Have you ever felt like you’re just going through the motions with your finances? You’re making money, spending it, and maybe saving a little, but you don’t really know if you’re on the RIGHT TRACK.

 

It’s easy to feel lost in the world of personal finance when you watch others make so MUCH MONEY, but it does NOT have to be that way.

 

Imagine having a clear picture of your financial health, knowing exactly where you stand and what steps to take to reach your financial goals.

 

This is where the POWER of MONEY RATIOS comes in.

 

These simple yet powerful tools can shed light on your financial habits, helping you gain control over your money and unlock your path to financial freedom.

 

Let’s dive into 5 ESSENTIAL MONEY RATIOS that YOU should know !

 

1. The Savings Ratio: Fueling Your Future

 

The savings ratio is a GOOD indicator of your financial well-being. This ratio reveals the PERCENTAGE of your income you dedicate to saving, which provides an understanding of how effectively you’re building your financial cushion.

 

A HIGHER SAVINGS RATIO indicates a healthier financial status, as it suggests that you are putting away more money for future needs.

 

To calculate your savings ratio, divide your total savings for a given period (usually a month or year) by your total income for the same period.

 

For example, if you saved $1000 in a month and earned $5000 in a month that equates to 20% ($1000 / $5000 x 100).

 

A general guideline is to aim for a savings rate of AT LEAST 15-20%, although some financial experts recommend saving even higher.

 

I personally aim for 30-40% savings rate and is consistent in doing so !

 

Why is the Savings Ratio Important?

 

• Building an emergency fund: A strong savings ratio ensures you have enough money tucked away for unexpected expenses like car accidents, emergency hospital bills, or losing a job. When I lost my job, I was able to use 3-6 months of savings to cover expenses like a car loan and other essentials like groceries.
  

 

• Reaching your financial goals: Savings is consistently essential, whether it’s buying a home, retiring comfortably, or achieving your dream vacation

 

• Securing your financial future: A healthy savings ratio provides a safety net for life’s uncertainties and allows you to weather economic storms with confidence.

 

How to BOOST Your Savings Ratio:

 

• Create a budget: Allocate your income strategically, ensuring enough goes towards savings.

 

• Track your expenses: Identify areas where you can cut back on unnecessary spending.

 

• Automate your savings: Schedule automatic transfers to your savings account to make saving effortless.

 

• Set realistic “SMART” saving goals: Start small and gradually increase your saving amount over time.
  

 

Check out my blog post about how to get started on budgeting as a beginner !

 

2. Debt-to-Income Ratio (DTI): Navigating Your Financial Obligations

 

The debt-to-income ratio (DTI) is a critical measure that assesses your ability to manage your debt burden. It quantifies the percentage of your monthly income that goes towards debt payments.

 

A LOWER DTI generally signifies BETTER  financial health, as it indicates that you have more disposable income and are less financially burdened.

 

This usually calculated on a PER monthly basis. To calculate your DTI, divide your total monthly debt payments (including credit cards, loans, mortgages, and other recurring debt obligations) by your gross monthly income.

 

For instance, if your monthly debt payments are $1,500 and your gross monthly income is $5,000, your DTI would be 30% (($1500 / $5000) x 100).

 

Remember this is only going to be typically interest rate amount and only a small portion of it actually going to the principal amounted borrowed. 

 

A good range is between 20% to 36% or even lower than that. 

 

Why is the Debt-to-Income ratio important?

 

• Financial stability: A high DTI can signal financial stress, making it more challenging to reach financial goals.

 

• Creditworthiness: Creditors often use DTI to assess your creditworthiness and determine your eligibility for loans or credit card.

 

• Debt management: Monitoring your DTI helps you identify potential issues early and take action to improve your financial position.
  

 

To IMPROVE your Debt-to-Income ratio:

 

• Reduce your debt: Prioritize paying off high-interest debt, such as credit card debt, using strategies like the snowball or avalanche method.

 

• Increase your income: Explore opportunities for additional income, such as a side hustle or a raise at work.

 

• Negotiate lower interest rates: Contact lenders to explore options for lowering your interest rates, which can significantly reduce your debt burden.

 

3. Credit Utilization Ratio: Master You Credit Limits

 

Your credit utilization ratio is another crucial factor that plays a role in your credit score. It measures how much of your available credit you’re using.

 

Understanding your credit utilization can also help you manage your expenses. By monitoring how much credit you use, you can develop BETTER spending habits and AVOID accumulating debt.

 

If you find yourself consistently overusing your credit, it may be time to reassess your budget and expenses.

 

To calculate your credit utilization ratio, divide your total credit card balances by your total credit limit.

 

For example, if your total credit card balance is $2000 and your credit limit is $10,000, your credit utilization ratio is 20% (($2000 / $10,000) x 100).

 

A lower ratio suggests responsible credit management, which can positively impact your credit score.

 

Generally, it’s advisable to keep your credit utilization ratio below 30%.

 

Why is the Credit Utilization Ratio important?

 

• Credit score: A high credit utilization ratio can lower your credit score, making it more challenging to obtain loans or credit cards.

 

• Financial responsibility: It reflects your ability to manage credit responsibly and avoid overspending.

 

• Credit terms: Creditors often use your credit utilization ratio to determine interest rates and other credit terms.

 

To IMPROVE your credit utilization ratio:

 

• Request credit limit increases: Consider requesting a credit limit increase if you have a good payment history, as this can lower your credit utilization ratio.

 

• Pay down your credit card balances: Prioritize paying down high balances to reduce your credit utilization.

 

• Use credit wisely: Avoid maxing out your credit cards and try to keep your balances consistently low.

 

4. Housing Ratio: Finding Your Ideal Housing Situation

 

The housing ratio, also known as the housing expense ratio, helps determine your ability to comfortably afford housing costs.

 

It assesses the proportion of your income spent on housing, including mortgage payments, property taxes, homeowners insurance, and other unexpected expenses like property maintenance. 

 

Understanding your housing ratio is essential when deciding to PURCHASE a home or RENT an apartment. If your housing expenses consume too much of your income, it may lead you toward financial strain in other areas of your budget.

 

To calculate your housing ratio, divide your Total Monthly Housing expenses by your Gross Monthly Income.

 

For example, if your monthly housing expenses are $1,800 and your gross monthly income is $5,000, your housing ratio would be 36% (($1,800 / $5,000) x 100).

 

Lenders generally use housing ratios as a key factor in evaluating mortgage applications.

 

Financial experts often recommend aiming for a housing ratio of 28% or lower for comfortable financial management.

 

Keeping housing costs manageable allows for greater flexibility in your finances, easing the way for savings, investments, and lifestyle expenditures.

 

Why is the Housing Ratio important?

 

• Financial Stability: A high housing ratio can put a strain on your finances, leaving less room for other expenses or savings.

 

• Mortgage Approvals: Lenders use housing ratios to assess your ability to manage mortgage payments and determine your eligibility for a loan.

 

• Financial Flexibility: A LOWER housing ratio provides greater financial flexibility and allows you to handle UNEXPECTED financial challenges more effectively. 

 

 

To IMPROVE your Housing Ratio:

 

• Consider Your Income: Evaluate your financial situation to ensure your income can comfortably handle the costs of your chosen housing. Making extra income through a side hustle or another job could help with this. 

 

• Negotiate Your Mortgage: Look into options for refinancing your mortgage to lower your monthly payments. Start doing your own research and shop around !

 

• Reduce Other Expenses: Identify areas where you can cut back on non-essential expenses to free up more income for housing.

 

5. The Investment-to-Asset Ratio

 

The Investment-to-Asset Ratio is a crucial financial metric that reflects the proportion of an individual’s or organization’s total assets allocated to investments. This ratio serves as a barometer of how effectively one is utilizing their assets to generate returns. 

 

 

To calculate this metric, one can use the formula: Investment-to-Asset Ratio = Total Investments / Total Assets. A higher ratio indicates a greater portion of one’s assets is being productively invested, potentially leading to higher returns over time.

 

 

For example, consider an individual with total assets amounting to $$Iftheyhaveinvested\; \$$50,000 in various securities, the Investment-to-Asset Ratio would be calculated as ($50,000 / $200,000) yielding a ratio of 0.25 or 25%. This means that 25% of their total assets are allocated to investments.

 

Understanding this ratio is essential for evaluating one’s financial health and guiding future investment decisions.

 

A favorable IAR indicates that an individual is not just accumulating assets but actively working to grow their wealth through investments. This proactive approach can lead to enhanced returns over time, outperforming traditional savings methods. Furthermore, maintaining robust investments can provide a buffer against INFLATION, ensuring that assets retain their value in real terms and supporting a comfortable retirement.

 

Why is the Investment-to-Asset Ratio is important? 

 

• Debt Management: Reducing liabilities can improve your overall net worth, indirectly supporting a healthier IAR. Managing or eliminating debt, such as consolidating loans or negotiating better terms, can free up resources for investment.

 

• Performance Tracking: Regularly monitoring the ratio allows for adjustments in investment strategy to align with changing financial circumstances.

 

• Risk Assessment: It helps assess risk tolerance, guiding individuals in making informed investment decisions.

 

To IMPROVE your Investment-to-Asset Ratio: 

 

• Diversify Your Investments: Aim to spread your investments across various asset classes—such as stocks, ETF’s, mutual funds, bonds, real estate, cryptocurrencies, and commodities. Diversified portfolio can mitigate risk and enhance returns, allowing you to maintain a higher investment level relative to your assets.

 

• Regular Contributions: Contribute consistently to investment accounts whether its small or big amounts. This could be through employer-sponsored plans like a 401(k) or individual accounts. Establishing a habit of investing a percentage of your income ensures that your investments grow over time – think long term !

 

• Review and Adjust Your Portfolio: Regularly assess your investment portfolio to ensure it aligns with your financial goals. Rebalancing can help you take advantage of market fluctuations.

 

• Make Time to Educate Yourself on Investment Opportunities: Understanding emerging asset, classes market trends, and various investment strategies can enhance your ability to make informed decisions. ALWAYS have a MINDSET of continuous learning can enable you to identify opportunities that align with your financial objectives.

Conclusion

 

Understanding these 5 ESSENTIAL MONEY RATIOS can be transformative for your financial journey.

 

They empower you to gain clarity, make informed decisions, and take control of your financial future.

 

By regularly calculating and tracking these ratios, you can identify areas for improvement, set realistic financial goals, and confidently navigate the path towards financial success.

 

Everyone starts somewhere and you can too !