Money Anxiety? 5 Numbers That Reveal Your Financial Health
Financial ratios and formulas are useful tools to gauge your financial health. By watching five ratios over time you can easily see if your finances are moving in the right direction or need some help.
Laura Adams, MBA
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Money Anxiety? 5 Numbers That Reveal Your Financial Health
A Money Girl podcast listener named Robyn M. says:
“I’m single and 38 years old with annual income about $80,000 and a net worth just over $100,000. I pay off my credit cards each month and have retirement savings, emergency savings, and various types of insurance. But I still have anxiety about money and worry that I won’t have enough to retire or to weather an emergency. I’m not sure if this anxiety is due to my upbringing or if I’m actually not doing well. How do I gauge my finances and know if I’m doing alright?”
Robyn, thanks for sending in this question! Many people feel uncertain about the health of their finances. No matter how much you earn, it’s not uncommon to feel anxious about your future or how your finances stack up to others.
(correction_with_script)
In this post, I’ll review five ratios that help you gauge your financial health. By watching these numbers over time, you can easily see if your finances are moving in the right direction or need some help.
5 Numbers That Reveal Your Financial Health
- Net Worth
- Cash Reserve Ratio
- Retirement Savings Ratio
- Housing Ratio
- Debt-To-Income (DTI) Ratio
Since everyone’s situation and goals are different, there isn’t one absolute way to measure your financial health. However, calculating and monitoring certain ratios is an objective way to know if your finances are improving and they can help you make better financial decisions.
Here are five key ratios to help you assess your finances and pinpoint areas that may need improvement.
1. Net Worth
Net worth isn’t a ratio, but an important formula to watch because it reveals your true financial resources at a given point in time. Your net worth equals your total assets minus your total liabilities:
Net Worth = Assets – Liabilities
For instance, if you own $250,000 in assets and have $200,000 in debts, your net worth is $50,000. If you owe more than you own, your net worth will be negative, which shows you have a lot of work to do to make it positive.
Tracking your net worth from year to year helps you stay focused on building wealth by increasing your assets, shrinking your liabilities, or doing both. While there’s no magic net worth number that you should have, here’s a rough and ambitious guideline to target: [Your age – 25] x [Gross income / 5].
Let’s plug Robyn’s information in: [38 – 25] x [$80,000 / 5] = 13 x $16,000 = $208,000.
Robyn says her net worth is currently over $100,000, which is fantastic. But using this target calculation for her age and income shows that increasing her net worth to about $200,000 would put her in an ideal financial situation. Robyn mentioned that she has little debt, so she can boost her net worth by increasing her savings. We’ll cover more about saving in a moment.
If you’re close to Robyn’s age and don’t have anywhere near her net worth, don’t despair. Improving your financial health doesn’t happen overnight. If you work on improving the formulas in this post, you can build wealth over time.
In my new book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, I give you step-by-step instructions to calculate your net worth and templates to document and track several key financial ratios.
2. Cash Reserve Ratio
The cash reserve ratio indicates if you have a sufficient emergency fund to manage an unexpected loss of income. Your cash ratio equals your total cash on hand divided by your monthly living expenses:
Cash Reserve Ratio = Cash On Hand / Monthly Living Expenses
Let’s say you typically spend $3,000 per month on living expenses, such as housing, food, transportation, insurance, and debt payments. If you have $6,000 in liquid emergency savings, then your cash reserve ratio is $6,000 divided by $3,000, or two. This ratio tells you how long your cash would last if your income dried up.
A good rule of thumb is to have a cash ratio of at least three to six. In other words, make sure you could survive with no income for at least three to six months.
A good rule of thumb is to have a cash ratio of at least three to six. In other words, make sure you could survive with no income for at least three to six months.
The right amount of emergency money will vary depending on your situation. For instance, if you have a large family, high debt payments, or work in an unstable industry, you might need a 12-month emergency fund.
The idea is to consider how long you could stay afloat if you lost your job or business income today. Having a cash reserve is a smart way to reduce financial stress and increase happiness.
If you don’t have any savings or enough cash on hand, don’t panic! Just get started setting aside small amounts on a regular basis. Even saving $20 a month adds up over time.
3. Retirement Savings Ratio
The retirement savings ratio is how much you save and invest for retirement compared to how much you earn. It’s calculated by dividing your retirement savings by your income over a set period of time, such as monthly, quarterly, or annually:
Retirement Savings Ratio = Retirement Savings / Gross Income
The higher your savings ratio the better. Your long-term financial health depends on investing for the future so your money has plenty of time to grow into a sizable nest egg.
I recommend saving a minimum of 10% to 15% of your gross income for retirement. But if you get a late start, you’ll probably need to save twice that amount in order to catch up.
I recommend saving a minimum of 10% to 15% of your gross income for retirement.
The trick to saving for retirement is starting small and gradually increasing your savings rate over time. When you get a raise or promotion always put it into your retirement or emergency savings instead of spending it. That’s how you build wealth!
4. Housing Ratio
The housing ratio is how much you spend on your rent or mortgage compared to how much you earn. It’s calculated by dividing your housing expense by your income over a set period of time, such as monthly or annually:
Housing Ratio = Housing Expense / Gross Income
This ratio is important because housing is typically your largest expense and you shouldn’t pay more than you can truly afford. Housing costs can vary dramatically depending on where you live, but a good rule of thumb is to keep your housing ratio under 25%.
For example, if you’re like Robyn and earn $80,000 a year, paying no more than $20,000 or about $1,650 per month for your rent or mortgage principal and interest is ideal. Also consider a total housing ratio that includes rent, mortgage principal, interest, property taxes, insurance, and utilities. Keeping this ratio under 30% of your gross income is wise.
If you’re in the market to buy a home, another guideline is to limit the amount you borrow to 2.5 times your gross income. For instance, if you make $80,000, try not to take out a mortgage that’s more than $200,000. If you make a 20% down payment, that would allow you to buy a home worth $250,000.
5. Debt-To-Income (DTI) Ratio
DTI is how much you pay for debt—such as minimum credit card payments, student loans, auto loans, and mortgages—compared to how much you earn:
DTI Ratio = Debt Payments / Gross Income
The lower your DTI the better. Paying less for debt means you can increase your cash reserve and retirement savings ratios, increasing your net worth. A healthy DTI is less than about 35%.
Calculating these five ratios and formulas is a great way to give yourself a financial checkup. But remember that they’re just benchmarks.
If you’re young or just starting your career, you may have more debt and fewer assets than older people. The real value of ratios is using them to analyze your finances over time and spot trends. Pat yourself on the back when your DTI ratio goes down and your savings ratio and net worth go up.
See also: When to Cancel a Credit Card? 10 Dos and Don’ts to Follow
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.