Financial management is about more than just balancing your checkbook and making sure you don’t spend more than you make. Let’s take a look at some of the financial management tactics you can start using today that can help you achieve your long-range goals.
Before we do, let’s make an important distinction between tactics and strategy. A strategy represents a goal or big picture plan of action; tactics are actions you are going to take to achieve the goal described by a strategy. For instance, one strategy might be to own your own home. The tactics you might use to achieve the strategy could entail cutting expenses, making more money, saving up, exploring financing options, borrowing from family or friends, liquidating assets, etc. In turn, some of these tactics become strategies that entail tactics of their own (such as those you would use to make more money).
You will need to take this type of tactical approach if you want to move from simplistic to a level of complexity in order to achieve the strategies described below. Here are three financial management strategies to consider.
1. Reducing Your Debt-to-Income Ratio
Your debt-to-income ratio is the total amount of money that goes out each month for mortgage, auto loan, student loans, credit cards, personal loans, business loans (for sole proprietors), etc., compared to the income you earn during the same month. As a formula, it’s expressed like this: Total Monthly Debt Payments / Gross Monthly Income. Here’s an example of how to calculate your debt-to-income ratio:
$10,000 Monthly personal income from all sources
$500 Car payment
$200 Student loan payment
$200 Business loan payment
Debt-to-Income Ratio: 41 percent ($4,100 / $10,000)
It’s important for you to know your debt-to-income ratio, since this ratio is often a key contributor to your credit score and impacts decisions lenders make about whether to extend credit to you personally. If you’re a business owner, your personal debt-to-income ratio can also affect your company’s credit rating and ability to obtain working capital. Bankrate.com’s debt-to-income ratio calculator can help you calculate your own score.
The 36 percent rule suggests that your debt-to-income ratio should never surpass 36 percent. A high debt-to-income ratio (43 percent or above) might even automatically disqualify you from financing while a lower ratio makes you more attractive to financial institutions. Plus, the more you can reduce your debt-to-income ratio, the more you become less susceptible to financial problems. For instance, if your debt-to-income ratio is low, you have more ability to take a cut in pay or weather temporary job loss.
2. Improving Your Credit Score
Most credit score rating systems have a scale that ranges from 300 to 850, broken down into five results:
750+ – Excellent Credit
700-759 – Good Credit
650-699 – Fair Credit
600-649 – Poor Credit
Below 600 – Bad Credit
Your credit score impacts your ability to obtain personal financing such as a home loan (mortgage), credit card, retail store financing, auto loan, etc. In addition, your credit score can also impact your cost of financing; for instance, a low credit score might mean financing companies offer you money at a higher rate of interest than they would offer if you had a high credit score.
Reducing your debt-to-income ratio is one obvious tactic you can execute in order to improve your credit score. However, simply making your payments on time (or early) and making payments on debt in excess of minimum monthly payments required can also help you improve your credit score, especially over time.
Given the number of financial data breaches where hackers have obtained personal identification information from retail and financial institutions during recent years, it’s important to check your credit score periodically. Monitoring your credit can help ensure that no one has “stolen” your identity and used it to rack up debt which can not only hurt your credit score, but even result in creditors pursuing you for repayment.
There are several credit score monitoring services that offer the ability to check your credit scores; however, many offer “free” credit score results only after you agree to another fee or subscription. Your bank or another financial institution may also provide both credit reporting and monitoring services at no cost.
3. Planning for Retirement
Just because you have enough money now doesn’t mean you will always have enough money to live the lifestyle you want. Planning for retirement – those years when you are not likely to have any income except for social security – is important for everyone. You can use tools like CNN’s retirement planning estimator to see how much money you should put away into savings or investments at the age you are now, in order to retire by a specific age and maintain your lifestyle (live in the same type of home, spend the same amount on discretionary items, etc.)
Make sure your financial management strategy goes beyond the basics. The more you understand how to optimize your financial position and avail yourself of tools that can help you find out where you are right now, the better you will be able to plan a strategy that gets you to where you want to be in the long run.