With personal finance everything is relative. Reading through blogs and comparing yourself to others using direct numbers might not be the best way to measure your progress, but using personal finance ratios could be a better indicator as to how you’re doing. For example, if you’re located in Iowa, your income is going to be significantly lower than if you lived in New York City, yet your expenses would be quite lower as well. Ratios give you a better understanding of how you’re doing in a relative sense and a give you a clearer understanding of your progress.
Liquidity Ratio / Emergency Fund Ratio
A liquidity / emergency fund ratio is your liquid assets that provide you with a short term cushion in case you need reserves. If you lose a source of income or incur a major expense, this fund will be handy to have.
You can calculate this ratio by simply dividing your liquid assets (mostly cash), by your monthly expenses.
So if you have $5,000 saved in liquid assets and your monthly expenses are $2,000 your liquidity ratio would be $5,000 / $2,000 = 2.5 months
If for some reason you lost your income you would be able to last 2.5 months without needing another source of income and assuming your expenses stay the same.
Ideally it would be good to have at least a 6 month emergency fund to remove the risk of job loss. However, in today’s economy it would be good to have an even higher liquidity ratio due to longer periods of unemployment. If you think you won’t have any trouble finding work then you should be okay with a smaller emergency fund. It would also be smart to build multiple streams of income so you’re not so dependent on one source.
Annual Savings / Annual Gross Income
Your annual savings are anything to you save over the course of the year… pretty obvious huh? This would include cash savings and any match by your employer to your 401k.
If you make $50,000 a year, save $5,000 and your employer matches $1,000 a year your annual savings would be $6,000.
($5,000 + $1,000) / $50,000 = 12%
After running the numbers we see that you’re effectively saving 12% per year. Is this enough? Well that would depend on your goals. If you want to continue with the same standard of living, start investing at a young age, and plan on not retiring early, this should be a fine amount. If you’re older and haven’t started yet you’re probably going to want to increase this ratio. For those looking to retire extremely early a 70%-80% savings rate is no uncommon and can mean retirement within 10 years.
Although that’s pretty high just focus on getting a savings rate started because even 100% return on zero dollars saved will result in zero dollars!
What other key personal financial ratios do use use to measure your progress?