Financial Planning

Why a Good Credit Score isn’t a Good Indicator of Financial Health

Do you know your number?

Contrary to popular belief, a good credit score is not always an indication of good financial health. We assume those with bad credit must be bad managing money, and those with good credit must be financial gurus. But this isn’t always the case.

Out of all the financial indicators a credit score is the least relevant for an individual. Credit scores are used by leading institutions to extend credit at applicable terms – if you have good credit then you’ll get a lower interest rate and if you have bad credit you’ll have a higher interest rate. But simply looking at your “number” each year isn’t going to get you any closer to financial freedom and success. This article will outline better indicators of financial success than an old-fashioned FICO score.

Income

A better indicator of financial success is income. Instead of focusing on ways to improve your credit score you should focus on ways to increase your income. Pick up certifications in your field or get additional training to advance to higher positions at your company. If you aren’t making more money each year then you’re losing money due to inflation.

Fixed Expenses as a Percentage of Income

Another great indicator of financial success is the ratio of fixed monthly expenses to your monthly income. Fixed expenses are those expenses that are reoccurring: rent, mortgage payment, car payment, cell phone bill, cable bill, monthly subscriptions, etc.

It’s important to have a strong ratio between your fixed monthly expenses and your monthly income so that you maximize your discretionary income. This can be used for investing, saving for your kids college, creating a rainy day fund, and paying for major life expenses.

Percentage of Income Invested in Retirement Accounts

The easiest way to retire a millionaire is also the slowest way to retire a millionaire. Investing a set percentage of your annual income over the course of your working career ensures you’ll be ready for retirement. Having a good FICO score doesn’t help you in retirement because by then you want to have your home paid off and your monthly expenses minimized.┬áHaving $800,000 in a 401k means a lot more than having an 800 credit score.

Net Worth

Your net worth is calculated by taking the total fair market value of all your assets less any outstanding debt. This isn’t part of your FICO score so an individual with a net worth of $1 million could have a lower FICO score than someone with a negative net worth.

Increasing debt decreases your net worth especially if you use debt to pay for personal expenses. Taking out $5,000 in credit card debt to pay for a vacation and paying it off in a timely manner might help your credit score in the short-term, but it does nothing for your net worth in the long-term.

Conclusion

Working on your credit score doesn’t mean you’re achieving financial success. Working on your career, reducing your fixed monthly expenses, investing for the future, and being debt free is the easiest way to financial freedom. If you have questions regarding your unique financial situation please consult with your financial advisor.


This article is intended for educational purposes only and does not constitute paid legal, financial tax or other professional advice or services. To see how the information described in the article impacts your unique tax, financial or legal situation consult with an advisor.

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