As an investor, understanding financial ratios is important to help assess the current state of a company. For example, we have P/E ratios, debt/equity ratios, EV/EBITDA ratios, interest coverage ratios, and so many more. We then compare each ratio to another company’s financial ratio to make a more informed investment decision.
As someone who worked in the investing field for 13 years and got my MBA, I can’t help but think of everything relative to another. Therefore, since starting Financial Samurai in 2009, I’ve come up with a whole host of personal finance ratios to help readers and listeners build wealth.
These ratios are designed to help people spend, invest, and save more responsibly, with the ultimate goal of achieving financial freedom sooner. It’s harder to see where you stand in a vacuum. By comparing one thing to another, you get a better idea of how to optimize your financial decisions.
The Most Important Personal Finance Ratio For Most People
As I reviewed all the personal finance ratios I’ve developed, I believe the most important personal finance ratio is the House-To-Car Ratio. Since everyone needs a place to live and over 90% of the American population owns a car, my House-To-Car Ratio is relevant for practically everyone.
Yes, your saving rate is crucial for financial freedom. Everyone knows that the more you save and invest, the greater your chances of building above-average wealth. However, my House-To-Car Ratio goes a step further because we ultimately save and invest to buy things. And two of the most common things we buy are houses and cars.
Hence, if you don’t think my House-To-Car Ratio is the most important, it is at least the most relevant.
Personal Finance Ratios Help You Build More Wealth
To build wealth, we must allocate our capital wisely. The more capital we can allocate towards appreciating assets, and the less we allocate towards depreciating assets, the better.
History has shown that investing in real estate is one of the best ways to build wealth over time. Real estate is my favorite asset class for the average person to invest in. Meanwhile, unless you buy a rare collectible car, cars are guaranteed to depreciate over time.
However, the problem I see is that too many people spend way too much on cars! My 1/10th Rule for Car Buying has helped millions of people spend less on cars for over 15 years. Now I’ve combined my car buying guide with my 30/30/3 Home Buying Guide to create the ultimate personal finance ratio.
Shoot for a House-To-Car Ratio of 30 or Higher
Your goal, if you choose to accept it, is to achieve a House-To-Car Ratio of 30 or higher. The higher your ratio, the better. The key way to reach this ratio is by buying an inexpensive car and owning it for as long as possible, while owning an affordable primary residence. Let the car’s depreciation work for you, not against you!
Yes, you can achieve a ratio of 30 or higher by buying a more expensive home. However, the decision to buy your dream home must be made within the confines of my 30/30/3 home buying guide. So I’m not talking about leveraging to the hilt to irresponsibly buy a home.
Here’s my episode about the most important new personal finance ratio. I hope you will share the concept and discuss the ratio with your significant other and friends. If you do, you might give them the best gift ever in time, because more money buys more freedom. You can listen on Apple or Spotify too.
Other Personal Finance Ratios And Financial Concepts
Here are some helpful personal finance ratios and financial concepts to learn about. They were created to address some of life’s biggest financial dilemmas.
My goal since 2009 is to come up with practical solutions to some of life’s biggest financial dilemmas. For new readers, I worked at GS and CS for 13 years, went to William & Mary for economics, and got my MBA from Berkeley.
Ratios For Investing
Debt And Investment Ratio (DAIR) – This ratio helps people decide how much to save and invest as interest rates change.
The Proper Safe Withdrawal Rate – Given the economy is always changing, it’s better to follow a dynamic safe withdrawal rate instead of a fixed one. As a result, I came up with the FS Safe Withdrawal Rate = 80% X 10-year Bond Yield.
Financial Freedom Savings Guide – As one of the pioneers of the FIRE movement in 2009, I encourage everyone to max out their tax-advantaged retirement accounts and save an additional 20% in taxable brokerage accounts and other assets. The ideal saving rate is 50% or higher to achieve FIRE.
Deciding On Public Or Private Grade School And University – Education is a vital investment; however, some households are spending too much on it. In the past, I believed a household needed to earn at least 5X the net tuition of the school per child to afford attending. Now, with the rise of AI and the proliferation of free education online, I’ve raised the multiple to 7X.
Ratios For Responsible Spending
Spending too much money on cars, houses, vacations, weddings, and engagement rings is where most people get in trouble.
A Vacation Spending Guide – I’m not sure most people are calculating their true cost of their vacations. Just like how it’s easily to spend irresponsibly on a car, it’s easy to spend irresponsibly on vacation. By following my guide, you won’t come back broke and needing to work many more years to pay for future vacations.
New Rule For Engagement Ring Buying – This personal finance ratio helps keep in check a partner who wants the most expensive engagement ring. It also helps the partner who has to pay for it.
Wedding Spending Rules To Follow – Spending lots of money on a wedding is also a big problem in America. You want to get your marriage off to as strong of a financial situation as possible. My wedding spending rules are based on your level of wealth and commitment to building wealth.
Net Worth Guide For Home Buying – In addition to my 30/30/3 home buying guide, I have a home buying guide based on a percentage of net worth. This guide is for older and wealthier people whose income is declining or who have no income.
Other Personal Finance Recommendations
Always Negotiate A Severance Package – Never quit your job. If you do, you will be left with nothing. Instead, try to negotiate a severance package. If you do, you may receive a severance check, all your deferred compensation, subsidized healthcare, and be 100% eligible for unemployment benefits. There is no downside if you planned to quit anyway.
Think In Probabilities, Not Absolutes – Be a flexible thinker. If you always wait until you have 100% certainty, you will miss opportunities you will regret. Instead, adopt the 70/30 philosophy, where if you believe there’s a 70% chance or greater of something succeeding, go for it.
Think Logically About Your Finances
It’s important not to wing it when it comes to your personal finances. If you do, chances are high that in 10 years, you’ll wonder where all your money went! These personal finance ratios will help you spend, save, and invest more logically.
All the best in your financial independence journey!
Regards,
Sam
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