When it comes to financial wellness, understanding your financial health is just as important as tracking your physical health. Just like a doctor uses key health indicators—such as blood pressure and cholesterol levels—to assess well-being, you can use financial ratios to evaluate and improve your financial stability.
At Palmer Financial Wellness, we believe financial literacy is the foundation for smart decision-making. That’s why we’re breaking down the five most important financial ratios that everyone should monitor to build a strong financial future.
Debt-to-Income Ratio (DTI)
Why It Matters:
How to Calculate It:
DTI = ((Total Monthly Debt Payments) / (Gross Monthly Income)) * 100
Example: If you earn $5,000 per month and your total debt payments (mortgage, car loan, student loan, credit cards) add up to $1,500, your DTI would be: ($1500 / $5000) * 100 = 30%
Ideal Range:
- Below 36% is considered healthy.
- Above 43% may make it difficult to qualify for loans.
How to Improve It:
- Pay down high-interest debt.
- Increase income to improve the ratio.
- Avoid taking on new debt unnecessarily.
Emergency Fund Ratio
Why It Matters:
An emergency fund is your financial safety net, covering unexpected expenses like medical bills, car repairs, or job loss. The emergency fund ratio measures how many months’ worth of essential expenses you have saved.
How to Calculate It:
Emergency Fund Ratio = (Total Emergency Savings) / (Monthly Essential Expenses)
Example: If you have $12,000 in savings and your essential expenses (housing, food, insurance, transportation) are $3,000 per month: $12,000 / $3,000 = 4 months
Ideal Range:
- 3 to 6 months of essential expenses for most individuals.
- 6 to 12 months for those with irregular income (freelancers, business owners).
How to Improve It:
- Automate savings contributions.
- Reduce discretionary spending.
- Store emergency funds in a high-yield savings account for easy access.
Savings Rate Ratio
Why It Matters:
Your savings rate ratio shows how much of your income you are setting aside for future goals, including retirement, investments, and major purchases. A strong savings habit is key to financial independence.
How to Calculate It:
Savings Rate = ((Total Savings Per Month) / (Gross Monthly Income)) * 100
Example: If you save $800 per month and earn $5,000 before taxes: ($800 / $5000) * 100 = 16%
Ideal Range:
- 15-20% of income is recommended for long-term financial security.
- More than 20% accelerates wealth-building and early retirement.
How to Improve It:
- Increase 401(k) or IRA contributions.
- Cut non-essential expenses and redirect those funds to savings.
- Automate savings to ensure consistency.
Net Worth Ratio
Why It Matters:
Net worth is the ultimate measure of financial progress. It represents the difference between what you own (assets) and what you owe (liabilities). A positive and growing net worth indicates financial stability, while a negative net worth suggests debt outweighs assets.
How to Calculate It:
Net Worth = Total Assets – Total Liabilities
Example: If you have:
- Assets: Home ($250,000), Car ($15,000), Retirement Accounts ($100,000), Savings ($10,000) → Total Assets: $375,000
- Liabilities: Mortgage ($180,000), Car Loan ($10,000), Student Loans ($30,000), Credit Card Debt ($5,000) → Total Liabilities: $225,000
Net Worth = $375,000 – $225,000 = $150,000
Ideal Trend:
- Net worth should be positive and growing over time.
- A good benchmark is age-based net worth targets (e.g., by age 30, aim for 1x annual salary; by 40, 3x; by 50, 6x).
How to Improve It:
- Pay off debt aggressively.
- Increase asset-building through investing.
- Avoid lifestyle inflation and unnecessary debt.
Financial Independence Ratio (FI Ratio)
Why It Matters:
The FI ratio measures how close you are to achieving financial independence, meaning the ability to live off passive income (investments, rental income) without relying on employment.
How to Calculate It:
FI Ratio = (Passive Income / Monthly Expenses) * 100
Example: If your investments generate $2,000 per month in passive income and your monthly expenses are $4,000: ($2,000 / $4,000) * 100 = 50%
Ideal Range:
- 100% = Financial independence (your passive income fully covers expenses).
- 50-75% = Strong progress toward early retirement.
How to Improve It:
- Increase investments in dividend stocks, rental properties, and bonds.
- Lower monthly expenses to reduce the amount needed for FI.
- Diversify income streams through side businesses or royalties.
Final Thoughts: Master Your Financial Ratios for Long-Term Success
Tracking these five essential financial ratios gives you a clear roadmap for achieving financial wellness. Whether you’re just starting or fine-tuning your financial plan, these metrics help you make data-driven decisions that move you closer to financial security.
Next Steps for Your Financial Wellness:
- Calculate your own financial ratios using the formulas above.
- Identify areas for improvement (debt reduction, savings increase, etc.).
- Set goals to improve your ratios over time.
- Monitor progress regularly to stay on track.
At Palmer Financial Wellness, we’re here to help you navigate your financial journey with confidence. Stay tuned for more insights on financial literacy, retirement planning, and smart money management!