I strive for healthiness in all areas of my life: physically, relationally, and financially. The signs of physical health and healthy relationships are obvious, but what about financial health? How do you truly know if you are on the right track financially? Enter: personal finance ratios. These are calculations that allow you to determine where your financial weaknesses are; once you know your score, you can then make changes to be on the right track. Here are some of the most important personal finance ratios that everyone should know.
Total debt to income ratio: Ideally 0%, but no more than 35% of monthly (net) income. Banks use this ratio to determine someone’s default risk on loans, especially mortgages. This would include all debt, such as mortgages, student loans, credit car payments, car loans, and personal loans. Most financial professionals consider student loans and mortgages as “good” debt and stress lowering at least the consumer debt, if nothing else.
Savings ratio: Between 10-20% of net income. This should be composed of your emergency fund, retirement fund, and college fund for children (if applicable.) Popular financial guru Dave Ramsey teaches that if you are working to pay off debt, you should have a basic emergency fund of $500-$1000 until you are debt-free, which I don’t necessarily agree with (I think it should be a bit higher.) He also teaches that you should wait to contribute to retirement once you are debt-free, which I also disagree with; if your employer offers a 401(k) match, to not contribute while you are paying off debt is like throwing away free money.
Housing ratio: around 25%-28% of net income. This would include not only rent/mortgage and utilities, but homeowners taxes, insurance, homeowners’ association fees, and money for ongoing home maintenance. If you live in an area with a higher cost of living, you may have to increase this amount slightly.
Liquidity ratio: Cash divided by monthly expenses. This is just a fancy term for “emergency savings.” In the event of an emergency, such as a job loss, how many months would you be able to stay current on your bills? Ideally, you would have a minimum 3-6 months’ of expenses available in liquid accounts, although I am more comfortable with 9-12 months’ emergency savings.
Solvency ratio: Net worth divided by total assets. Ideally your net worth would be 50% or more greater than your total assets. For someone who is just starting their career, this amount would be lower because most likely they have student loans and few assets, but as someone gets closer to retirement this amount should increase.
Being properly insurance is important because you never truly know what could happen in the future and want to be protected for anything that might happen.
Disability insurance amount: around 70% of your gross income. If you were somehow unable to work, you would need a way to pay your bills.
Homeowners’ and auto insurance: the cost of replacing them and the belongings inside. If something happened to your house or vehicle, you would also need a way to purchase new ones. Ideally, this would be by insuring them for the cost it would take to replace them. At minimum, you should insure them for their fair market value.
Life insurance: This one is a bit more complicated, because it depends on your life situation. For example, I’m a single woman with no kids, so I don’t need as much life insurance as my friends with kids. If you’re debt-free with a large chunk of money in savings, you won’t need as much insurance as a person with a mortgage
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