Let’s just imagine you actually had the opportunity to run personal finance ratios for your situation. If you handled your personal life like a business I’m sure things will run smoothly and efficiently compared to how you handled your dollars beforehand. A budget is for the most part in disarray before running the household finances within the personal finance ratios that matter.
When I say within I mean keep things in a preferred range for each ratio. Now a days some people think that paying for vacations which equals 30% of the yearly income is financially smart. I will tell you this person is not being financially aware of the personal finance ratios that matter. Because if they did, the vacation ratio which falls under entertainment and or vacation category should only be 15% of the annual income.
For a simple example let’s assume this person makes $3,000 dollars a month, net pay or about 50K monthly off annual income. (About the national Average)
The Personal Finance Ratios That Matter:
Debt to Income – Try to stay below 30%, and preferable less than 10%. The perfect ratio for this is always 0%
1,000 debt payments / 3,000 monthly income = 33% Ratio To High, Run the same for your scenario based on total debt payments divided by net income. (Exclude the car as we will include in another ratio)
Housing Expenses to Income – Do your best to Keep this below 40%, and every year attempt to get it lower. Preferred range is 10% -20% housing expense.
1,200 Rent / 3000 Income= 40% This is on the high end, so attempt to run the same numbers to see where you stand on the housing expense.
Surplus Cash to Income – The higher amount the better able you will be to invest & save. Aim to have at least 10% or more. If surplus cash consists of 20-50% of income, =personal finance success.
500 Surplus Cash/ 3000 Income = .16 or 16% If you have 500 left over at the end of the month, move it over to a savings account as an emergency fund.
Transportation Expense to Income – 15% or less is very important. Car payment, Bus Pass, Gas, Auto Insurance, etc.(Includes all costs associated with traveling / commuting every month)
600 Car Costs / 3000 Income = 20% this amount is above the threshold for this category. Find ways to cut it out or reduce the monthly commuting drain on household income.
Savings / investment Amount to Income – Try to calculate this on a monthly basis, and this will tell you how much of your income is being invested. It will help you decide if you need to increase or decrease this going forward.
300 Savings / 3000 Income – .10% This is a decent amount and better than most people. But remember the more you save the better results you have later for various money goals.
Life Insurance amount / Income – You want to have the insurance amount you have on your life to be 10X times or more based off income. Anything less and you are taking a risk in providing future income for your loved ones.
500,000 Life Insurance Policy / 50,000 Income = 10
Entertainment Expense to Income – OK this is a tough ratio to talk about because people sure love to entertain. But realistically we all need to keep this below 15% of income. If in debt this should probably be 10% or less. Entertainment is fun but not at the expense of all the other goals, needs, wants in life. (Vacation Included in this)
350 Entertainment / 3,000 Income = .11 or 11%
Now can you see why these personal financial ratios matter and why you need to be on top of them to achieve financial success. I doesn’t matter how much you make or how much you think you know about finance. What matters is keeping the ratios in line with the percentages to make life easier. If success should become you in the matters discussed above then you shall be a financial guru. (Sort of) Knowledge is nothing without the wherewithal of applying it in life.
It is appalling that people think that the ratios don’t matter because justifying financial abuse might suit them in the present. But I will help you out here as justifying things only delays the inevitable and maybe the unfortunate outcomes could have been avoided. By taking a stand to recognize the personal finance ratios you will hopefully never realize a horrendous financial setback and when your old and grey the importance of your actions will make you smile.
Update: the ratios are easier to stay in range if income is on the high end and harder if on the low end. Be mindful how income can sway the ranges.