What I Learned From the CFP® Professional Education – Part One

CHECK YOUR GAUGES

I haven’t posted online for months in order to focus on completing CFP® certification education requirements and studying for the CFP® exam. Happy to report I completed the coursework in April and passed the exam in July (whew!) and am waiting for official approval from CFP® Board to use the designation.

I learned a lot from the education coursework and wanted to share for those looking to improve their finances.

Let’s dive in 👇🧵

I’ve written about using a #budget to take your financial pulse:

We decide whether we take a journey of #wealth creation or debt slavery at the crossroads: "can we live on less 💵 than we make?" If so, we move toward wealth. If not, we’ve got work to do.

We answer this question is by taking our financial pulse, AKA #budgeting

👇👇👇🧵🧵🧵 https://t.co/dCWFlyxr3l
— Matthew Gagnon, CFA (@fin_empowerment) December 12, 2023

Keep it simple, track major income and spending categories, aim for a monthly cadence.

As you develop your budget, there are some helpful rules of thumb to identify potential problematic areas of your overall financial picture.

For example, are you …

spending too much on housing? carrying too much debt around? prepared for a financial emergency?

Some simple rules can help you confidently answer these questions.

HOUSING COST RATIO

Add up your monthly housing costs – mortgage payment (principal + interest), taxes, homeowner’s insurance, HOA, etc. and divide by your total monthly gross income. IDEAL: 28% or less.

EXAMPLE: someone with total monthly housing costs of $3,000 and gross monthly income of

$10,000 has a ratio of 3,000/10,000 = 0.3 or 30%. Little on the high side.

Thinking about moving? Want to know how much you can comfortably spend on housing? Multiply your monthly income by 0.28. Monthly income of $9,000 suggests total housing costs of $9,000*0.28 = $2,520. Look for something within that budget.

TOTAL DEBT RATIO

Add up all monthly payments you make on various types of debt and obligatory payments – credit cards, loans (auto, student, etc), alimony, child support, etc. Include your monthly housing costs (mortgage, PITI, HOA).
Divide that number by your total monthly gross income.
Ideal result: 36% or less. If higher, you may have too much debt and obligations.

EXAMPLE: someone with $2900 monthly housing costs, $300 credit card bills, and a $400 car payment with gross monthly income of $10,000.

$2900 + $300 + $400 = $3600.

$3600/$10,000 = 36%. This person should avoid taking on more debt and possibly look to reduce it.

FLIP IT: Again, you can use the ratio in reverse to estimate a comfortable level of total debt and obligatory payments by multiplying monthly income by 0.36. Monthly income of $13,000 =

$4,680 or less (ideally) total payments.

If you just want to look at consumer debt (credit cards, auto loans, etc.), the ideal ratio is 20% or less of monthly NET (after tax) income. $8,000 monthly net income and $700 consumer debt payments implies a consumer debt ratio of 8.75%.

The rationale of using net vs. gross income in the calculations involves the preferential tax treatment of mortgage debt vs. consumer debt. Although the recent tax law changes include limited deductibility of interest on new car loans (subject to a bunch of rules and limits).

CURRENT RATIO

Divide current assets / current liabilities
Current assets can be easily converted to cash or used within one year, such as bank accounts, publicly traded securities, and accounts receivable.
Current liabilities are due within one year, such as credit card debt, accounts payable, and taxes.
IDEAL: > 1.0 means short-term debt can be satisfied even if cash flows stop (job loss, etc).

EMERGENCY SAVINGS

IDEAL: enough to cover 3-6 months fixed + variable expenses
Held in CASH or LIQUID equivalents (< 90 days maturity)
2 breadwinners: smaller fund probably ok (3 months)
1 breadwinner: larger fund recommended (6 months +)

Progress building your nest egg

NET INVESTMENTS TO NET WORTH

Divide total investments by net worth (excluding home equity)
IDEAL: > 50%. < 20% suggests a need to build investment portfolio as retirement approaches.

Overall financial STRENGTHS & WEAKNESSES

If you work with a financial advisor they will likely try to tease these out: