The 3 Most Important Financial Numbers You Need to Know

Liz Davidson

Are you getting the right answer to the wrong question? When people find out I used to run a hedge fund, they often ask me, "What is a hot investment right now?" Of course, I don't attempt to answer the question for a lot of reasons, the least being that I would have to ask them a series of probing questions about their finances. Besides, I am not a money manager. Either way, it always occurs to me that they might just be asking the wrong financial question.

I have built my company around the belief that people aren't really interested in money, but rather making their own lives richer, deeper, and more fulfilling. With that in mind, a better question to ask would be, "What are the most important numbers I need to know when it comes to personal finance?" It isn't the hot stock or right mutual fund that will make the biggest difference in their finances or help them attain their financial goals. What they should be looking at are their savings percentage, net worth, and credit score. For someone who is on their way to achieving financial success, each of these numbers will be trending in the same direction -- up.

Want to find out if you are on the right path? Here are three essential questions you should ask yourself:

What percentage of my income am I saving?

The hardest thing about finance is that you can't focus on one thing at a time. If you focus only on eliminating debt, you'll neglect your long-term retirement savings. If you max out your retirement savings while holding on to high-interest debt, you'll get stuck wasting dollars on high interest payments rather than saving more for your future. Your financial decisions don't exist in a vacuum, but people who save a high percentage of their income tend to find it easier to make the moving parts work.

How much should you be saving? Many people follow the rule of thumb to save at least 10 percent of their income for retirement and another 10 percent for other goals, such as an emergency fund. High-percentage savers also save on borrowing costs since they are able to pay cash for things, such as automobiles, rather than getting loans. In fact, one of our financial planners calculated that someone could actually save as much as $185,000 over the next 20 years by simply not having a car payment. Imagine how much your net worth would increase if you could do the same. Find out where you stand by reviewing your current contribution rates to your 401(k) and other retirement plans, as well as your overall savings percentage.

What is my net worth?

Watching your wealth build can be like watching the grass grow; sometimes the mower comes in and cuts everything down. Use an annual personal net worth statement to track the incremental changes to your financial landscape from a helicopter view. That way you can easily determine if you have too much of your net worth in one investment, too much debt, or not enough saved for emergencies.

Imagine being able to review your net worth statements for the past 10 years showing your debt slowly declining as you pay down your mortgage and your assets increasing as you save more. You would have a better perspective on things so that when real estate values fluctuate or the stock market falls you can know when to relax, and when to be concerned.

What is my credit score?

Your credit score is not the "be all and end all" of finance -- it is not an investment and doesn't generate future income -- but it does help reduce costs by lowering the expense of borrowing money. For example, if you have a credit score around 680, you might qualify for a 30-year fixed mortgage around 5% in today's market, but if you have a credit score over 760, you might qualify for a rate around 4.625%. It may not seem like much, but if you were to borrow $250,000 over 30 years, a few tenths of a percent could cost you over $20,000 in additional interest. When you combine that with the savings you might get from better rates on things like credit cards and auto loans, you start to see why a good credit score is important to your financial success.

Paying lower interest rates on debt is not the only benefit of having good credit. Some employers look at an applicant's credit history before considering them for hire, and many auto insurance companies give discounts to customers with high credit scores because having good credit is correlated with lower insurance claims. Having excellent credit can save you a significant amount over your lifetime. Learn how you can improve your credit score at myFICO.com.

It should surprise no one that financial problems are a leading cause of stress, and while studies show stress is a leading cause of illness, new research suggests that there is a link between financial stress and metabolic syndrome. In light of this, it is more important than ever to focus on the right things and to get our financial numbers in order. We want our net worth to go up and our blood pressure to go down -- not the other way around.

Liz Davidson is CEO of Financial Finesse, the leading provider of unbiased financial education for employers nationwide, delivered by on-staff Certified Financial Planner professionals.

9 Ways to Build Wealth in 2011

by Dana Dratch

Want to build some wealth in 2011? Revisit those New Year's resolutions.

You probably haven't thought about your pledges in more than a month. But odds are at least one of them involves getting rid of debt, increasing your income or building some financial security.

To help you out, nine experts in the fields of money, debt, real estate and consumer affairs have shared their best wealth-building tips for 2011.

1. Funnel That FICA Cut Into a Retirement Windfall

David Bendix, CPA/PFS, CFP, president of The Bendix Financial Group:

Take the money you won't pay in FICA, or Federal Insurance Contributions Act, taxes this year and redirect it to your 401(k). "It's a great concept that you're taking that 2 percent and using it to fund your retirement," he says. "It's one great technique for the coming year."

[Click here to check savings products and rates in your area.]

Tip for success: For the maximum impact, talk with human resources ASAP and change your deductions, Bendix says. One hopes the habit of saving a little more will stick with you through next year, too, he says.

2. Look For Low-Cost Mutual Funds and Watch Those Fees

Jill Gianola, CFP, owner of Gianola Financial Planning, LLC, and author of "The Young Couple's Guide to Growing Rich Together":

"One of my favorite ways to build wealth is to pay close attention to the cost of investing and stick to low-cost, no-load mutual funds," she says.

One example: "If you invested $10,000 in small-cap, value funds with a commission and higher-than-average operating expenses and earned 7 percent a year for 10 years, your balance would be $16,005 and you would have paid a sales charge of $575 and $1,890 in operating expenses," she says.

"Compare that to investing the same amount for the same time period earning the same return in a no-load, small-cap, value fund with low operating expenses," she says. "Your balance would be $19,128 and you would have paid $408 in operating expenses." The difference: $3,123.

Tip for success: Calculate cost and differences with Bankrate's mutual fund fees calculator.

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3. No Shortcuts: Year After Year of Consistent Savings

Ric Edelman, chairman and CEO of Edelman Financial Services LLC, and author of "The Truth About Money":

"The best way to build wealth remains unchanged: Invest as much money as you can (which is usually more than you think you can) into a diversified set of low-cost mutual funds and exchange-traded funds -- and keep doing this for many years, no matter what."

4. Get Rid of High-Interest Card Debt

David Jones, president of the Association of Independent Consumer Credit Counseling Agencies:

"For most people, building wealth is not about what to do with excess disposable income," he says, but "how to keep more of the money that they earn."

"The best way to do that: Reduce the amount of money spent on interest payments -- especially high-interest payments attached to credit card purchases," Jones says. "If a consumer can work to pay off just one high-interest credit card and not overcharge it again, then the money saved after it is paid off can go to a building-wealth plan. This may not be easy, and it may take time, but it's a realistic goal for just about every consumer."

Tip for success: Find a certified credit counselor to help you draft your own personal spending plan for free. To find one, visit either the AICCCA or the National Foundation for Credit Counseling.

"If the consumer sticks to that plan, it will be their best chance to begin a systematic process for building wealth," Jones says. "It may be modest at first, but with diligence, everyone can have a chance to improve their financial circumstances."

5. Buy a Home

Ron Phipps, president of the National Association of Realtors and principal broker for Phipps Realty in Warwick, R.I.:

Want to build wealth in 2011? Buy a home, Phipps says. Mortgage rates are low, selection is great, prices are about one-third lower than five years ago, "and, by the way, you can live in the investment," he says.

Homeownership remains a long-term vehicle to financial independence and wealth, Phipps says.

Tip for success: Even though it sounds "pretty elementary," it's especially vital to "use common sense when buying and selling," Phipps says. "Price at the market to sell. Buy what you need and can afford."

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6. Balanced, Diversified Portfolio Plus Education

Karen Altfest, CFP, principal adviser and executive vice president of client relations at Altfest Personal Wealth Management, a fee-only financial planning firm based in New York:

"Have a balanced portfolio," Altfest says. "So many people think that as they get older, money will come from interest. The secret is (keeping) a well-balanced, diversified portfolio and learning what it all means."

Too many times, people take the "set it and forget it" approach with their retirement accounts, she says. But you shouldn't "let it get cobwebs because you can't deal with it," Altfest says. "Get help." Your goal for the year: Get educated about what's in your retirement accounts and why.

Tip for success: You don't solely want only fixed-rate instruments such as bonds and CDs, she says, because it takes more than compounding interest to build a retirement fund.

7. If You Have an HSA, Max It Out

Eric Tyson, author of "Investing for Dummies" and "Personal Finance for Dummies":

"I'm a very big fan of (health savings accounts) because they offer better potential tax benefits than a traditional retirement fund," Tyson says. With HSAs, investors receive an upfront tax break, compounding investment earning, and pay no tax on the money that is withdrawn "as long as its use is for health expenses," he says.

But the device might not work for everyone. "Obviously, you have to have a high-deductible health plan," he says.

Before 65, if you pull money from your HSA for nonhealth expenses, you'll pay income tax and a 20 percent penalty on the withdrawal. After 65 (or in cases of death or disability), such withdrawals are taxed as income -- without the 20 percent penalty.

The maximum you can put into an HSA in 2011 is $3,050 for an individual account (plus an extra $1,000 if you're 55 or older), and $6,150 for a family account, he says.

8. Do Your Due Diligence

John Breyault, director of the National Consumer League's Fraud Center:

To build wealth that you can rely on, vet the adviser and the investment thoroughly, Breyault recommends. Some red flags:

• Guaranteed returns. "There's no such thing as a guaranteed return," he says.

• Pressure. "If it's a good investment opportunity today, it will be a good investment opportunity tomorrow."

• Nothing in writing or a reluctance to share information you could present to a third-party. "If it's a significant sum of money, I wouldn't hesitate to run it by an attorney," Breyault says.

• A significant upfront sum. "You shouldn't have to invest more than you're comfortable with," he says.

Also, "you should be able to get your money out easily," Breyault says.

Tip for success: Run investments and their representatives past state protection agencies such as the office of consumer protection and the state attorney general's office, he says. Also check with business sources such as the Chamber of Commerce and the Better Business Bureau.

Check with regulating authorities such as the Financial Industry Regulatory Authority, or FINRA, BrokerCheck, the Federal Communications Commission and the Securities and Exchange Commission. And verify any degrees and accreditations directly with the bodies that offer them.

And run a Google search on the company name, principals and basics of the investment.

9. Start Your Own Side Business

Robert Pagliarini, CFP, president of Pacifica Wealth Advisors and author of "The Other 8 Hours: Maximize Your Free Time to Create New Wealth and Purpose":

"Start a business in your free time," he says. "I'm a big proponent of having a side venture, something you are passionate about that you can work on after your 'day job.'

"I think this is the best advice to give someone now -- especially for those who are unemployed," Pagliarini says. "And starting a business doesn't have to cost much, if any, money."

With Retirement Savings, It's a Sprint to the Finish

by Tara Siegel Bernard

What would you do if your financial planner prescribed the following advice? Save and invest diligently for 30 years, then cross your fingers and pray your investments will double over the last decade before you retire.

You might as well go to Las Vegas.

Yet that's exactly what many professionals and fancy financial calculators have been telling consumers for years, argues Michael Kitces, director of research at the Pinnacle Advisory Group in Columbia, Md., who recently illustrated this notion in his blog, Nerd's Eye View.

The advice is never delivered in those exact words, of course. Instead, this is the more familiar refrain: save a healthy slice of your salary from the start of your career, invest it in a diversified portfolio and then you should be able to retire with relative ease.

The problem is that even if you do everything right and save at a respectable rate, you're still relying on the market to push you to the finish line in the last decade before retirement. Why? Reaching your goal is highly dependent on the power of compounding — or the snowball effect, where your pile of money grows at a faster clip as more interest (or investment growth) grows on top of more interest. In fact, you're actually counting on your savings, in real dollars and cents, to double during that home stretch.

But if you're dealt a bad set of returns during an extended period of time just before you retire or shortly thereafter, your plan could be thrown wildly off track. Many baby boomers know the feeling all too well, given the stock market's weak showing during the last decade.

"The way the math really works out is unbelievably dependent on the final few years," Mr. Kitces said. "I just don't think we've really acknowledged just what a leap the very last part really is."

Consider the numbers for a 26-year-old who earns $40,000 annually, with a long-term savings target of $1 million. To get there, she's told to save 8 percent of her salary each year over her 40-year career. (We assumed an annual investment return of 7 percent, and 3 percent annual salary growth, to keep pace with inflation). Yet after 31 years of diligent savings, her portfolio is worth just slightly more than $483,000.

To clear the $1 million mark, her portfolio essentially must double in the nine years before she retires, and the market must cooperate (unless she finds a way to travel back in time and significantly increase her savings).

Should the markets misbehave, however, delivering a mere 2 percent return over the 10 years before retirement (not all that hard to imagine, considering the return of a portfolio split between stock and bonds over the last decade), she falls short by about a third. Her portfolio would be worth only about $640,000. The chart accompanying this column illustrates this.

You can quibble with our assumptions in this example. But a similar pattern emerges regardless of your financial targets and projected returns, Mr. Kitces says. So if your target is to save $500,000 or $2 million, and if you assume a 6 percent return or a higher 10 percent, you're still relying on your investments to roughly double in the final years before retirement.

Of course, an extended period of dismal returns during any point in your career can inflict damage. But the homestretch before retirement is often the most anxiety-inducing because workers have neither the time nor the financial capacity to recover before they begin taking withdrawals. "Getting the bad 2 percent decade in the earlier years has far less impact because there are fewer contributions already invested," Mr. Kitces said. "Conversely, when the bad returns come in the final 10 years, no reasonable amount of savings will make up the shortfall."

So what's an investor to do about all of this, especially as one of the other pillars of retirement savings — pensions — disappears? And who's to say how Social Security may change by the time that 26-year-old retires?

Most of the solutions, if you can call them that, fall into the "easier said than done" category. If you can't handle the uncertainty of missing your financial targets, you can try to save more and create a less volatile portfolio, Mr. Kitces says, which may also provide a firmer retirement date.

And naturally, the earlier you start saving, the sooner you're likely to reach the critical mass you'll need for compounding to accelerate (assuming the markets provide some lift in the first half of your career). But you will still need to save more than many retirement calculators suggest, since they're likely to recommend saving a lower amount when you have such a long time horizon. Then you can end up in the same predicament, where you are heavily leaning on market returns in the years before retirement.

"What the wise person does is save a large amount of money when they are young," said William Bernstein, author of The Investor's Manifesto: Preparing for Prosperity, Armageddon and Everything in Between and other investing books. "And if they can do that, when they are older, they can cut back on their equity allocation. When you've won the game, you stop playing the game."

But that can be hard to accomplish when you have other needs competing for those dollars, whether it's a down payment for a house, a 529 college savings plan or starting a business. Or perhaps you're already living on less because you're unemployed (or underemployed) or because health insurance consumes a significant chunk of your income.

"It's the cruel irony of retirement planning that those people who most need the markets' help have the least financial capacity to take the risk," said Milo Benningfield, a financial planner in San Francisco. "Meanwhile, the people who can afford the risk are the ones who least need to take it."

A more prudent course of action is a flexible one that acknowledges the many possibilities and accounts for ideal and less-than-ideal spending amounts.

Try using different assumptions for the years leading up to retirement, suggests Scott Hanson, a financial planner at Hanson McClain in Sacramento. If you want to retire in 25 years, for instance, you might use a return assumption of 8 percent for the first 15 years of savings, then reduce that rate to 6 percent or less in the final decade, he says.

"Here's the catch: most folks aren't saving enough using standard growth assumptions," he said. "If they begin to use lower growth assumptions in order to ensure their retirement, they'll fall further behind and become even more discouraged."

But simply going through these exercises may help the reality sink in. At the very least, it will show how imprecise even the most sophisticated projections may be.

"The actual date I get to check out with my target sum to retirement is much more uncertain than we give it credit to be," Mr. Kitces said. "It's more like 40 years, plus or minus five to 10 years. If you want more certainty, you can have it, but you have to save more and take less risk."