Plan your finances like a professional.
If you seek out a financial planner or advisor for help managing your money, the first thing they’ll do is conduct an analysis of your financial situation. A big part of that analysis will come down to ratios. Professional planners use ratios and benchmarks to make recommendations about asset allocations, debt repayment and more. If you’re interested in a DIY money approach, calculating these simple financial ratios yourself will offer a window into your money strengths and weaknesses.
Emergency fund ratio
An emergency fund is easily accessible money set aside for an unexpected event, like a job loss or sudden home repair cost. This ratio measures the number of months your cash savings could cover your monthly essentials without any additional income. Experts typically recommend an emergency fund in cash amounting to three to six months of monthly nondiscretionary expenses. Nondiscretionary expenses include items like rent, utilities and groceries.
Emergency Fund Ratio = Cash / Monthly Nondiscretionary Expenses
Basic housing ratio
The basic home ratio can be useful for homeowners and renters to determine what sort of housing individuals can afford. This ratio can also be important for those seeking to qualify for a conventional mortgage. Experts typically suggest that housing costs should be less than or equal to 28% of your gross pay. When calculating this ratio, note that housing costs include principal, interest, property taxes and home insurance.
Basic Housing Ratio = Housing Costs / Gross Pay
Broad housing and other debts ratio
This ratio is a more broad version of the basic housing ratio. In addition to housing debts, this ratio measures the percentage of income spent on housing and other other recurring debts, and it may be particularly useful for those carrying other large debts, like a student loan, car loan or credit card payments. Experts suggest all debts be no more than 36% of an individual’s income.
Broad Housing Ratio = (Housing Costs + Other Debt Payments) / Gross Pay
Savings rate
Your savings rate is the portion of your income you put aside for retirement or other long-term goals. A typical savings rate benchmark is 10% to 13%, but this benchmark can vary widely by goals and age. For example, the closer to retirement you are when you start saving, the larger your savings rate should be.
Savings Rate = (Savings + Employer Match) / Gross Pay
Debt to total assets ratio
The debt to total assets ratio measures the portion of your assets that are owned by creditors. As individuals begin to repay debts, like a mortgage, this ratio will decline. There is no general benchmark for this ratio. Instead, financial advisors will track this ratio over time. Debt to total assets is typically highest when a person is young and should decline as a person ages. Generally, the lower the ratio, the better.
Debt to Total Assets Ratio = Total Debt / Total Assets
Net worth to total assets ratio
So you know your net worth is assets minus liabilities. But this net worth ratio will take your understanding of net worth a step further. By determining the percentage of total assets you own, you can see your wealth growing over time — an encouraging ratio to follow if you’re in the midst of debt repayment. This ratio is essentially the reverse of the debt to total assets ratio. A net worth ratio of about 20% is common for younger individuals, while an individual who has reached retirement should have a net worth ratio of 90% to 100%, indicating the elimination of debts. This ratio is also known as the solvency ratio.
Net Worth Ratio = Net Worth / Total Assets
Return on investments ratio
This return on investments ratio measures the performance of your investment assets over the course of one year. This ratio will give you a sense of how your investments are growing. Typically, an ideal return on investments ratio falls between 8% and 10%, but an individual’s goals, time horizon and risk tolerance will determine his or her specific performance goals. In the formula below, beginning investments are asset values from the preceding year and ending investments are asset values at the end of the current year.
Return on Investments = (Ending Investments – (Beginning Investments + Savings)) / Beginning Investments
Investment assets to gross pay ratio
One easy way to measure your progress toward saving for retirement is to calculate your investment assets to gross pay ratio. This ratio measures your ability to replace your gross pay with your savings when you reach retirement age. Common benchmarks for this ratio vary by age, starting at around 0.20:1 for individuals in their 20s and ideally growing to around 20:1 as a person ages.
Investment Assets to Gross Pay Ratio = (Investment Assets + Cash) / Gross Pay
Common financial ratios you need to know:
— Emergency fund ratio.
— Basic housing ratio.
— Broad housing and other debts ratio.
— Savings rate.
— Debt to total assets ratio.
— Net worth to total assets ratio.
— Return on investments ratio.
— Investment assets to gross pay ratio.
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Personal Finance Ratios to Know at All Times originally appeared on usnews.com
