Peter Dunn (www.petetheplanner.com), author and speaker on personal finance, has developed a helpful tool that he calls Power Percentage. It is designed to give the user an objective measure of financial health. The tool measures how much of a person’s gross monthly income is spent on consumption. Less money spent on consumption produces a higher Power Percentage result. Those with higher Power Percentages have healthier personal finances because they are living farther beneath their means.
Calculate your Power Percentage
Here is how to calculate your Power Percentage. Total all of your monthly saving activity such as:
- Contributions to retirement plans, including employer match, if any.
- Contributions to a college fund.
- Deposits into savings accounts that will not be spent in the immediate future.
- Deposits into other investments.
- Contributions to a qualified Health Savings Account that are not earmarked for a specific procedure in the immediate future.
Now add to your saving activity the total of your monthly debt repayment activity such as:
- The principal amount only of your mortgage payment (exclude interest, property taxes, and insurance).
- Payments on medical and student loan debt (principal and interest). Do not include interest-only payments.
- Payments on credit card debt, but only on credit cards you are not currently using.
- Monthly payments on any other debt except auto loans.
The final step is to divide the total of your monthly saving activity and debt repayment activity by your gross monthly income (the income figure before any deductions are made). Now you have your Power Percentage. As an example, say the total of your monthly saving and debt repayment activity is $2,000 and your gross monthly income is $6,000. Divide $2,000 by $6,000 to get your Power Percentage which is 33% ($2,000/$6,000 = 33%). In the example, two-thirds of the monthly income was spent on consumption while one-third was invested in saving or debt reduction. Note: The repayment of mortgage principal is both debt reduction and saving as the repaid principal becomes equity in the house.
What your Power Percentage means
Where do you rank on the Power Percentage scale?
- Less than 10%: Poor. Nearly all of your income is spent on consumption
- 11% to 20%: Fair. You are dedicating some income to saving and debt repayment but not enough.
- 21% to 34%: Good. This is a healthy mix of saving, debt reduction, and consumption.
- 35% and over: Excellent. You are on your way to financial independence.
Rating the Power Percentage tool
The Power Percentage gives a snapshot of your finances that provides a useful measure of the constructive use of monthly income to improve your finances. The idea is to increase the Power Percentage by lowering the amount of gross monthly income that is spent on consumption.
The Power Percentage tool does not distinguish between saving and debt repayment, treating both equally. As a result, it may give a somewhat misleading indication of financial health. Using our example above, a person with a gross monthly income of $6,000 who is on an aggressive debt retirement program might pay off $2,000 of credit card and other debt each month and contribute nothing at all to savings and register a 33% Power Percentage while another person with no debt contributes $2,000 of her $6,000 monthly income to savings and has the same 33% Power Percentage. But the financial health of these two people is not the same. The person with no debt who saves $2,000 per month is in a much better financial position than the one who is paying off $2,000 worth of debt each month with no money going into savings.
In addition, the Power Percentage is no indication of a person’s financial liquidity or net worth, two critical factors in determining financial health.
Spending less and saving the rest is a core principle of a cash-based lifestyle and a frequent topic on this blog. It is the key to improving your personal financial health and security. The Power Percentage can help you evaluate and track your progress in this area.
K. C. Knouse is the author of True Prosperity: Your Guide to a Cash-Based Lifestyle, Double-Dome Publications, 224 pages