Financial Fitness: Simple Money Ratios To Master Your Finances
Unleash the power of money ratios! These financial health indicators, like savings rate and debt-to-asset ratio, help you track progress, make smart decisions, and build a secure future. Learn more and take control of your money!
Femwealth Team
Updated on 28 Dec, 2024
Table of Contents
What are Money Ratios
Money ratios are also called financial ratios. They form the foundation for assessing your financial health. Money ratios compare different parts of your finances, like income vs. expenses (liquidity ratio) or debt vs. assets (solvency ratio).
Why Should You Use Money Ratios
They help monitor how your finances are changing over time.
Identify areas where you might need to adjust your spending and saving habits.
Ratios help you choose investments or loans that fit your financial situation.
Here are a few common Money Ratios and their uses:
1. Savings Rate(%)
It's a simple calculation that tells you exactly what percentage of your income you're actually saving.
Savings Ratio = (Savings / Disposable Income) x 100
Savings: This is the money you stock away after taxes and essential expenses.
Disposable Income: This is your income minus taxes. Basically, the money you have left to spend or save as you please.
Your savings ratio shows you if you're on track to meet your goals, whether it's a dream vacation, a down payment on a house, or a secure retirement. It is generally recommended to aim for a savings rate of at least 15-20%. A higher savings rate helps you to reach your goals faster.
2. Emergency Fund Ratio
This ratio helps assess your readiness for financial emergencies (unforeseen events like job loss, medical emergencies, or urgent home repairs). It's calculated by dividing your total liquid assets by your total monthly expenses.
Emergency Fund Ratio = Total Liquid Assets / Monthly Expenses
3. Debt To Assets Ratio
The debt-to-asset ratio is simply the amount you owe compared to what you own, expressed as a percentage. It is a useful tool to see if you are leaning too heavily on debt. If your debt to assets ratio is high then you might need to adjust your spending or debt repayment plan.
Debt to Assets Ratio = Total Debt / Total Assets
Here, Debt includes your loans , credit cards etc and Assets are your savings, investments etc.
4. Retirement Savings Ratio
It is the percentage of your income you aim to save specifically for retirement each year. As an indicator you can use the Rule of 25.
The rule of 25 has two steps.
First, multiply your monthly expenses by 12. This is your annual expenses.
Second, multiply that annual expense by 25 to get the amount you’ll need to retire. So, if you guess you'll need $20,000 annually, aim for a stash of $500,000 (25 x $20,000).
So if you annual income is $60,000 then for the above example
Your Retirement Savings Ratio = $20,000 / $60,000 = 0.33 or 33%
Hence you need to put away 33% or 1/3rd of your income to hit your retirement goal.
Various other factors also come in to play when you plan for retirement like your lifestyle, an estimate of inflation, estimate of how much you need on a monthly basis etc. As such use this ratio as a guideline and not something that is etched in stone.
5. Net Worth Ratio
Your Net Worth is a snapshot of your financial health.
Net worth = Stuff you OWN (assets) - Money you OWE (liabilities)
Simply list out all your assets (cash, car, house, etc.) and liabilities (credit card debt, student loans, etc.). Then subtract your liabilities from your assets. There you have it, your net worth!
The higher the net worth, the better! A higher net worth generally means you're in a good financial spot. It shows you've been building wealth over time and have a buffer for unexpected expenses.
Finding your Money Ratios :
Don't worry, you don't need a math degree! Most ratios involve simple calculations using numbers you can find on bank statements or paystubs.
Takeaway
Understanding money ratios empowers you to take control of your finances. It is not about obsessing over every detail, but about gaining valuable insights into your financial life.
Remember, everyone’s financial situation is unique, so it’s important to choose the right money ratios that best fit your personal circumstances.
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