My Favourite Net Worth Ratios

net worth

In my career as an engineer as well as in my post-grad studies I have always loved the use of ratios. Comparing two numbers in order to paint a picture by using a simple quantitative correlation is enlightening. I know you might say “shame this poor geek has no live”, and you might be half right. But hold on have a look as some of these as they might just assist you as well.

Tracking your net worth is an important tool to provide visibility in your finances. Many personal finance blogs and sites can explain this in more detail as it is very popular. I believe your personal finances are like a business and should be managed accordingly. Ratios are already commonly used as a fundamental analysis tool to measure share prices and business health. Your net worth is your personal balance sheet. So here are my favourite ratios to apply to it in order to know more about my personal financial state.

Current Assets to Liabilities

In this ratio I take my current assets and divide it by my total liabilities, it is known in business as the current ratio or with some exclusions as the acid test.

I classify current assets as any investable assets which is relatively liquid. This includes any funds in cash, ETF’s shares or something that can be sold within a short space of time. Liabilities I classify as all the debt I have. I generally do not distinguish between short-term and long-term debt as my goal is to be debt free. If you leverage some debt to make a profit from the return on capital enabled by the debt like a margin loan or investment property it is a bit of a different story, although the ratio is still applicable.

For someone who wants to live debt free this is a great ratio. If the ratio is above 3 you are probably theoretically debt free and should understand the best solution between either paying off your debt or keeping your current assets. It is also a great ratio for someone who wants to be mobile and understand how liquid their money is.

My goal for this ratio is to be #DIV/0! (if you didn’t get it don’t worry) in other words debt free. The only debt above that should be for investments like real estate, I am personally not a fan of margin loans or similar instruments.

Earning to Debt or Savings to Debt

In this ratio I take my monthly earnings and divide it by my total liabilities (debt).

In personal finance people like to use the Debt to Income ratio. I like to turn this around a bit as I hope you would agree that we are not here to see how much more debt we can afford for our lifestyles. I would like to see how many paychecks I need to invest fully into my debt to eliminate it. And this is what this calculation provides you with as the result will be in months if you use your monthly income.

Another way to look at it is to use savings if you know your savings rate. If you know you can save 20% of your income every month you can calculate how long it will take to pay off your debt. For example, you earn $ 1000 per month and can save $ 200 per month. If you have debt of $ 2000 you can therefore pay it off in 10 months if all your savings goes towards servicing the debt.

Although earnings or savings is not an item shown explicitly on your net worth it is an easy enough ratio to apply. My goal for this ratio is to be 0 or as stated above to only have debt which funds investment or income generating assets.

Current Assets to Fixed Assets

This ratio is open to a bit of interpretation but basically it is dividing your current asset by fixed assets. Another way to look at it is to divide your growing invested assets with your fixed lifestyle assets.

If you use the latter you can take all your investments, retirement funds etc. and divide it by with your lifestyle assets like vehicles and non-income generating real estate.

Although all of this is assets which is a good thing it is far better to have assets that grow for the future than assets used for your lifestyle like the house we are pondering of purchasing. Balance is good but the older you get the larger this ratio should become. The closer you are to retirement the more income generating assets you should own.

This ratio is ideal for short/medium-term goals which is a bit more personal. I would like to get this ratio above 2 in the next 2 years. Naturally having this ration at 1 trillion would not be bad.

The Financial Independence Ratio

The 4% rule is very popular and used in many applications. Normally you use your expenses to do the calculation especially if you already save a large portion of your income. So, if you know your required annual expenditure, multiply it by 25 to get the FI Amount or in Mr Money Moustache’s terms “The Stash”

Take your current or investable assets and divide it by the FI Amount times 100. This will give you a percentage of your progress towards financial independence (FI). The goal naturally is to get to 100%, if above 100% you are theoretically richer than you need to be which might be worth that smirk on your face…ah one day.

I hope you can apply some of these in your personal finances. If you have any favourites or suggestions please let me know.

Always grow your wealth for tomorrow while being content with your wealth today.

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