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.
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.
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.