Thanks to a post on Sitting Pretty Financially, I found an interesting article that talks about personal financial ratios that we could use to analyze our financial standing.
The three ratios that the article talks about are:
- The savings to income ratio would be familiar to readers of The Millionaire Next Door
. Savings is defined as the current value of financial assets not including the family home. - Debt to income ratio, with debt being all obligations like mortgages, car loans, student loans, credit card debt etc.
- The savings rate, which is the percentage of pre-tax income that an individual saves every year.
. Savings is defined as the current value of financial assets not including the family home.The article also provides guidelines for the financial ratios at different ages with the only constant being the savings rate at 12% of pre-tax income. For example, a 30-year old just starting out in life is expected to have a S/I ratio of 0.1 and a high D/I ratio of 1.7 and a 50-year old starting to think about his retirement should have a S/I ratio of 4.5 and a D/I ratio of 0.75. The assumption is that when retiring at age 65, an individual should have savings of 12 times income and no debt.
While useful as a benchmark, the personal finance ratios are as meaningless as stock ratios without a context. An individual with a very high savings rate doesn’t need anywhere close to a nest egg of 12 times income, since they are frugal to begin with. Also, I would argue that home equity should at least partially be included in the savings column as a paid-off house provides “income” in the form of a rent that would otherwise have to be paid.
