What’s your Personal Finance (PF) score and how do you calculate it?
This is a new way to score:
This is measured by taking the ratio of your net worth and dividing it by your annual expenses.
So if you have a net worth of $100,000 and your annual expenses are $25,000, your score is 4.
Alternatively you can have a negative score if you have a negative net worth, someone who owes more to others than the cumulative total of all their personal assets.
HOW TO CALCULATE YOUR PF SCORE
Your net worth divided by your annual expenses
Simple enough, no?
WHAT IS YOUR NET WORTH
Your net worth is how much you own minus how much you owe.
If you have $10,000 in the bank and owe $15,000 your net worth is -$5,000
$10,000 – $15,000 = – $5000
You can see my net worth over the years as an example; I track it monthly and yearly.
What you own:
- Bank account balances (your chequing, savings, cash)
- Investment portfolio balances (market value, not book value)
- Your home’s value (market value)
- Your car’s value (resale/market value)
- Company pension funds IF THEY ARE INDIVIDUAL BALANCES IN YOUR NAME
What you owe:
- Credit card debt
- Line of credit outstanding
What is not included in net worths:
- Life insurance (you only get it if you die, not really part of your net worth)
- Communal “one big citizens pot” government pensions (you don’t really know what you’ll get), like Old Age Security (OAS), Canada Pension Plan (CPP) or Social Security
- Future amounts coming in (inheritances – don’t rely on any of this)
- Future amounts you’ll earn (you haven’t earned them yet)
- Future amounts you’ll owe
WHAT ARE YOUR ANNUAL EXPENSES?
Depends! You tell me.
My 2020 Example:
I am using my income & expenses from 2020, and my net worth from the end of 2020.
WHAT DOES IT ALL MEAN?
So now that you have your number, what does it all mean?
- Anything in the negatives: You need to get out of debt now.
- Score of 1: You have enough for one year’s worth of expenses.
- Score of 5: You are picking up steam.
- Score of 10: Getting better.
- Score of 25: You are financially independent!!
- Score of 30: Your investments are making more than you spend.
- Anything above 30: Sit back and relax, you’re golden!
Since I can’t sell my home easily, I can’t release that $400K to use it without doing so, I am now going to only look at my 2020 LIQUID net worth (investment portfolio + cash + bank balances) as part of my calculation:
It doesn’t look as rosy, does it? I am about 6.65 off from where I “should” be.
Liquid net worth means:
- Bank balances – chequing and savings
- Investment balances
- Pension balances individually allocated to you, IN YOUR NAME (not in some communal government pot)
- Anything you have in actual cash or you can sell THIS VERY MINUTE and get money for
That’s it. Everything else that is not considered liquid – your home, car(s), electronics, clothing, etc. You need time to sell them to raise money and you may not get what you expect.
If I now look at my expenses and decide that I am willing to live on my bare bones amounts, this is what I’ll get:
My bare bones amounts include:
- Condo fees
- Cellphone / Internet bills
I took out completely the following as they’re superfluous to “living” on a bare bones budget:
- Wardrobe – Clothing, Accessories, Shoes, Jewellery
- Gifts of any kind
- Traveling of any kind
- Eating Out
….basically anything “fun”, in my book.
Some other things to consider:
What the different calculations mean:
Obviously the most conservative estimate is your liquid net worth only, and then your annual expenses to be at your highest (mine would be $60K). That makes you SECURE that in your highest spending years, you are still able to live high on the hog, off just your investments.
The very least conservative estimates would be your TOTAL net worth (including fixed assets like homes or cars), and then your lowest barebones expenses.
You decide what’s best for your situation.
Bare bones expenses may not be realistic
This is where I am at. Bare bones is doable for me, but misery personified. I’d like to spend about $35K a year as my comfortable budget, but I can go as low as $22,500 if I am forced to (like if I want to truly leave a toxic work life, I end up with health problems and I CANNOT make another dollar, actively taking on contracts or working).
Some people, like my partner, are totally fine with bare bones. He retired a couple of years ago on bare bones expenses, and barely spends anything. He’s fine with it, he hated his job with a passion and want to retire ASAP. Now he’s back in school studying, and living on as little as he can.
Many financially independent people don’t retire
This is me. I could “retire” on bare bones expenses today, but again I am too bougie to do this, but also, I love my job. I enjoy working hard, using my brain, taking on contracts once in a while, and I make good money doing it. What’s not to love?
Once you reach financial independence, you don’t need to stop working. All it means is that you have a sense of security and peace of mind.
You can use your side incomes to offset costs
For me, I am okay with liquid net worth & bare bones expenses because I know I have money coming in even if I don’t actively work.
My truly, TRULY passive income from 2020 was: $23,010.62
This means, if I redid my numbers, they would look like this:
- My liquid investments only: $621,500.68
- My COMFORTABLE expenses at: $33,863.30
My truly passive income of $23,010.62 offsets my expenses, and drops it to $10,852.68 that needs to be covered by my investments, it would look like this:
As you can see, with side incomes, it makes it all the more possible because you only need to “find” another $11K to not have to ever work again.
What are all of these different retirement levels?
They call this “BARISTA” FIRE, and you can read all about the different versions of early retirement here.