Personal Finance Ratios
What gets measured, gets improved.
But what exactly should we track for our finances? Here’s some of the most crucial ratios worth measuring.
#1: Personal Liquidity Ratio
Personal Liquidity Ratio = Total Liquid Assets/Net worth
Liquidity is a measure of how easily an asset can be converted into cash. The larger the portion of your net worth is highly liquid, the more easily you can come up with cash in the event of a large emergency expense.
Of course, this doesn’t mean that more liquidity makes an asset necessarily better. However, it might be wise to maintain at least a decent portion of one’s net worth in easily liquidatable assets, just as a protective measure.
#2: Savings Rate
Savings Rate = Monthly Savings/Monthly Income
This one is not particularly new to anyone, but it is one that many people still do not consistently track. I can testify first hand that, tracking your expenses closely is one of the most effective ways to reduce spending.
Personally, I’ve been using a google form, linked to a google sheet to record down all my expenses. The moment I spend any amount of money, I manually key it into the form. The form automatically routes the data to the google sheet. This keeps me acutely aware of how much I’m spending on a daily basis.
#3: Debt To Asset Ratio
Debt to Asset Ratio = Total Liabilities/Total Assets
The debt to asset ratio is an indicator of whether a person has accumulated a healthy or excessive amount of debt. By measuring one’s total liabilities relative to total their assets, it essentially tells you your debt level relative to your ability to pay it back.
Having a lower debt to asset ratio is not necessarily better. When used responsibly, debt is a tool for financial leverage, such as taking a loan for an investment property. As such, it is not merely the debt to asset ratio that matters, but also the nature of the debt (e.g., high-interest credit card debt is not favorable).
#4: Emergency Fund Ratio
Emergency Fund Ratio = Emergency Savings/Average Monthly Spending
This ratio is especially pertinent to your financial security. An emergency fund is an amount of cash you set aside, not to be used for daily spending or investments. Its sole purpose is to be a source of readily available funds in the event of an emergency.
A lot of people set their emergency funds to be a fixed amount (e.g., $10,000). However, it might be wiser to set it as a ratio relative to your average monthly spending. After all, that same $10,000 would run out way quicker if you have a higher cost of living than someone else.
A common guideline is that your emergency fund should be 3 to 6 months worth of your typical monthly expenses. But given the uncertainties of the world, such as what we saw during the pandemic, I prefer to be even more well-insulated.
#5: Debt Service Ratio
Debt Service Ratio = Monthly Debt Payments/Monthly Income
This ratio tells you how much your debt obligations are weighing on your income
Though there’s no fixed guidelines, if the ratio is particularly high, this reflects that a person’s debt burden is taking a significant toll on their ability to keep what they earn. There would be little left for investments, savings, and expenses if a large chunk of your income is being devoted to your debt payments
#6: Lifestyle Inflation Ratio
Lifestyle Inflation Ratio = Rise in Monthly Spending/Rise in Monthly Income
Lifestyle inflation is the invisible enemy of financial progress. It’s what happens when peoples’ spending rises just in-line with a rise in income. And it means that at the end of the month they effectively still have the same amount left – so the rise in income had no real effect.
Lifestyle inflation can keep even high-income earners stuck in the same financial position for years. Tracking this ratio can help you identify whether you’ve been making the same mistake.
The lower this ratio, the better. Of course, it’s natural to demand a higher standard of living as your income rises. But if this ratio rises above 1, it means that your spending has outpaced your income.