Personal finance money ratios is something that you may have seen from reading other personal finance blogs. Basically, common stock ratios like current ratio (assets/liabilities), debt to equity ratio, income to debt, or cash flow are applied to personal finance instead of companies.
Although I haven’t calculated money ratios for my finances, I’ve always had a curiosity as to how effective they are in helping achieve financial goals. An indicator is one thing, but used in context of the bigger picture is another.
The book “Your Money Ratios” does just that, it basically shows you the ratios that you should have at certain age levels to achieve your financial goals. Although this book was written for an American audience (social security etc), the theme is relevant for everyone. I’ve written a money ratio’esque article in the past where I calculated how much you need to save for early retirement, but perhaps I’ll do more Canadian relevant stuff in the future.
About the Author:
According to the book:
Charles J. Farrrell is an investment adviser with Northstar Investment Advisors, in Denver. He writes the “Retirement Roadmap” column for the CBS Moneywatch site and contributes a monthly retirement column for advisers to InvestmentNews. His research is frequently cited in The Wall Street Journal, SmartMoney, the Chicago Tribune, and many other consumer and professional media outlets.
About the Book
As you can probably conclude from the book title, the content focuses around personal finance money ratios for different age groups. What I like about this book is that it shows the ratios that you should aim for to reach certain financial milestones. It’s one thing to say to save 10% of your income, but what does that really mean during retirement? Other questions that the book answers is how much mortgage debt is acceptable at certain age groups? How much capital should I have relative to my age (net worth)?
The 8 Money Ratios covered are:
- Capital to Income Ratio – How much capital do you have relative to your income? How much do you need to retire? The author does not include principal home equity as part of the calculation, but states that a 30 year old should have a ratio of 60% of income in capital. For example, if a 30 year old was making $100k per year, he should have at least $60k in capital not including his home equity.
- Savings Ratio – How much of your income are you saving to reach your desired capital to income ratio? The author recommends saving at least 12% of gross income starting at age 25, increasing to 15% at the age of 45. Of course, the higher your savings ratio, the earlier you can retire.
- Mortgage to Income Ratio – How big is your mortgage relative to your income? The author and I have the same beliefs about this one, the mortgage size should not be greater than 2 times family income.
- Education to Average Earnings Ratio – This ratio indicates how much student debt you should take on to obtain a degree.
- Investment Ratio – How to grow and protect the capital you have accumulated.
- Disability Insurance Ratio – As a big believer in disability insurance, I believe that enough disability should be obtained to cover expenses, and not to simply replace income. The book describes how much disability insurance you need at each age group.
- Life Insurance Ratio – As another pillar of personal finance, term life insurance is a must. The author explains how much life insurance you need at each age group. To me, it’s a factor of your dependents and how much assets you have already accumulated.
- Long Term Care Ratio – This helps determine if you need long term care insurance. Personally, I haven’t given much thought to this one.
I enjoyed this book as it provided hard numbers and facts that show the path to financial freedom. As well, the author had a part on retirement withdrawal rates. I’ve written about these before, but he explained that a 5% retirement portfolio withdrawal rate is perhaps a bit aggressive, but a 4% withdrawal rate should work 95% of the time.
Although all the ratios may not be completely accurate to Canadians, most of them are pretty close as Canadians have CPP and OAS instead of Social Security.
Want a Free Copy?
The book publisher was generous in offering Million Dollar Journey readers the chance to win 3 copies of the book. The details are below:
- New and existing MDJ Money Tips Newsletter Subscribers get an entry. You can sign up here (it’s free).
- Tell me what your favorite book is in the comments for an additional entry. It doesn’t need to be finance related.
- Only those with a North American mailing address may enter (publisher rules, sorry).
- Contest will end Sat 5pm EST Jan 16, 2010 and the winner announced shortly after!