I am often asked, “Am I on track?” Every situation is different, but some objective measures can be used as a snapshot and tracked over time to measure progress. Finding the right balance between current lifestyle and saving for the future is tricky. Here are some indicators I use with clients and why I think they are relevant.
Personal net worth is a measurement of an individual’s total wealth. It is calculated as the total value of assets minus the total value of liabilities: what you own versus what you owe.
Net worth is a snapshot in time and its value is in tracking progress over time. Ideally, you would see an increase in net worth over time.
Net worth = total assets – total liabilities.
I like to think of emergency cash in two levels. My minimum recommended amount is enough cash readily available to cover three big unexpected expenses. For example, a new refrigerator, new tires or dental crown. This is especially important if you carry credit card debt.
The next level is, if something happened to your income, how long would you be able to cover your monthly expenses? The first step is to identify what you spend on a monthly basis. There are two components: committed expenses and discretionary. Committed expenses are those you are contracted to pay on a regular basis. Think mortgage/rent, cable, utilities, gym memberships, loan payments. Discretionary are those you can defer. For example, clothing, entertainment, hobbies, elective medical procedures. There also are the “gray area” expenses of food, auto fuel, debt repayment, subscriptions, personal care. These are expenses you have, but you might have some control over the amount and timing. Most financial experts agree that individuals should maintain an emergency fund that would cover three to six months of household expenses.
Emergency fund balance = six times monthly expenses.
The liquidity ratio is an extension of tracking your emergency fund. Assets that can be redeemed within three to four working days with no loss of principal are defined as liquid assets. This ratio should be three to six.
Liquidity ratio = liquid assets/monthly expenses.
If you tend to have more month than money, you might have assumed too much debt.
Debt-to-income ratio = monthly debt payments/gross income.
Your debt-to-income ratio should decrease over time. The target is no more than 36% of your gross income.
One area where there is a tendency to overspend is housing. A good rule of thumb is no more than 28% of gross income to cover housing expenses. These expenses are rent/mortgage, property taxes and insurance.
Housing ratio = monthly housing costs/gross monthly income.
Retirement savings ratio
This measures your contributions to long-term savings, either in employer-sponsored retirement plans, Roth IRAs or after-tax money earmarked for long-term savings. This does not include savings earmarked for your emergency fund, for college, or for a house or vacation. If you start saving in your 20s, a good target is 15% of gross income, including employer contributions to retirement plans. If you wait to save until you are in your 30s or beyond, the rate increases to 20% to 25%.
Savings ratio = savings/gross income.
Measure progress over time
While your current situation might not be ideal, even small changes will add up over time. While it is nice to compare yourself to others, we all start from different places and have different experiences along the way. The most important measure is how you are doing year to year. Start tracking your measurements, adjust along the way, and in five years, you will see all the progress you’ve made.•
Hahn is a certified financial planner and owner of WWA Planning and Investments in Columbus. She can be reached at 812-379-1120 or [email protected]