The Moneystepper Personal Finance Score
They came up with the idea of assigning yourself a “Personal Finance (PF) score”. It is a brilliant idea and something that the personal finance world has been lacking. Their formula is simple:
The simplicity of this is great. However, being a geek, I craved something more!
This calculation gives you a very simple overview of your position. It breaks your score down into the following:
The traditional understanding of your financial position is net wealth. However, the balance sheet (net wealth) is clearly not enough. One person has $1m, but spends $1m per year. Another person has $500k, with annual expenses of $20k. Although the second person’s net wealth is not as much today, clearly their lifestyle means that they are in a better position in the long-term. This formula overcomes this problem.
The calculation doesn’t take into account income. When analyzing investments, you should look at the present value of the future cashflows. However, I like that the personal finance score doesn’t do this. For most people, maximizing future income streams through work isn’t their objective, and hence including your annual salary would not be beneficial to show your “financial position”.
There are three main problems I see with this calculation:
1) It doesn’t work with negative net wealth. If you have net wealth of -$100k and expenses of $10k, your score is -10. If your net wealth was still -$100k and your expenses were now doubled at $20k, your score would be -5, which would suggest you are in a better position, which isn’t true.
2) It ignores passive cash inflows. Whilst I believe it is a good idea to ignore your main source of income, your net wealth is clearly affected by your passive income streams. Say one person has $100k cash as part of their net wealth, and is earning 0.5% cash interest. Another person has $100k, but it is invested in a long-term bond paying 3% interest. Clearly, the second person is in a better position.
3) It ignores age. To make it comparable, the Personal Finance score should take into account the age of the person. The average 20 year old is going to have a lower net wealth than the average 50 year old. However, it would be good if their scores could be comparable.
A revised personal finance score
Ladies and gentlemen, let me introduce the “Moneystepper Personal Finance (MPF) Score”:
It is calculated in the following way:
This works on the assumption that your annual expenses exceed your annual passive income. If your annual passive income exceeds your total annual expenses, then congratulations, you have completed the Moneystepper Personal Finance Score!!
Also, this formula is still only useful for those people with a positive net wealth (as it has the same limitation as the original).
An alternative formula for people with negative net wealth
However, if you are in debt, you are probably more in need to a Personal Finance score to keep you motivated going forward. Fear not, moneystepper is here for you!!
Although a little ugly in the formula, the age multiple keeps the outcome in the same proportion as the positive net wealth.
I intend to make this standard for all moneystepper readers. Therefore, if you could please ask any questions you have in the comments below, I would be very grateful:
1) Should I include my mortgage? Yes. You should include all your assets and liabilities, including your home mortgage. Your home property should be valued prudently (at the lower of cost price or latest actual valuation).
2) Your question here…
Work out your score
I would really, REALLY, love to hear what score you get.
If you could let me know your age, score and whether it was calculated using positive or negative net wealth, either in the comments below or via email at email@example.com, I can work out an average to give you a benchmark of how well you are doing against your peers…