Money Management

6 Personal Finance Ratios You Need to Know

Personal Finance Ratios

Want to measure your financial health?

Personal finance ratios are a great starting point. In a matter of seconds, you can identify if you’re on or off track. Even for something as complex as figuring out when you can retire.

Let’s take a look at 6 personal finance ratios and see which ones are worth tracking (starting with the most important financial planning ratio).

6 Personal Finance Ratios You Need to Know

#1 — The Most Important Financial Ratio

What’s the most important financial ratio — the one financial ratio I’d track above anything else?

Your savings ratio.

This is easy to calculate:

Savings Ratio = How Much You Save / How Much You Made

For those starting out, it’s better to track this number on a monthly basis. The formula looks like:

Savings Ratio = How Much You Saved This Month / Monthly Income

It’s also important to define what saving is. My preference is to count only savings I invest. Specifically, what goes into my IRA, 401(k), or taxable investments.

What’s the ideal number you should aim for? Some experts say 10%. Others 20%.

My preference? Don’t worry about the perfect savings ratio today. Instead, start to track this number. Then, aim to increase it. If you were to increase it 1% every three months, in four years you’d be saving 16% more than you were today.

#2 — Expense Ratios of Investments

A study by the Center of American Progress found that the average 401(k) plan charges a 1% fee.

Another study by the ICI found the average mutual fund expense fee was .63%.

Why are these numbers important?

Look at this example, from the Department of Labor:

Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

That’s why it’s important to know any and all fees. But they’re called hidden fees for a reason, they’re hard to find.

Here’s two ways to discover any hidden fees you’re paying:

  1. Get a free 401(k) audit from Blooom, which identifies any fees you’re paying and compares them to industry benchmarks
  2. Use Personal Capital’s Free Fee Analyzer, to learn investment fees outside of your 401(k).

These tools will assist you uncovering the fees you’re paying.

If you’re paying too much in fees, considering switching to a low-cost provider like Betterment or Vanguard.

In the case of 401(k), if lobbying your boss for a better plan is out of your control — use Blooom to manage your 401(k). Blooom will find the ideal mix of funds, to maximize returns, while minimizing risk for $10 a month.

#3 — The Emergency Fund Formula

How big is your emergency fund?

To find out, take your:

Cash On Hand / Monthly Expenses = Emergency Fund

The general rule of thumb is you want an emergency fund of at least 3 months but no more than 6.

An emergency fund that’s too small puts you at risk of not being able to overcome a financial setback. An emergency fund that’s too big means you’re losing money to opportunity cost.

But instead of worrying about rules of thumb, it’s better to answer this question:

“How much cash do you need to feel comfortable and sleep well at night?”

In one study, How Your Bank Balance Buys Happiness, researchers found:

“Having readily accessible sources of cash is of unique importance to life satisfaction, above and beyond raw earnings, investments, or indebtedness.”

Everyone is unique. My preference is to have as little as possible. I’ve gone as low as 1-month. However, I’m a personal finance geek who likes to optimize everything.

Others may not be able to sleep well at night on 1-months savings. Instead, they may prefer 6-months or even 12-months.

One tip to help you calculate your emergency fund is to imagine your financial doomsday. For example, answer the following question:

What would I do today if I lost my income, the value of my home cratered, and my portfolio dropped in half?

By thinking through your actions, you’ll get clear on the role an emergency fund would play in your life.

Related Reading: How to Build an Emergency Fund

#4 — The 28/36 Rule

The first thing you need to know about the 28/36 Rule is it’s NOT a rule used in financial planning. Instead, it’s a rule lenders use to determine how much debt you can afford.

The rule states that you shouldn’t spend more than 28% of your monthly gross income on housing (Principal, Interest, Taxes, and Insurance). Then, total debt payments (housing + all other debt) should not exceed 36% of your income.

It’s important to look at this ratio from both a lender’s and consumer’s perspective. The purpose of the 28/36 Rule for lenders is to determine the largest amount of debt one can have.

In other words, this is the largest amount of debt banks have found you can take on with a reasonable chance of paying it back. This maximizes the bank’s bottom line, not your finances.

What’s a better way then to determine how much house you can afford?

Dave Ramsey has a solid rule of thumb for a starting point:

Limit your mortgage payment (including insurance, HOA fees and taxes) to 25% or less of your monthly take-home pay on a 15-year fixed-rate loan.

#5 — How To Determine Your Asset Allocation

A general rule of thumb for asset allocation is:

Stock Allocation = 100 – Your Age

Specifically, one should invest in a percentage of stocks equal to 100 minus their age. A bond allocation would then make up the remaining balance. For example, a 40-year-old investor would invest in 60% stocks and 40% bonds.

While one can argue this advice is outdated (I would agree) there’s still a lot to.

The below chart shows the average asset allocation among younger vs. older investors. Most notable, you can see that the average stock allocation of millennials is only 30%.


Asset Allocation


There’s clearly a misunderstanding of asset allocation among investors both young and old.

As for this formula being outdated — we have better models today to maximize return and minimize risk. Nonetheless, the ratio teaches an important concept — your investing strategy should get more conservative as you age.

To determine your ideal asset allocation — one easy way is to head over to Betterment and take their quiz. Insert your age, retirement status, and annual income and Betterment will suggest for you an asset allocation:

For example, here is what Betterment suggests for a 30-year old, investing in an IRA, making $60,000 a year.


#6 — What It Takes To Become Financially Independent

The rule of thumb for retirement savings is you need to save 25x your annual expenses. For example, to live on $40,000 a year, you’d need $1,000,000.

For those closer to retirement, there’s a lot better way to get this number. I recommend using Personal Capital’s Free Retirement Planner, which leverages real data from accounts you link to calculate how prepared you are for retirement.

This is outside of any other income sources such as social security, work from part-time jobs, etc…

Why is this personal finance ratio good to know?

There’s two reasons:

  • It’s helpful to have a rough idea of what you need to save to retire.
  • It allows you to see how lifestyle changes impact your estimated retirement date

For example, say you have a taste for luxury cars. This increases your expenses $200 a month or $2,400 a year. You can afford it, so no big deal, right?

Well, know to keep this up in retirement, you’ll have to save $60,000 more.

It’s a good mental exercise to go through a lot of your expenses this way. Take a monthly expense and calculate it by 25X. That’s how much more you’ll need to save to continue to afford this expense.

R.J. Weiss
R.J. Weiss is the founder and editor of The Ways To Wealth, a Certified Financial Planner™, husband and father of three. He's spent the last 10+ years writing about personal finance and has been featured in Forbes, Bloomberg, MSN Money, and other publications.

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