Epic Formulas to Win The Money Game
In order to be successful in the money game, you will need to understand the principles that best position you on the pathway to wealth building. Below are several best practices that are sure to help you avoid common mistakes and maximize the use of one of the most neglected resources…. money.
1. Savings rate to income (monthly savings/monthly income)
This ratio is extremely important to building wealth. It calculates the percentage of one’s income that is saved. The ideal ratio is greater than 10% of income placed in savings. Very few people practice this principle and thus live life from paycheck to paycheck. This is one of the oldest principles and surely the one that should be followed religiously. Pay yourself the first 10% of your income before you pay anything. Also, automate the process to take “You” out of the decision. If you rely on yourself to transfer 10% of income into savings each time you are paid, it will never consistently happen. The government, creditors, and even brokerage firms all understand that people simply don’t have the discipline to regularly choose to delay financial gain. Ever wonder why most businesses operate with automatic bill payments or why the government takes its share of taxes before you get your hands on your paycheck. The government, creditors, banks, and brokerage firms all understand this principle.
2. Debt to Income ratio (monthly recurring debt/monthly income)
You can’t escape the importance of this calculation, most banks use this ratio in calculating your mortgage eligibility. It’s a good idea to keep your recurring debt to less than 30% of your monthly income. Below you can see the rating of monthly recurring debt.
- 30% or less = Great
- 31% to 49% = Needs improvement
- 50% or more = Insane
3. Credit Utilization (total balances owed/total limits)
Credit card utilization represents 30% of the formula used to calculate your credit score. in order to maintain a good score, a person’s credit utilization should be kept below 30%.It is a good habit to pay off balances in full each month to avoid carrying large balances that are subject to interest. A great way to ensure you stay on track is knowing your targeted limit of utilization in dollars and never exceed that number. For example:
- If you have a credit card with a limit of $10,000, you need to keep that balance below $3,000.
4. Home Affordability (.30 * Monthly Income)
Your mortgage payment or rent should not exceed 30% of your monthly take-home pay. This is extremely important and should be a principle everyone should follow. The logic behind the 30% resides in what it leaves available. You would now have 20% of your income for variable expenses. That means 50% of your pay is going financing your essentials. The other 50% should be 30% lifestyle and 20% savings. Many people buy a home or rent an apartment without understanding these rules and they are certain to struggle attempting to make it work… when the math simply doesn’t work. Signing a lease for an entire year is an awful idea if it does not pass the 30% test. Understanding the rules of the game is important to make the most out of your circumstances. It can be said that you could increase the 30% to a higher percentage, but you would be taking from savings, lifestyle, fixed, and variable expenses to do so… it is not a wise choice.
5. Depreciating Asset to Income (Maximum should be 50% of annual salary)
A car is a depreciating asset that will suck the life out of your opportunity to build wealth. No one should finance or own vehicles that cost more than 50% of their annual salary. That doesn’t mean you should target 50%, the less u spend on depreciating assets the better. Another suggestion would be, to buy that vehicle and stay in it for 6-10 years.
6. Net worth (Assets – Liabilities)
Easily the most important calculation a person needs to understand in order to build wealth. Understanding what an asset is a simple. Assets are things that you own, they can be liquidated with relative ease to get back cash value. Homes, bank accounts, investments, retirement accounts, and vehicles if paid in full. Some people don’t even consider a vehicle an asset at all because of the rapid depreciation and low percentage of ownership.
A liability is something you owe. Credit card balances, student loans, personal loans, leases, mortgages, car loans, court orders, and collection accounts. These are called debts and they dramatically slow down cash flow and investment opportunities. Debt is the biggest obstacle for wealth because it not only prevents cash flow from being invested, but it also operates on the other side of the balance sheet.
7. Disposable Income (income – all obligatory expenses)
Disposable income is very important because it determines your quality of life. The greater this number the more options you have available financially. A person should seek to have a minimum of 30%-50% of their monthly income free and clear of obligation to all expenditures. Increases in disposable income can greatly improve one’s quality of life.
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