RATIOS
These ratios will help you gauge how well you’re doing with your finances.
Emergency fund RATIO
What is it?
How many months of savings do you have on hand in case of an emergency? We look for 3-6 months of your non-discretionary expenses on hand at any given time. (Cash on hand/monthly non-discretionary expenses).
If 0 - 3 months
We should definitely start here. The first step to improving health and wealth is not having to stress about money all the time! The fastest way to alleviate some of this stress is to build up your emergency fund. We’d like to see at least three months of your non-discretionary expenses in the emergency fund for the uh oh moments in life.
If 3- 6 months
Great job! You’re in the range. If you’re a single-income earner, you may want to be closer to the six-month mark. If married and you both earn similar incomes in different industries, you can remain closer to the three-month mark. Assess your risk of losing some or all of your income at any given time. The higher your risk of losing all, the closer to 6 months of non-discretionary expenses we’d like to see in your emergency funds.
If 6+ months
Good! You have more than enough in your emergency funds. While it is good to be safe, being too safe is also an issue. Have you ever heard of inflation? While your cash is sitting in the account, not earning much, the costs of the things you need to buy are going up. This means that you’re losing buying power by keeping too much in cash. Get some of that to work for you by investing at an appropriate risk tolerance!
CONSUMER DEBT RATIO
What is it?
The goal of this ratio is to keep you from paying too much of your current income toward items you purchased before. The goal range is below 20% (All loan payments outside of a mortgage/net income).
If 0 - 15%
Great job here! One of the most important lessons I can teach you is to spend less than you make, and you’re doing an excellent job if you can keep your debt payments low. With this ratio, the lower, the better. If you’re not at 0, keep pushing forward.
IF 15 - 20%
You’re still within the acceptable levels but cutting it close. If your emergency funds are built up, this is the first place you may want to put in some work. Try to get this ratio as low as possible by paying off your consumer debts.
If 20%
Uh oh. Time to do some work here. In the world of finance, one of the fundamental rules is to spend less than you make. Have a lifestyle that fits your budget. If your consumer debts are this high as a function of your income, you may be living a life that’s too rich. You may have to forego some immediate gratification for a while to pull this ratio back in line.
HOUSING DEBT RATIO
What is it?
This ratio is built to make sure you are not house rich and cash poor. The ideal range is below 28%. (Mortgage payment PITI/gross income).
If 0 - 20%
Good! Your home fits well within your income.
If 20 - 28%
Your payments are within the appropriate range for the housing debt ratio. If you were to lose a portion of your income, this could pose a problem, so you may want to add some extra emphasis on your emergency funds just in case.
If 28+
The size of your home payment is outside the goal levels of the housing payment ratio. While I realize it may be difficult to change something like a house payment as it is more than just a financial decision, you may want to consider adjusting your mortgage to a longer-term, lower interest rate or downsizing a bit to meet appropriate expense levels based on your income.
ALL DEBT RATIO
What is it?
The all debt ratio is exactly what it sounds like. What percentage of your gross income is going to pay for debt? The ideal range is less than 36% (gross income/all debt payments)
If 0 - 25%
Good job! Your debt is a low enough portion of your gross income. Having your debt under control allows you the flexibility to save, give, and live your life today the way that you want.
IF 25 - 36%
While you’re within the appropriate range, your debt is a good chunk of your gross income. You may need to do some work here before you can fully live the life you want today. Continue to pay down debt and save to create the life you want for yourself in the future.
If 36%+
Oops…We’ve let debt get away from us a bit. Before you can truly save as much as is necessary, you will probably have to do some work here. It may benefit you to forego some lifestyle decisions now to save a little bit while paying off debt at the same time.
RETIREMENT SAVINGS RATIO
What is it?
Are you saving enough? This is a rule of thumb. Each person will be slightly different in their savings needs based on how much they already have and what lifestyle they want in retirement. I recommend at least 10% of your income going to save for retirement, but that recommendation is only if you are very young or well on your way with a lot already saved. If you’re getting a bit of a later start or feel behind, the ratio should be more like 15 or even 20% or more. (Total retirement savings/gross income).
Less than 10%
Retirement is the most significant expense you’re going to have in your life, so get started as early as possible. Try to get to at least 10% as early as you can in life to get off on the right foot. If you’re getting started with saving later in life or feel behind, you’re going to want to bump the retirement savings rate up!
BETWEEN 10 - 15%
Good job. You’re in an appropriate range for retirement savings while trying to accomplish other goals. I realize that you have to prioritize, and there are times in life where saving for a college education, paying down debt, or other goals will take a portion of your savings. If you can keep your retirement ratio between 10 and 15% while working toward the other goals as well, you’re doing a great job!
OVER 15%
Wow! You’re either playing some catch-up, or you’re a true go-getter. Good for you, and keep it up. You’re genuinely reaching toward the future of your dreams!
Total Liquid Net Worth
What is it?
Your total liquid net worth is your investment and cash assets minus your debts. We shoot for a positive number here at a minimum, but there will be times in your life where your owned property could be your largest asset. Properties are not included in liquid net worth. Like weight in fitness, this number is not extremely useful by itself. Use liquid net worth with your other savings ratios to determine where you should be.
Percent of current savings required
What is it?
This time value of money calculation considers your savings amount and need for income in retirement. Assuming a 3.5% inflation rate and 7% growth on investment for retirement, what percentage of your future nest egg in investment savings do you have in accounts right now, given your current savings rate? We also assume that the required nest egg is the dollar amount that will allow you to reach your stated monthly income need in retirement with a 5% withdrawal rate annually.
ABOVE 100%
Wonderful! You’ve already done some of the hard work to save enough based on your current savings rates! Do you have any clue how far ahead of the curve that gets you? No? Way ahead! Not many people have enough to keep doing what they’re doing to get to the finish line they want (given a 7% rate of return on average in your investments, 3.5% inflation rate, and a 5% withdrawal rate). Keep up the good work.
IF 50 - 100%
You’re well on your way. Not many people are on track because of inflation and market growth in investments, so don’t feel like you’re behind. Like most Americans, you will have to increase your savings rate over the next several years to get across the finish line, but you’re on the right path. Just keep walking it!
If less than 50%
You may have to play a bit of catch-up here. Keep in mind that the calculation is based on your current savings amount. Being behind on your retirement savings amount just means that you’ll have to increase your savings rate over the coming years to attain your goals. You may need to work a bit longer than you’d like or save more and spend less for a while to get there, but now you know what you’re shooting for!
PERCENT OF MONTHLY SAVINGS REQUIRED
What is it?
This is a time value of money calculation as well. Given your current savings amount, we are looking for the monthly amount you need to save, assuming a growth rate on all retirement investments of 7%. We also assume the retirement nest egg required will generate 5% withdrawals to reach your retirement need after a 3.5% inflation rate.
ABOVE 100%
Fabulous! You are well on your way. Without changing the amount you’re investing right now, you could get to a reasonable retirement number given the calculator’s parameters. It’s possible to reach financial fitness if you’re willing to make the tough decisions, and you are obviously doing that. Good work.
BETWEEN 50 - 100%
Okay, we’re going to have to increase that savings rate over some time. You’re not quite on track to reach your goals for financial freedom, but that’s okay. Every year commit to increasing your 401k deferrals by a percentage or two, set up your appropriate retirement savings vehicles outside of work if you qualify, and save as much as you can to get there in the future. If you’re willing to put in a little extra work today, you will have a more secure tomorrow.
Less than 50%
There’s a lot of work to do here. Saving for your future is the building block of a healthy retirement. It may be time to look at your budget and prioritize expenses to make room for more savings. It could also be necessary to evaluate your retirement date or lifestyle and adjust your expectations. If you are very early in your journey, then you may be right where you need to be but definitely increase your savings rate as you can in the future.
RATIOS WORKING TOGETHER
Emergency Fund > 3 Months, Consumer Debt Ratio > 15%
It seems that you have a chunk of cash earning you not much with a chunk of debt where you’re probably paying higher interest rates. You may want to look at using a portion of your emergency funds to pay down your highest interest debt to save on those interest payments. Don’t deplete your cash reserves, but it seems you have enough extra to take some of it to apply toward your consumer debts. Do the math and pay down anything with an interest rate higher than you’re earning in your cash accounts until you still have three months’ worth of your “have-to” money. If you have multiple rate debts, start with the highest and work your way down. Once your consumer debt is paid off, you can beef up the emergency savings if you need to.
Debt to Income Low, retirement savings rate is low with needs for savings to retirement negative.
Save more! You have a low debt to income, and your savings rate is low. Since you have a gap in your savings rate to hit your retirement goals, you should add some of the extra income to financial freedom savings. I know that means you may not be able to drink that extra latte in the afternoon or get the really nice bottle of wine at dinner but think of your future self! Work on your cash flow to make the hard choices of cutting back where you don’t place a high priority. If you don’t care that your milk is organic, save a few bucks. If you can’t tell the difference between a latte and black coffee, then drink black coffee!