This post may contain affiliate links. We may receive compensation when you click on links to those products at no additional cost to you. Read our full disclosure here.
If you’re reading this, you’re probably interested in taking your financial situation seriously and start making money moves towards financial freedom one day. However, desire without action is merely wishful thinking, and sometimes not knowing where, or how to start can hinder one’s ability to take action and achieve their goals and objectives.
So where do we start? By knowing how to assess your financial situation. To illustrate this, let’s say that you are lost in a new city and only have a map of the city on hand. The first thing you’d probably do is to figure out exactly where you are, and only then can you map out the steps and directions to get to your destination.
The same goes for your finances. You need to know where you are financially first to know where to go and what actions to take. So let’s jump right into the 7 steps on how to assess your financial situation!
1. Be Honest
The first thing you need to do when learning how to assess your financial situation is to be honest with yourself. As we work through the different aspects of your finances, you may start to realize patterns and habits that are not financially prudent. Some of you may also experience shame in your financial situation as you are not saving enough, making enough, or perhaps made financial decisions in the past that you’re not proud of.
Either way, being honest with yourself when assessing your financial situation is crucial so that you can identify the right solutions to tackle your individual financial issues.
2. Know Your Net Worth
Your net worth is essentially what you own (assets) – what you owe (liabilities). Knowing your net worth is important as it gives you a true measure of your wealth.
To calculate your net worth:
- Start by grabbing a piece of pen and paper, or opening up an excel sheet, and list your assets and liabilities as well as their corresponding values.
- If you want an easier way to calculate your net worth, you can use a financial planning tool/app like Personal Capital to do so. Simply link your accounts, add on other assets and liabilities, and the software will calculate your net worth for you.
- Use the formula assets minus liabilities = your net worth. For example, if you have assets totaling $150,000 and liabilities totaling $50,000, your net worth is $100,000.
- Track your net worth over time to see if you’re gaining wealth or losing wealth.
See below for an example of calculating your assets and liabilities:
| Assets | Amount |
| Home | $100,000 |
| Investments | $10,000 |
| Checking and Savings | $10,000 |
| Retirement Accounts | $30,000 |
| Total Assets | $150,000 |
| Liabilities | Amount |
| Mortgage | $35,000 |
| Student Loans | $7,000 |
| Credit Card Debt | $2,000 |
| Auto Loan | $6,000 |
| Total Liabilities | $50,000 |
| Net Worth | $100,000 |
3. Know Your Credit Report and Credit Score
Your credit score is a three-digit number that grades you on your ability to repay loans and how responsible you are doing so. This number is derived from your credit report, which contains information about your credit history (such as loan payments, amounts, types of loans, etc.)
Knowing your credit report is important as the information about your credit history is used by current and future creditors to make decisions about you. Negative information in it about you can impact your credit score and how you have access to credit.
Knowing your credit score is important as it can potentially save you money on loans through lower interest rates as well as grant you access to capital for leverage. Besides, some landlords and employers may also check your credit score to ensure that you’re in good standing.
To view your credit report:
- Go to www.annualcreditreport.com
- Click on “Request your free credit report”.
- Fill out the form.
- Choose which reports you want from one of the three credit bureaus
- You can do this once every 12 months for each report. Any additional reports may be charged a fee for any additional reports. (Note: Due to COVID-19, you can receive 3 free credit reports weekly until April 2022).
To check your credit score:
- Go to each individual credit bureau’s website to create an account and get your credit score.
- Alternatively, you can use a third-party app or services like Credit Karma or CreditWise to check your credit score.
- If you have a credit card, your credit card issuer may also provide free credit score checks for you.
Ultimately, knowing your credit report and credit score is crucial for setting the foundation of your finances as good credit is often tied to more opportunities to build wealth.
Read more:
- What Is A Credit Score And Why It Matters
- 7 Ways To Improve Your Credit Score
- How To Check Your Credit Score Online
4. Know Your Budget
Knowing your budget means knowing where your money is coming from and going. Having a budget is important as you want to be in control of your money by keeping track of your income and expenses.
If you don’t have a budget, creating a budget would be your first step. You can do so by using budgeting apps like Personal Capital, YNAB, or Mint to do so. You can typically link your accounts and the software will pull in all the transactions to create your budget. Do note that you probably will have to categorize your transactions to ensure that the budget is reflected accurately.
Once you have a budget, be sure to track it monthly and make necessary adjustments to ensure that you are not spending more than you make and are saving or investing any leftovers. If you are in a budget deficit consistently, assess your spending habits for the past 3-6 months and find out if there are any expenses that you can cut.
Your budget is the one simple thing that can make a big difference in your financial situation. A budget will give you clarity on what your money is for you to game plan on what actions you can take to achieve your financial goals.
Read more:
5. Know Your Debt-to-Income Ratio
With good knowledge of what your income and expenses are, you can now figure out what your debt-to-income (DTI) ratio is.
First, start by listing out:
- What you owe (mortgage, student loans, auto loans, etc.)
- How much you are paying monthly
- The interest rate for each loan
- The term for each loan
Staying on top of your debts is important to ensure that you don’t miss a payment and you are not accruing interest on bad debt like credit cards.
Next, calculate your DTI by dividing how much you pay monthly in debt payments by how much you earn monthly. For example, if you pay a total of $1,000/month towards loans (mortgage, auto loans, credit cards, etc.) and you make $5,000/month, your DTI is 20% ($1,000/$5,000 = 0.2).
Your DTI is an important number as:
- A high DTI means you may be spending above your means and any loss of income can negatively affect your debt-paying abilities. Anything above 40% is considered high and bringing your DTI down by aggressively paying off debt or increasing your income should be a priority. Try to aim for a DTI of 20-25% if possible.
- Creditors may use this ratio to determine if you qualify for other loans or not.
Read more:
- How To Pay Off Debt: 3 Effective Ways
- The Ultimate Guide to Debt Consolidation: 5 Ways to Get Out of Debt Fast
6. Evaluate Your Investments
If you have any investments in brokerage accounts or retirement plans, you need to evaluate your investments to see if it fits your risk tolerance as well as goals and objectives.
You’ll need to first identify your investment goals and objectives. What is the time horizon for your investments? What are your investments for? How much do you want your investments to grow?
From there, you can determine what your risk tolerance is. Generally, the younger you are, the higher your risk tolerance is because you have more time to recoup any losses as you are accumulating assets. Your personality also plays a big role too as some people are just more risk-averse than others.
As a general rule of thumb (not investment advice):
- If you have a higher risk tolerance, you may want to structure your portfolio to have more money in stocks.
- If you have a lower risk tolerance, you may want to have more money in bonds and cash.
For a more in-depth analysis of your investments, Personal Capital provides free investment analysis on your holdings. If you require professional help, they also have licensed investment advisers that can help manage your investments for a fee.
Other things you need to assess are what investment fees are you paying, your investment’s performance, and if you taking advantage of tax-advantaged accounts like the Roth IRA, 401(k), HSA, etc.
Read more:
- How To Build A Retirement Portfolio
- 5 Easy Ways to Invest With Little Money
- Stocks 101: Complete Guide on How To Invest in Stocks for Beginners
7. Evaluate Your Insurance Coverage
One of the most overlooked aspects of one’s financial situation is insurance. Having adequate insurance is important to ensure that your assets are protected and your loved ones are taken care of in case of any unfortunate events.
There are many types of insurance and each serves a different purpose. Life insurance is important especially if you have dependents and want to leave them some money if you pass away. Disability insurance is to ensure that you’ll continue to have some income even if you are not able to work anymore due to disabilities.
If you are unsure about how much life insurance you may need, Policygenius can help you with a rough estimate of how much coverage you may need. Experts typically recommend coverage of at least 10x your annual salary, but it really depends on how many dependents you have and what are your financial obligations like debt.
As for disability insurance, it should replace about 60% of your annual salary, which can be a game-changer especially if you’re the breadwinner of the family and cannot work one day.
Most employers do provide group life and group disability insurance so be sure to reach out to HR for more details. However, it typically isn’t enough and you may have to get additional coverage from insurance providers. Be sure to also assess how much existing coverage you have, how much premium you are paying, and whether your coverage is too much or too little depending on your situation.
Read more:
- Types of Insurance
- Do You Need Life Insurance And How Much?
- Disability Insurance Basics: 5 Important Things to Know
Summary
Knowing how to assess your financial situation is important to know where you are financially so that you can know where to go next. Once you have a good idea of where you are financial, you can then identify where you want to improve and find solutions to do so. I recommend reading the follow-up articles below if you want to learn more about the topics in this article:
Credit
- What Is A Credit Score And Why It Matters
- 7 Ways To Improve Your Credit Score
- How To Check Your Credit Score Online
Budgeting
Debt
Investing
- Why Investing Is Important
- How To Build A Retirement Portfolio
- 5 Easy Ways to Invest With Little Money
- Stocks 101: Complete Guide on How To Invest in Stocks for Beginners
Insurance
- Types of Insurance
- Do You Need Life Insurance And How Much?
- Disability Insurance Basics: 5 Important Things to Know
This post may contain affiliate links. We may receive compensation when you click on links to those products at no additional cost to you. Read our full disclosure here.
