Make Cents of Your Money with These 4 Ratios

Managing your finances can feel like trying to make it through a maze blindfolded while juggling flaming torches.

Do I pay down my student loans? Should I invest more? Will I ever be able to afford a house?

Managing your finances in your 20s can be both confusing and intimidating, especially when you’re trying to juggle student loans, living expenses, and saving for the future, all while still enjoying life now.

It’s a lot.

The following financial ratios can help clear up the confusion so you can quickly gauge if you’re on track or need to make some changes. With these tips in your arsenal, you won’t have to miss out on any of the fun while still being financially responsible.

Emergency Fund

This is the money you live on when something unexpected happens like a sudden layoff or medical emergency. It’s also the fund you dip into when your car decides to not pass inspection so you have to replace all of the tires, brakes, and rotors at one time.

Ouch.

Here’s how you calculate your emergency fund ratio:

Total Savings / Monthly Expenses = Emergency Fund Ratio

If you have $7,640 in total savings
and $2,253 in monthly expenses (rent, car, student loans, food, utilities, etc)

7640 / 2253 = 3.39 months that you can support yourself on your savings

The ideal benchmark for this number is 3 to 6. If your ratio is lower than 3, you may not have enough savings to cover unexpected expenses. If it’s higher than 6, you may be keeping too much money in your emergency fund, and you may want to consider putting the extra money toward other savings goals or investing it for higher returns.

Debt To Income

The Debt To Income Ratio, or DTI, helps answer the question, “How much of my income goes toward debt?” Lenders use this ratio to determine if you qualify for a loan and how much money you can borrow.

Here’s how you calculate it:

Monthly Debt Payments / Monthly Gross Income = Debt To Income Ratio

If you have $320 car payment + $860 mortgage + $215 student loan payment = $1,395 monthly debt payments
If your monthly gross income = $4763 (before taxes)

DTI = 1395 / 4763 = .29 (29%)

The ideal benchmark for the debt to income ratio is below 0.36 (36%). If your ratio is higher than that, you may have trouble getting approved for loans or credit cards, and you may want to consider paying off some of your debts to improve your ratio.

Debt to Disposable Income

This ratio helps you understand how much of your take-home pay is consumed by debt like credit card payments, car loans, student loans, and personal loans.

Here’s how you calculate it:

Monthly Non-mortgage Debt Payments / Monthly Take Home Pay = Debt To Disposable Income

Let’s say you have $156 credit card payment, $220 car payment, and $270 student loan payment = $646 non-mortgage debt
Your take home pay is $4,862

Debt To Disposable Income = 646 / 4862 = .13 (13%)

The ideal benchmark for this ratio is 0.14 (14%) or below. If your percentage is higher than 14%, be careful not to take on more debt, and explore the best option for you to reduce your debt payments.

Net Worth

Your net worth is snapshot in time of what you own vs. what you owe. It’s the value of your assets (like savings, investments, and property) minus your liabilities (such as loans and credit card debt).

To calculate your net worth, add up the dollar amount of all of your assets:

Property values – home, car, etc.
Total savings amount
Total investments amount (401k, Roth IRA)

Now add up the dollar amount of all of your liabilities:

Credit card debt
Student loans
Mortgage and car loans

Assets – Liabilities = Net Worth

The goal is to have a positive net worth, and one that increases over time. Having a positive net worth means that you have more assets than liabilities, which provides you with the resources to comfortably retire, tackle unexpected expenses, and pursue your dreams.

If you start tracking your net worth now, you can use it to prioritize goals and see how your spending, saving, and investing habits impact you over time.

Trust me, your 65-year-old self will thank you for it.