If you want to evaluate your personal financial position, you can use the personal financial ratios which are comparisons of the financial statistics and are calculated by dividing one number by another. These personal financial ratios examine and measure the relationships between two different items.
19 Personal Financial Ratios You Need to Know
Your personal financial statements provide you with an indication of your financial condition and the personal financial ratios help you to know your net worth and to give you the financial position insights that your personal financial statement alone cannot reveal.
I’ve been using my personal finance ratios to invest for financial freedom.
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What are personal financial ratios?
Personal financial ratios are key metrics that help people make conscious decisions about their financial future. Personal financial ratios give you an edge in your analysis by using simple math.
Financial planners, a family, and individuals are the main users of personal financial ratios. Personal financial ratios are the key elements of financial management. The ratios help in personal financial planning and determine the essential financial metrics used to make ideal financial decisions. The personal financial planning process can be a bit tedious.
Here’s a personal financial plan example to help you.
These key financial ratios are simple to calculate, easy to analyze and provides insights into individuals or a family’s financial condition. The ratios are ideal financial self-assessment tools and aids to judgment. They help pinpoint areas that an individual needs to pay attention to and to help them to make an informed decision.
Personal Finance Ratios Help the Personal Financial Planning Process
Financial ratios can tell the truth about a particular financial situation. I can’t tell you how many times I hear people say “just look at my net worth”. That simply will not tell the entire story. Does this person have liquidity? Can this individual live off other sources of income if the primary day job income goes away?
Personal financial planning is partly an art and partly a science. Meaning that any given situation can vary and sometimes financial ratios won’t tell the full picture either.
Using a site like Personal Capital can help you compare your financial position relative to your age group and help you do your own personal financial ratio analysis.
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List of 19 Personal Financial Ratios
People used to think that there are only 5 types of financial ratios. I beg to differ. Here is the list of the 19 common (and not so common) types of personal financial ratios that are used in personal financial planning.
The personal financial planning process takes some time to become familiar with what is really important and what you do not need to focus on. Use these ratios to evaluate your financial health. It’s time for a check up…
1. Savings Ratio
The savings ratio indicates the amount an individual puts aside as savings for future use. It is calculated as savings over the gross income.
Savings Ratio = Savings / Gross income
Savings can include any form of fixed deposits, liquid funds, savings accounts, and others. Gross income, on the other hand, includes money earned in form of a salary, business profits, bonus, interests, and dividends among others.
An ideal savings ratio should at least be 10% of your gross income, but should be as much as possible (especially in your early years). This is obviously one of the most simple, but important personal financial ratios.
If you need to transfer money via ACH to your savings, here’s how you understand the routing number process.
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2. Personal Net Worth
This is an easy one. Okay, this is not a ‘ratio’ per se. However, it is a key metric that drives all of your other ratios. Personal net worth is a measurement of an individuals’ total wealth. It is calculated as the total value of all your assets minus the total value of all your liabilities.
Net Worth Ratio = Total Assets – Total Liabilities
The total assets include all the resources both physical and monetary that an individual owns whereas Total Liabilities includes the aggregate debt and the financial obligations owed to individuals at any specific period of time.
Net worth represents what you own minus what you owe. It helps to evaluate how much you are worth. If you aren’t using Personal Capital to track your net worth, you are simply missing out.
3. Liquidity ratio
The liquidity ratio is the ratio that indicates the individual’s financial ability to meet committed expenses when an emergency arises. It is calculated as liquid assets over the person’s net worth.
Liquidity Ratio = Liquid Assets / Net Worth
Liquid assets include all the cash or cash equivalents, equity mutual funds (not equity-linked savings schemes such as a certificate of deposit that have 3 year lock-in period), equities, debt funds (including short-term gilt funds, monthly income plans other plans except for the closed-ended funds) and all other assets which can be redeemed within 3-4 working days.
Net worth, on the other hand, is the amount left after deducting total liabilities from the total assets.
This ratio can help you to know how fast you can convert your assets into cash. It is important to maintain at least a 15% level of liquidity to be able to combat any unforeseen financial emergencies.
Most financial advisers suggest that an individual should at least set aside enough funds that can cater for their 3-6 months total expenses as an emergency fund savings.
With Wealthsimple, their algorithm will invest in liquid assets at the most optimal situation for your personal financial profile.
4. Debt to Asset Ratio
This ratio indicates the individuals borrowing position to know if they can borrow a new loan or should wait until the previous loan amount is settled. It is calculated as total liabilities over the total assets.
Debt to Asset Ratio= Total Liabilities / Total Assets
The total liabilities include personal loan, home loan, car loan, student loan, any credit card outstanding and any other form of a loan. Total assets, on the other hand, represent the person’s investments, cash (near cash), car, home among other assets.
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An individual should at least have a maximum of 50% debt to asset ratio. That means that the maximum amount of debt that an individual can take should never exceed 50% of his total assets.
5. Current Ratio
This ratio shows the ability of an individual to repay a short-term debt in the event of an emergency occurs. It is calculated as cash or cash equivalents over the short-term liability.
Current Ratio= Cash (Cash Equivalents) / Short-Term Liabilities
The Cash represents all the assets such as cash in hand, cash at the bank and other liquid assets or assets that can easily be converted into cash.
The short-term liabilities on the hand represent all the equated monthly installments (EMI) payments and all debt repayments that are made in the current year such as the credit card outstanding balance and other obligations met in the current year.
6. Investing Ratio
When you are building your investment portfolio, you need to determine how to do the asset allocation. If you need to learn more, here’s how to invest money wisely.
The investing ratio helps to determine the percentage of your assets in equities and in bonds. It is calculated as 120 minus your age.
Investing Ratio=120 – your age (equity) and the remaining portion (bonds)
If you are 30 years, then you should have 90% of your investment assets in stocks and 10% in bonds. This is however not a one-size-fits-all approach. If you are more risk-averse, then you can use 100 minus your age instead of 120. As you advance in age, the asset allocation shifts from more equities to more bond assets.
Asset Allocation is a strategy of dividing your investments and mitigating risks and helps to give you a balanced portfolio of investments. There are different types or classes of investments and they have varying levels of risk and returns and so you should determine the right investments to make based on your risk tolerance.
With Personal Capital, they help me understand my asset allocation position and where I am tracking to retirement. This is a great example of how a wealth management tool can help you understand your personal financial situation and achieve financial freedom.
Also, try downloading my calculator to see what it will take for you to live off dividends.
7. Investment Assets to Total Assets Ratio
This ratio helps to compare the liquid assets held by an individual against the total assets accumulated. It is calculated as Liquid Assets over the Total Assets.
Investment Assets to Total Assets= Liquid Assets/Total Assets
Liquid assets are the assets that include cash, and near cash assets like the investments in stocks, mutual funds or other investments that can easily be converted into cash.
The Total assets, on the other hand, represent all illiquid assets such as the real estate or other assets that can take longer to convert into cash. Wealthsimple is a great platform to automate your investment strategy at a very low cost.
An individual should at least have 20% of the total assets in liquid assets to be able to cater for any emergencies. Try to increase your retirement contributions through a mega backdoor Roth IRA.
8. Passive Income Ratio
This one is a bit of a foreign financial ratio, but it is one that we really like. What ratio of passive income to current income can you earn? Current income would include your ordinary day job income. I love this financial ratio because it really tests how close you are to hitting actual goals of replacing your day job income with passive income assets.
Passive Income Ratio = Passive Income / Primary Income (Primary income is your day job income)
I think a target of about 50% is ideal for Passive Income to Primary Income. I will get to that in a second…. If you don’t know what the difference is between passive and nonpassive income is, you can review our primer on passive vs nonpassive income.
9. Side Hustle Income Ratio
Another uncommon personal finance ratio! What are side hustles? A side hustle is something that you work hourly, fixed fee or even something that is sold on the side. Side hustles are a great way to increase your income.
Side Hustle Income Ratio = Side Hustle Income / Primary Income (Primary income is your day job income)
I think a target of about 50% is ideal for Side Hustle Income to Primary Income. Why? I will get to that in a second…. I swear!
Use these income opportunities to boost your income.
10. Financial Freedom Ratio
The Financial Freedom Ratio is a great barometer of how close you are to being able to fully quit your day job and live completely financially free to do whatever you want!
Financial Freedom Ratio = (Passive Income + Side Hustle Income) / Primary Income (Primary income is your day job income)
Ok, so you should have 50% Passive Income Ratio and 50% Side Hustle Ratio, right? That would imply that you have a 100% Financial Freedom Ratio!
Get it? Good. Keep in mind that you don’t always need 100% for your Financial Freedom Ratio. Some people enter financial freedom by taking a pay cut from their current primary day job income. Think about your personal financial situation and evaluate on your own. This ratio is a great barometer on your true meaning of financial freedom success.
11. Personal Cost of Debt
Personal cost of debt is so important. I cannot stress this enough. This is a line in the sand that helps you understand if you should pay down debt or invest. This is the best metric for debt prepayment. This personal finance ratio analyzes your cost of borrowing on a blended interest rate basis. In the below example an individual has two loans in their name.
Personal Cost of Debt = (Loan 1 / Total Debt) * (Interest Rate for Loan 1) + (Loan 2 / Total Debt) * (Interest Rate for Loan 2)
Here is a visual example of the way you want to calculate your personal cost of debt.
|Debt||Debt Amount||Interest Rate||Weighting (Debt Amount Divided by Total Debt)||Interest Rate x Weighting|
|Student Loan 1||$10,000||6.0%||40%||2.4%|
|Student Loan 2||$15,000||4.5%||60%||2.7%|
For your personal cost of debt, you want to do anything in your ability to pay down the highest interest rate debt first. Lower your personal cost of debt to 4.5% or lower. At that point, you can invest everything you have.
The long-term average of the stock market is approximately 6-7% per year. With taxes, this is basically an annual return of about 4.5%. Thus, for every dollar you put into the stock market you should exceed your personal cost of debt. Keep in mind interest rates could increase or decrease, so this is somewhat relative. Here are some creative ways to repay student loans.
12. Personal Debt Service Ratio
The personal debt service ratio is a great way to track you ‘coverage’ over your debts. The debt service ratio basically indicates the percentage of income being accounted for debt repayment and the percentage leftover for household expenses and savings.
Personal Debt Service Ratio = Short-Term Liabilities / Total (Gross) Income
The lower the ratio the better state of an individual’s current financial health. By refinancing your debt at lower interest rates, you enable yourself to increase your debt service ratio.
13. Solvency Ratio
I love the solvency ratio as it typically indicates the ability of an individual to repay all existing debts using existing assets in case of a downside scenario.
Solvency Ratio = Net Worth / Total Assets
You should have your solvency ratio be as high as possible.
14. 20-30-50 Budgeting Ratio
The budgeting ratio is a guideline that tells you how to allocate your income appropriately. This is not for everyone because each person’s financial situation is different. However, I can guarantee financial success if you exceed the budgeting ratio and start as early as possible. I’ve been exceeding this since I started working. At this point, it is ingrained in my saving DNA.
Budgeting Ratio = 20% Saved or Put to Pay Down Debt, 30% Maximum Spend on Housing, 50% Should Be Spend On Everything Else
For example, if your primary (take-home) income is $5,000 per month. Put $1,000 towards retirement, emergency fund and/or your debt. Pay no more than $1,500 per month in rent or mortgage. Spend no more than $2,500 for everything else (utilities, food, entertainment, etc.).
15. Mortgage Ratio: Limit Mortgage Payment to 2.5x Primary Income
This is another budgeting type ratio that can help you understand how much house you can afford to purchase.
Mortgage Ratio: Mortgage Payment = 2.5 x Primary Income
For example, if you make $100,000 a year, your mortgage shouldn’t be greater than $250,000. If you put a 20% down payment, that’s a house worth $312,500. If you want more house, you need to come up with a larger down payment. I’m trying to live mortgage free by house hacking.
16. Life Insurance Ratio
The life insurance ratio is very difficult because there are so many financial situations. This ratio cannot be applied to every since age is a factor here. Someone that is 28 with multiple kids and getting their life off the ground is going to need a lot more life insurance than someone that is 50 years old without a family.
Life Insurance Ratio = 10 * Annual Salary
If you are younger, I’ve seen the ratio be applied at 15x your annual salary. As you get older, this ratio should decrease over time. The ratio really says that if you make $100,000 in annual salary, you should have a $1 million life insurance policy for you.
Use our guide to determine how much life insurance you actually need.
17. Net Worth Ratio v2 (from The Millionaire Next Door)
The Net Worth Ratio (from The Millionaire Next Door) is a way of calculating what your net worth should be. This is a bit relative because age is a factor in the equation here. For example, someone that is a 26-year-old accountant will have a significantly different personal financial net worth requirement than a 26-year-old gas station cashier.
Net Worth Ratio = Age x (Pretax Income / 10)
For example, you are 25 years old making $80,000 per year. This would be calculated as 25 * 8,000 equals $200,000. This is one of those ratios that is for the high saver. Don’t be ashamed if you don’t have a net worth at that age. This is one of those ratios that will continue to push you to increase your goals. I like calculating this ratio as a form of motivation to save more! If you haven’t read the book I highly suggest you give it a read, The Millionaire Next Door: The Surprising Secrets of America’s Wealthy
18. Retirement Savings Ratio
How do you determine how much money you should have in retirement savings? The Retirement Savings Ratio does the best job of estimating that.
Retirement Savings Ratio = 25 * Primary Income
Personal finance planners believe a reasonable withdrawal rate in retirement is 4% of your assets. By withdrawing 4% a year, it’s likely that your retirement accounts will last as long as you live. A calculation of the retirement savings ratio is pretty simple. If you make $100,000 per year, you should have $2.5 million in retirement savings.
Use our retirement readiness checklist to ensure you are in good shape for retirement.
19. Emergency Fund Ratio
Last but not least! Good ‘ole emergency fund. Everyone should have an emergency fund set aside for a rainy day or doomsday scenario. This should be the first step you take in your personal financial planning process.
Emergency Fund Ratio = 6 months of Monthly Expenses (food, utilities, rent, etc.) or for the equation 6 * Monthly Expenses
The Emergency Fund Ratio is a clear example of setting aside money for a doomsday scenario. You need to be able to live for 6 months if you get laid off. In addition, if something happens at home or a medical situation occurs, the emergency fund will be there to give you a financial buffer if you need it. Trust me, you will thank yourself for your hard earned emergency fund savings.
Integrate Personal Finance Ratios with Personal Financial Statements
Users of financial ratios are oftentimes the top percentile savers and investors. Don’t forget that personal financial statements are crucial to integrate with your personal finance ratios. This is the only way to get the full picture of a financial situation. Improve your financial health by using a personal financial statement and personal finance ratios together.
1. Personal balance sheet
A personal balance sheet tells you what is currently on the books in terms of current assets (cash, real estate, etc.) and current liabilities (short-term obligations, short-term debt, long-term debt, mortgage etc.).
This is a snapshot in time that looks at the current value of everything on the books of your personal balance sheet.
2. Personal cash flow statement
A personal cash flow statement measures your cash inflows (interest income, work income, side hustle income, passive income, etc.) and your cash outflows (mortgage/rent, utilities bills, food expenses, car loan, insurance, etc.) over time. Personal Capital does a fantastic job of analyzing your personal cash flow statement. I love refreshing the app and seeing all of my new dividend and freelancer income.
By tracking your personal financial statements, you can simply calculate all of the above ratios automatically.
I strongly suggest that you monitor both your personal finance ratios AND your personal financial statements on a monthly basis. If not, definitely refresh your personal financial ratio analysis every quarter.
Downloadable Personal Financial Statement Template
What do personal financial statements entail? Well, just like a business you should be able to build personal financial statements.
Here is a downloadable personal financial statement excel template for you to use. This fillable personal financial statement will give you a great opportunity to get started evaluating your financial situation.
You must tailor the personal financial template to your personal situation. This is a template for a reason. Track your financial health with ratios now! There are no excuses.
How will use personal finance ratios to track your current financial status?
There are numerous personal financial ratios and it is crucial to know each ratio and understand how they relate to different financial situations. Let’s not forget the PERSONAL component to the equation. Personal financial ratios are only general rules of the thumb and may not necessarily give you the exact picture of the financial situations.
However, they are relevant and can give you a general direction on how to relate to your finances to gain accumulated wealth and achieve financial freedom.
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Do your own personal financial ratio analysis
The personal financial ratios are sensitive to a specific period of time and only represent the financial situation at the time that the underlying figures were prepared.
The individual should, therefore, conduct their personal financial analyses on a regular basis. Personal financial ratios can be used as an ideal money hack to help you achieve your financial goals.
In addition, there are a number of other wealth management resources that can help track your personal finance ratios to achieve financial freedom and accumulate wealth. Check them out to get started improving your financial position now.
If you need a financial planner and are a millennial, here is how to find a financial planner for millennials.
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