10 Financial Formulas to Know

For those looking to best understand their financial situation, I have 10 simple formulas to clarify your financial picture. These are great formulas as they allow you to track progress over time.

Personal finance is dynamic. Situations change. Priorities change. Use these formulas to guide your financial decision making to ensure your ship is heading in the optimal direction.

1.      Net Worth

Net Worth = Assets - Liabilities

Everything you OWN minus everything you OWE.

Example:

• Assets totaling $1,200,000

  • $50,000 - Cash

  • $250,000 - Stock Investments

  • $500,000 – 401(K)

  • $400,000 – House

• Liabilities totaling $200,000

  • $200,000 – Mortgage Debt

This person has a net worth of $1M. Many SRNAs and recent graduates have a negative net worth. If you only have a couple bucks in your checking account, but carry $200,000 in student loan debt, I’m sorry to say, you are financially worthless.

Everyone has significant social value. Don’t get the two confused.

With the power of the CRNA income, it won’t take long to pay off those pesky debts all while seeing your retirement accounts grow. Achieving a positive net worth is a milestone for those working in high opportunity-cost professions.

Mrs. TFC and I track our net worth monthly using this sheet. We have a set amount that we invest every month. I expect our net worth to increase to match our monthly investments accounting for market fluctuations.  

Monthly tracking may be more frequent than necessary, but I like to know if something doesn’t add up so I can intervene sooner rather than later.

2.      Gross and Net Income

Gross income is the total amount earned before taxes. If you sign a contract for $200,000 annually as a W2 employee, $200,000 is your gross income. Your monthly gross income is $16,666. But your paycheck doesn’t look like that.

Net income is the income after deductions. Think take-home pay. Your employer deducts taxes and insurance (among other things) from your check each month. So that $16,666 gross income shrinks to $12,000 per month depending on your withholdings.

As a W2 employee, I calculate everything off my net income. No use worrying about the dollars siphoned by Uncle Sam. Taxes are by far my largest expense. I take note and move along.

When the following 8 formulas refer to income, it’s almost always NET income because that is the income you can control.

This is where 1099 folks differ. Sometimes they run into trouble. There is no employER to withhold any money for taxes and insurance. 1099 contractors are responsible for managing these aspects on their own.

Best to set aside half of everything earned to be on the safe side. There are a lot of places one can cut spending, but the quarterly amount to the IRS isn’t one of them.

I’m reminded that if I have a “paying too much in taxes” problem, it means I’m making money.

3.      Money as Hours Equivalent

Hours To Be Worked = Cost / Net Hourly Earnings

This is a great formula for purchase decisions. Let’s say you want to buy a vehicle that costs $50,000 and your NET income is $100 per hour.

Hours To Be Worked = $50,000 / $100 per hour = 500 hours

This means you need to work 500 hours or 12.5 standard weeks to pay for the vehicle. Would you pass gas for 12.5 weeks without pay in exchange for a brand-new car?

If that’s worth it, go for it.

I use this formula for conveniences. When is it worth buying food vs preparing food? How about mowing your lawn? Cleaning or improving your house?

4.      Cost of Living

This is a very valuable metric and one you should track monthly. Just as it sounds, this formula is simply how much you spend to live.

Include all expenses -- housing, transportation, food, supplemental insurance, entertainment, and discretionary spending. Note where every dollar goes.

As with net worth, Mrs. TFC and I track expenses monthly. We categorize spending with the following categories because it works for us:

• Monthly (mortgage/utilities)

• Vehicles

• Food

• Date Night

• Home Repairs

• Discretionary (one for each of us)

Mrs. TFC made the cards, so I didn’t dare question it. Monthly really means housing and utilities. Vehicle expenses are insurance, fuel, and repairs. Food means groceries. Date night means entertainment. Home repairs were significant at first but lately just includes small fixes. And we each have a discretionary fund to do with as we see fit.

If we travel or have a major expense, we add a category. If you have student loans or other debts, those deserve their own category.

Add everything up at the end and you have your cost of living for the month. Track the trend over time to estimate your monthly cost of living.

5.      Savings Rate

Savings Rate = (Net Income – Spending) / Net Income

Using the aforementioned CRNA salary, I have a net income of $12,000 per month. Over the course of a year, let’s say my spending, or cost of living, is $7,000 per month.

SR = ($12,000 - $7,000) / $12,000 = 0.416 or 42%

Not bad.

Now this formula will vary slightly if you have a bunch of pretax retirement dollars coming out of your check. Those contributions may decrease your true take-home pay by $2,000 or more per month monthly. I use my true take-home pay because again, it’s all about the trend.

Tracking net worth will show the retirement account contributions.

Financial advisors will commonly recommend a 5-15% savings rate. That’s a joke. My blog, my opinion.

I say 5-15% is way too low for CRNAs because the income is so strong, there is little reason to be spending this much AFTER paying off high interest debts. I acknowledge student loan payments skew this value.

CRNAs should look to put away 25-50%. Really though, invest early so it has time to compound.

Mrs. TFC and I run between a 75-85% savings rate of our net income and we live a comfortable middle-class lifestyle. It’s a bit excessive for most, but financial independence is the goal and your job is never as secure as you think.

6.      Financial Independence Number

Financial Independence = 25 x Annual Cost of Living

There is a bit of nuance to this formula that you can read about here. The premise behind this formula is that a nest egg 25 times your cost of living allows for a 4% annual withdrawal rate to live on.

This accounts for no earned income during this time. It also looks for your portfolio to return 6-8% annually to compensate for market fluctuations and inflation.

Multiple simulations ran the annual 4% withdrawal over 20- and 30-year periods starting at the most and least opportune times. The nuances involve adjusting cost of living based on investment returns.

All in all, this is a reasonable target to aim for. It’s a broad estimate of how much you will need to retire.

I mentioned a $7,000 monthly cost of living. That’s $84,000 annually. Multiply by 25 and you have an FI number of $2.1M. If this is a standard of living you are looking to maintain, you could theoretically walk away from all earned income today with a nest egg of $2.1M.

The biggest pitfall of this formula is changing one’s cost of living during retirement. Say you want to travel, which may cost $10,000 per month. Calculate the cost of living based on your expected expenses. Look for $2.5M to retire.

The second pitfall is major purchases. Many of the financial independent, retire early (FIRE) community keep their costs extremely low, which makes their FI number low. Well, it’s tough to buy that $50,000 vehicle if you expect to live off $84,000 annually.

One can save up during retirement or account for additional expenses by overshooting their FI number. Again, it’s a rough calculation.

It bothers me knowing so many CRNAs in their 20s, 30s, and 40s have ZERO idea about how much they will need to retire. That’s pretty senseless to me. How does one determine if their investments are appropriate without a target on the horizon?

Priorities change. And the ability to work may change. Both great reasons to track your progress towards financial independence.

7.      Rule of 72

Years for Investment to Double = 72 / Annual Rate of Return

If you have $100,000 invested and don’t add another dime, what would it look like down the road?

Let’s say the stock market averages a 9% annual rate of return.

72 / 9 = 8 years to double

So, 8 years from now, that $100,000 investment doubles to $200,000.

Keep in mind, this accounts for exactly a 9% return every year. It also accounts for no additions or subtractions from the account. It doesn’t account for inflation and buying power.

Nevertheless, this formula is a great way to estimate future returns. It really notes the difference a small increase in return can make over the long run.

For example, certificates of deposit were earning less than 3% for many years. At 3%, a CD would take 24 years to double. The stock investment doubled in 8 years. A successful investment in real estate that produced a 20% return would double in 3.6 years.  

These are the results of a $100,000 investment after 24 years. The 3% CD would double to $200,000. The stocks returning 9% annually would be worth $800,000. The high performing real estate that just keeps on giving would be worth just over $9.5M

The power of compounding interest.

8.      Asset Allocation

Percent of Portfolio in Stocks = 120 – Age

If you are young and just starting your gas passing career, it is advantageous to have a greater percentage of investments poised for growth compared to fixed income products.

To keep this simple, stocks have a greater growth potential than bonds. To maximize portfolio returns over a career, it is suggested that younger individuals invest heavily in stocks because a multiyear downturn will be negated over a 30-year period. And the stock market traditionally outperforms fixed income products over time.

Aging investors should utilize fixed income products that guarantee return, even if the return simply keeps pace with inflation. This maintains buying power through retirement. The importance shifts from growing the portfolio to maintaining the portfolio.

Target date funds in your 401(k) use a similar formula to gradually adjust the allocation mix from 90/10 stocks to a 50/50 mix of stocks and bond.

9.      Debt to Income Ratio

DTI = Monthly Debt / Gross Monthly Income

Monthly debt includes the mortgage, any loans or debts, credit card payments, and child support. Expenses such as food, utility, insurances, and taxes are not included in “monthly debt.”

Gross monthly income is just that. For high income earners, this number is skewed because there will be a greater percentage of taxes unaccounted for. Using net income would be more appropriate, but I didn’t invent these formulas.

So that CRNA grossing $16,666 per month should keep their monthly debt below $7,166 to avoid red flags from a lender.

Monthly debt adds up quickly. A $4,000 house payment, $2,000 student loan payment, and $1,000 on a credit card.

Lenders begin to worry if your DTI ratio is over 43%. They consider a desirable ratio to be less than 35%, which would be closer to $5,833 per month.

When Mrs. TFC and I applied for a mortgage, it was pretty easy to calculate as we don’t carry personal debt. Our rent payments would have been classified as monthly debt. We use credit cards, but don’t carry a balance. Needless to say, they didn’t bother us about our DTI ratio.

10.  Credit Score

A number created to assist lenders in assessing your reliability to pay back a loan. There are three credit bureaus that generate a credit score – Experian, Equifax, and TransUnion.

They gather the following information to calculate a score on one of two scoring models – FICO or VantageScore.

Factors of a FICO credit score per cnbc.com:

• Payment history (35%) – reliably pay bills

• Amounts owed (30%) – credit utilization

• Length of credit history (15%)

• New credit (10%) – open new accounts

• Credit mix (10%) – having a variety of loans

A chart I borrowed from the credit score blog post.

Lenders reserve the best rates for those in the “very good” and “excellent” categories. Rates vary by score. One may see a 1.5% rate difference from a “good” to “excellent” rating.

There are a lot of misconceptions about credit scores that I won’t go into as they are more than most of you care to know. If you want a detailed breakdown of credit scores, read about it here.

I can safely say, a CRNA with an average income and reasonable cost of living shouldn’t have any trouble getting approved for waaaay more than is reasonable. Remember, lenders are not afraid to push the limits of lending if the loan is backed by an “asset.”

From the lender’s view, over lending means at worst, the lender receives interest on the loan. At best, a borrower bit off more than they can chew and consequently becomes delinquent on their payments. This translates to penalties and red marks on a credit report. Penalties are gravy for the lender.

Ultimately, the lender may collect a few penalty payments, then seize the asset, in which they sell to pay off the loan. Repossessions are quite impactful on a credit report, so best to avoid.

Just because you can borrow a certain amount doesn’t mean you should.

Disclaimer:

I’ll be honest, the last two formulas are something I have calculated in the past, but rarely reference. This is because I’m generally debt averse. If you plan on borrowing money for a mortgage in the near future, take a look at these to spot any potential red flags before starting the borrowing process.

I would highly recommend tracking many of these monthly as it will shed light on your dynamic personal financial situation. Hopefully the trends are for the best. As always, thanks for reading!