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Jonathan Clements  |  August 4, 2018

FOR THE PAST MONTH, I’ve been inviting readers to test a rough-and-ready financial tool called the Two-Minute Checkup. The tool is designed to provide a quick initial financial assessment.

The hope: It’ll eventually be one component of a larger website and app that help folks figure out what financial steps they need to take and then nudges them to follow through. This reflects a notion that’s been much on my mind in recent years: Improving America’s personal finances is partly about education—but it’s also partly about finding ways to change behavior.

Because we’re in test mode, my business partner Derek and I are doing everything on the cheap. The Two-Minute Checkup is just a spreadsheet loaded onto a web page. It isn’t pretty—and navigating the spreadsheet can be frustrating. But I like to think the underlying logic is far more robust than the clunky user experience suggests.

The Checkup asks for just nine pieces of personal information—things you likely know off the top of your head—and then provides feedback across 10 areas of your financial life. How can we say so much based on so little information? Here’s a look at some of the logic behind the Two-Minute Checkup:

Financial Fitness. Suppose you make $80,000 a year. You expect some money from Social Security, so you want a nest egg that, as of age 65, will replace half your $80,000 income, or $40,000 a year. Assuming a 4% portfolio withdrawal rate, you’d need 12.5 times your current income saved by retirement, equal to $1 million in this example.

For the Two-Minute Checkup, we took that end point and figured out what milestones those still in the workforce need to hit along the way. This notion isn’t original. Others have made similar calculations.

So what milestones should you be hitting? You would want 0.8 times your income saved at age 30, 2.7 times at age 40, 5.5 times at 50 and 9.7 times at 60. The multiples increase slowly at first and then ever faster, as an increasingly large portfolio reaps escalating benefits from each year’s market gains.

Spending. As regular readers know, I put a big emphasis on limiting fixed living costs—things like mortgage or rent, car payments, cable bills and insurance premiums—to 50% or less of pretax income. That’s built into the Checkup’s spending advice for those still in the workforce.

What about retirees? The Checkup suggests withdrawing 4% to 5% each year of a portfolio’s beginning-of-year value—unless a retiree is age 50 or younger, in which case it recommends 3%.

Borrowing. Lenders will typically let borrowers take on monthly mortgage payments equal to 28% of pretax monthly income. This is the so-called housing ratio. But before lending that much, lenders also assess borrowers using another measure: the debt ratio. This looks not only at the proposed mortgage payment, but also at other debt payments, such as credit cards, car payments and student loans. As a rule, lenders don’t want to see all these various debt payments consuming more than 36% of a borrower’s pretax monthly income.

The difference between the 28% housing ratio and the 36% debt ratio is 8%. That’s the maximum sum that lenders believe borrowers should be devoting to nonmortgage payments, so that’s the threshold suggested by the Two-Minute Checkup.

Houses. For the Checkup, we use the housing and debt ratios to assess how much folks might borrow to buy a home. But we had to guess at one number: How much, as a percentage of pretax income, would most folks end up devoting to property taxes and homeowner’s insurance? Remember, the 28% housing ratio considers the total proposed mortgage payment—and that includes property taxes and insurance.

After researching the issue, we settled on a number that may surprise folks: As a percentage of pretax income, we assume most homeowners are likely to devote 6% of monthly income to property taxes and insurance. That means that—under the housing ratio—just 22% of someone’s monthly income is left for a mortgage’s principal-and-interest payment.

Financial Emergencies. An emergency fund is, more than anything, an unemployment fund—and that notion drives the Two-Minute Checkup’s recommendation. If your job is stable, it advises keeping three months of living expenses. If it’s iffy, it recommends six months. If you’re a couple and both have jobs, the Checkup combines the two figures.

The Checkup pegs living expenses at 60% of pretax monthly income. This is above the 50% figure we suggest for fixed monthly living costs. But we wanted to leave some room for error—and we realize not everybody hits that 50%.

Insurance. The Checkup recommends disability insurance if you’re working, life insurance if you’re in a relationship or have children age 21 or younger, and long-term-care insurance if you’re over age 50.

All these recommendations get dropped if you have $1 million or more in savings, on the assumption that your household would be fine financially, even if disaster struck. At the same time, however, the Checkup recommends umbrella liability insurance for the seven-figure crowd, because of the risk that your wealth will make you a target for lawsuits.

Estate Planning. The Checkup’s estate planning advice has three components. First, everybody should have a will, while also making sure they have the right beneficiaries listed on their retirement accounts and life insurance. Second, those with children age 21 or younger should make sure they name a guardian for the kids in their will. Finally, those over age 50 are advised to get powers of attorney—preferably one for financial matters and one for health care issues—in case they’re incapacitated.

If you try the Two-Minute Checkup, please also take the survey we created, by double-clicking on the link at the bottom of the spreadsheet. Alternatively, you can head to the survey directly from here.

Follow Jonathan on Twitter @ClementsMoney and on Facebook.

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