The 3 Financial Ratios You Need to Know

Posted by | · · · | financial planning · personal finance

A good financial plan will consist of your goals, specific action steps, and a set of simple, but useful metrics or ratios to track your progress and keep you focused. Today, we are going to teach you 3 financial ratios that should be a part of your financial plan.

 

#1 Your Savings Ratio

 

15% is the rule of thumb, but for every rule there are many exceptions. Do you make more than the average person? Do you plan on spending more or less in retirement? How much other income  (social security, pension, annuities, etc.) will you have? What tax bracket are you in? How old are you? How old will you be when you start cashing out? What’s your asset allocation? How much are you paying in fees? What interest rate are you paying on your debt? And the list goes on.

 

Want to know your unique savings ratio, but too busy to figure it out yourself? Call Perennial Trust and we’ll run the numbers for you.

 

In the meantime, here are some oversimplified benchmarks:

 

Age Target Savings Ratio
25 – 29 5%
30 – 34 10%
35 – 49 15%
50 – 65 20%

 

# 2 Your Debt Ratio

 

0% is the target, but most of us don’t have a half million sitting in our checking account to pay off all our student loans (or your kids’ student loans), car payments, and mortgage(s). At the same time, that doesn’t mean you can’t control your level of debt at a young age.  Despite the many temptations to buy things you don’t need, your future self will thank you if you only use debt for the necessities in life.

 

So how much debt should you have?

 

You probably guessed it – it depends on your individual needs and circumstances. But to keep you from going off the rails, I’ll give you the basic guideline of one-third or 33%. That’s the max debt ratio a person should have when starting out. To break it down a bit, that means your mortgage balance should never be more than 5x your household income and you shouldn’t be buying a car that’s worth more than half of your annual income.

 

Put differently, your mortgage payments shouldn’t be more than 20% of your income and your car payments shouldn’t be more than 5% of your income. If you’re saying, “Wait a minute, my mortgage and car payments exceed 33% of my income and I have student loans on top of that” then that should be your wake-up call. In other words, if you are above the max debt ratio then you are likely just working to stay above water – a depressing but eye-opening conclusion. Fortunately, now that you are aware, you can do something about it before it gets any worse.

 

# 3 Your Capital to Income Multiple

 

Similar to #1, the idea here is that your savings will dramatically increase as you get older. In fact, as long as you stick to a good financial plan, you will eventually get to the point where your money does all the work for you. In other words, you will have so much saved that you can live off the interest, dividends and capital appreciation of your investments. If you still want to work to keep yourself busy then that’s great, but just knowing you don’t need to work anymore is priceless.

 

Once again, your unique ratio is specific to you, but generally you are shooting for at least 15x your income. So if your household income is $100,000 then you’ll need at least $1.5 million to hit the minimum mark. However, if you’re a more conservative investor or plan on retiring early, you may want that multiple to be closer to 20x your household income.

 

Here’s another generalized chart so you can get a sense of where you stand:

 

Age General Estimate More Conservative Estimate
30 1x capital-to-income 1.5x capital-to-income
35 2x 3x
40 3.5x 5x
45 5x 7x
50 7x 9.5x
55 9x 13x
60 12x 16x
65 15x 20x

 

Now that you know your ratios, make sure to calculate them at least once a year and make adjustments accordingly. Good Luck!

 

For those of you who have already built up some savings, make sure you are investing it wisely. If you don’t know where to start you may want to check out our Free Investing Basics Guide – designed to teach you the basics of investing in less than 30 minutes!

 

If you have any other questions about investing, retirement planning, or wealth management, contact Perennial Trust at 781 202 6368, email jlento@perennialtrust.com or visit our website at PerennialTrust.com


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