Besides your net worth, try tracking the following three ratios. I guarantee you will see large improvement in your finances.
Net Wealth = (Net Worth) / (average monthly expenses/30)
No other financial ratio gives you a better description of your current financial state, than your net wealth.
What I like about calculating your net wealth, is that it gives meaning to your net worth.
For example, Sam Spender has a net worth (asset – liabilities) of $1,000,000. Sam spends $1,000 a month on average a day. Therefore, his net wealth would be 1,000. Meaning, if Sam maintained the same lifestyle and had no income, he would run out of money in 1,000 days.
Next, we have Frank Frugal. Frank has a net worth of $500,000. Frank spends on average $3,000 a month or $100 a day. With his current spending habits, Frank can maintain the same lifestyle for 5,000 days without any income.
If you just looked at their net worth, one would assume that Sam’s financial situation is twice as good as Frank’s. However, by looking at their net wealth, you see that Frank is five times “wealthier” than Sam.
Net Savings = Money Saved / Money In
I started tracking my net savings, when I first heard that John Templeton’s rule was to invest $1 for every $1 he spend. He eventually went on to becoming a billionaire, so I think it worked.
While I’m far from achieving this $1:1 ratio, I do plan on getting there. Every year, my goal is to increase my savings rate from the previous year.
What I also like about tracking my net savings is that it takes away the guilt I usually put on myself for spending. As long my net savings has increased from the previous year, I can buy whatever I like.
Emergency Fund = Cash / Monthly Fixed Expenses
The last meaningful financial ratio that I track, is my emergency fund.
Why do I find it important to track my emergency fund? There are two reasons.
First, it’s comfortable knowing that if something happened, I could live off of just cash for a certain period of time. In other words, I sleep better at night.
Second, I don’t like having cash sitting around without a purpose. For example, say my optimal emergency fund is $10,000. If I have more than $10,000 in my bank account, that’s money I should put towards goals.
How Often Should You Calculate?
When I first begin tracking my finances, I computed the above equations, plus my net worth, twice a month. The reason, I wanted to update my net worth each time I was paid.
After doing this for a few months, I moved on to tracking my finances once a month.
I then tried to track once every three months. However, I found that three months was too long.
By calculating once a month, I could easily estimate what my progress had been. When I switched to three months, I felt like a lost some control. I had no clue how I was doing because so much changes inside of 90 days.
Calculating these ratios and my net worth once a month, has worked well. At all times, I feel like I know where exactly where I stand.
Test different lengths of time for yourself. If you feel like you can go an entire year and still have an accurate snapshot of where you currently stand, that’s great. There is no right or wrong answer. The goal is to know where you’re and where you’re going, at all times.
What about Benchmarks?
There are so many variables when you’re younger, that it’s pointless to try to benchmark each financial ratio.
I was lucky enough to graduate college without any debt. Plus, I lived at with my parents, while working full time for two years. I also had another job coaching basketball. By the time I moved out, I was contributing to my 401(k), maxing out my Roth IRA, saved for an engagement ring and wedding, and had enough for a down payment on a house.
In contrast, some of my friends are just getting out of grad school right now at 26 years of age, with a good chunk of debt to payoff.
Instead of comparing our situations, it’s better just to track your own improvement. Don’t worry about where others are at. Each month your goal should be to do better than you did the previous month. Not to compare yourself to others.
In the comments, let me know what else you find helpful to track.
Photo by: Patrick Hoesly