As a young adult, you’re at the early stages of your financial journey through life. You may be thinking about saving for a down payment, paying off student loans, or maybe even planning that dream vacation.
But how do you know if you’re truly on track? This is where personal finance ratios come in – they’re like your financial GPS, giving you a quick snapshot of your financial health and helping you make informed decisions.
There are 5 essential ratios that you should know, and track regularly over time. These ratios give you a well-rounded view of your financial stability and highlight areas for improvement, such as reducing debt, increasing savings, or building investments. If you are already following your money, then calculating these ratios on a regular bases will be straightforward.
To learn more about the 5 personal finance ratios and how to calculate, please read on.
5 essential personal finance ratios
Here are five ratios every young adult should understand:
1. Savings Ratio: Your foundation for the future
The amount of your gross income that is being saved for shorter and longer-term goals such as emergency funds and retirement. Financial experts generally recommend saving between 10% and 30% of your income, but a common goal is to save at least 20% under the 50/30/20 budget rule.
Formula: Monthly Savings / Monthly Income
2. Debt-to-Income (DTI) Ratio: Are you overleveraged?
Your DTI ratio is a crucial indicator of your ability to manage monthly debt payments. Lenders use this to assess your creditworthiness, but it’s also a powerful tool for your own financial planning. A DTI under 36% is generally
considered healthy.
Formula: Total Monthly Debt Payments / Gross Monthly Income
3. Emergency Fund Ratio: You’re prepared for the unexpected
An emergency fund ratio is a personal finance metric that helps determine how much savings you should set aside to cover unexpected expenses. Financial experts recommend setting aside at least $1,000 for emergencies and adding to it until you’ve saved three to six months’ worth of your living expenses.
Formula: Emergency Fund Balance / Monthly Living Expenses
4. Investment-to-Income Ratio: Your path to financial independence
This ratio compares the total value of your investments to annual income, and helps you understand how well you’re building long-term wealth. Aim to save at least 1x your salary by 30, 3x by 40, 6x by 50, 8x by 60, and 10x by 67, according to Fidelity.
Formula: Total Investment Value / Annual Income
5. Net Worth Ratio: Your overall financial progress
Your net worth is the sum of all your assets minus all your liabilities. While not strictly a ratio of income, it’s a powerful indicator of your overall financial health and progress. Your goal should be to consistently increase your net worth over time.
Formula: Total Assets – Total Liabilities
Start tracking these ratios and celebrate your progress
Understanding and regularly tracking these personal finance ratios will give you a clear picture of your financial condition. They act as your financial compass, guiding you towards responsible spending, smart saving, and ultimately, greater financial independence and well-being.
Don’t be discouraged if your ratios aren’t perfect right away; the important thing is to start tracking them, make conscious efforts to improve them, and celebrate your progress along the way. Your future self will thank you!
To learn more about why each of these five ratios matter and how to improve, please download this one-page information brief.
It Pays to Know!