receive your check. This info is available to you on the paystub.
For this reason alone, budgeting can become a hazy picture because you’re not actually taking home the full amount. What you take home is called net income.
Net income: This is your gross income less taxes and withholdings. This is the actual amount you bring home.
Also called “burn rate.” This is the total expenditure over the course of a month. All the things you spend money on -- housing, food, clothing, transportation, bills, etc.
This is one of the more important elements you’ll need to understand and have control over. There are many ways to reduce spending, and by doing so, you can free up money for savings.
Credit cards (rates and balances)
Credit card balances are particularly important to keep track of, if not for any other reason than the fact that credit cards usually carry the highest interest rates. While some offer a 0% introductory rate, that rate is aptly named - it cranks up after the “introductory” time period and can climb as high as 35% or higher.
Typically, credit cards carry a rate of between 7% and 36% in the United States. The rate you’re paying will affect the balance by adding debt to the balance. It would be worthwhile to investigate balance transferring to a low interest card, if you find yourself paying a high interest rate on your credit cards.
There are many different ways to save and just as many types of accounts and funds named for each kind. Here are some common savings funds that are worth knowing about and understanding:
A bank account with a low bank interest rate (currently the average savings account offers about 0.06% return, according to the FDIC).
This would be a 401(k) or an IRA fund specifically for your retirement.
An account set aside especially for unforeseen events, such as extended unemployment or medical emergencies. Usually this would hold a predetermined number of months’ worth of expenses, so that you can continue living uninterrupted in case of a major catastrophic event or emergency.
Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable-- we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
David Lerner Associates does not provide tax or legal advice. The information presented here is not specific to any individual's personal circumstances.
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Founded in 1976, David Lerner Associates is a privately-held broker/dealer with headquarters in Syosset, New York and branch offices in Westport, CT; Boca Raton, FL; Teaneck and Princeton, NJ; and White Plains, NY. For more information contact David Lerner Associates Call 516-921-4200 Visit our website: www.davidlerner.com