Personal finance is a numbers game. As much as I like to vouch for the “personal” part of personal finance, it’s only half of the story – “finance” is part of the phrase, too.
In the end, you’re still looking at the dollars and cents on your paycheck, on your income tax forms, on your investments, in your retirement accounts, and so on.
A long time ago, I wrote a post called Everything You Ever Really Needed to Know About Personal Finance on the Back of Five Business Cards. Since this post went up more than five years ago, I’m sure many of you don’t remember it, so here are those five cards:
The first four cards really just focus on one specific thing: the gap. I consider the size of that gap to be the most important number in personal finance.
In more straightforward terms, the “gap” refers to the percentage of your income that you save for the future.
Here’s a quick way to figure out your “gap,” and it’s pretty timely since most of us have this information sitting in front of us thanks to tax season.
First, figure out exactly how much your family earned in 2012. You can use either net (after taxes) or gross (before taxes), whatever makes you feel more comfortable, as long as you’re consistent about it. If you use gross for this calculation, always use gross. I usually suggest excluding any big one-time income streams from this calculation – for example, a big one-year bonus can really mess up this calculation.
Second, figure out exactly how much your family saved in 2012. How much of the income that was brought in by your family is now sitting in a savings or investment somewhere? For this info, you might have to look at bank statements and investment account statements.
Then, merely divide the amount saved by the amount earned using your calculator or a spreadsheet, then multiply that by 100 if you prefer to work with percentages. This will tell you the percentage of your income that you’re saving for the future.
The bigger that number is, the better you’re doing financially. I haven’t found a single number that so accurately reflects how powerfully a person is working to improve their finances than this single number.
It works for any income level. A person that earns $18,000 a year and saves $1,800 is doing just as well as a person who saves $10,000 on an income of $100,000. Why? They’re both saving 10% of their income, and that 10% is going to have a similar profound life effect on each of them, though it will show up in different ways. It also leads toward self-sufficiency at exactly the same pace for each of them.
You can cause improvement in the number via both frugality and increased earnings. If you earn more without increasing your spending, the amount you save will go up. If you spend less without a change in income, the amount you save will go up. You can tackle this number from both sides if you wish, or focus on just one side or another.
It’s also an incredible motivator. Want to push yourself to improve your finances? Focus on finding ways to beat your savings percentage from the previous year.
For us, our percentage has remained almost exactly the same for the last four years – about 35%. Over certain stretches of months, it’s been as high as 50%, but during other stretches, it’s been lower (thanks to vacations and so forth). My focus is mostly on maintaining this number.
Another tip – debt repayment accelerates the growth of this number. Paying off a debt early makes it much easier to start saving a higher percentage of your income sooner rather than later.
Where should you be saving? The answer to that question depends heavily on your lifestyle and your goals. A single twentysomething who wants to be “set for life” at the first possible second is going to save in different ways than a family in their thirties with lifetime career goals.
If you’re not sure how you should be saving, sock money away in a savings account for now and start studying up, then use that saved money to set things up as you see fit.
Your “gap” – or savings percentage – is a vital number. The bigger you make it, the better off you’ll be.