Thursday, August 8, 2013

Ratios to Rate Your Personal Finances

Don at My Dollar Plan wrote a post about 4 ratios to rate your personal finances. I thought I’d see how our family finances fare in this test and maybe learn something new. For each ratio, Don gives a recommended minimum or maximum level. Here goes.

Liquidity Ratio = Liquid Assets / Monthly Expenses

Our family comes in at 6.2 months right now, but this figure varies over time from about 4 to 8 months. I usually let cash sit in trading accounts until it builds up to about $5000, at which point I buy some ETF that’s below its target allocation in our family portfolio. The amounts in each account vary over time, but the total of all these amounts has some stability.

We almost always have less than the 10 months of living expenses that Don recommends. I’m not too concerned because I have a large line of credit available and could also sell off some ETFs in non-RRSP accounts if necessary.

Savings Ratio = Savings / After-Tax Income

Don actually had gross income in the denominator, but I don’t see why your savings ratio should be penalized for paying taxes. Remember to count only the after-tax portion of any RRSP contributions.

My family comes in with a very healthy 61% savings rate. Don recommends saving 20% of your gross income. Let’s call this 25% to 30% of your net income. I’m pleased to be saving double this amount and look forward to full financial independence.

Housing Expense Ratio = Homeowner’s Expenses / After-Tax Income

Don recommends housing expenses of no more than 20% to 25% of net income. My family is at a comfortable 10%.

Non-Mortgage Debt Ratio = Non-Mortgage Debt Payments / After-Tax Income

This is where it gets embarrassing for me. My wife had to replace her car recently and we paid for it on our line of credit. We’ll have this paid off very soon, but a debt is a debt. We plan to pay far more than the minimum 2% each month, but using the minimum payment, our non-mortgage debt ratio is 0.3%, well below Don’s maximum of 15%. Because we have no mortgage, our total debt ratio is also 0.3%.

So that’s it. We’re doing fine everywhere except possibly with our liquidity. How do your finances stack up?


  1. This is an interesting exercise. For me:

    Liquidity Ratio: I'm with you, I try to keep all my cash invested and rely on available credit lines and liquidating investments if necessary. But I have never had to liquidate or dip into the credit line for unexpected expenses, cash flow from taking a break from savings has always buffered unusual expenses. So my intended liquidity ratio is zero but I wait until I have enough cash built up to justify the transaction costs.

    Savings Ratio: I've always tried to go with 1/3 savings, 1/3 spending and 1/3 taxes so I'm usually at 50% by your definition with after tax income in the denominator. More spending on taxes than all other spending combined, grrr!

    Housing Expense Ratio: I'm too lazy to calculate this one precisely, in the 5-10% range. Maybe more depending on how major maintenance expenses and home improvements are amortized.

    Non-Mortgage Debt Ratio: 0- at high marginal tax rates paying interest in after tax dollars is a big wealth destroyer.

    1. @Greg: It sounds like you're doing well. I prefer to have some liquidity in case of the small chance of very tough times (loss of job combined with stock market crash and the bank closing our line of credit). I was actually surprised that my housing expense ratio was so high. I did amortise things like replacing windows, roof, flooring, etc.

  2. We're having a bit of a flood of liquidity. I think we need to find something worth investing in sometime later this year. With an older home, though, it's tempting to keep quite a bit on "standby."