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[Prefer to listen? You can find a podcast version of this article here: E224: Unlocking Financial Stability – Mastering the Personal Finance Metrics that Matter Most]

Imagine feeling confident about your financial future, knowing you have enough saved for emergencies, and not being weighed down by debt. This is the essence of financial stability. Achieving this stability requires mastering three critical financial metrics: Savings Rate, Liquid Term, and Debt Rate.

While there are many more metrics relevant to financial wellness, these are three of the most important. If you focus on these metrics and improve them over time, you will have a foundation of financial stability that will unlock potential in many other areas of your life.

Metric 1: Understanding Savings Rate

Definition

The Savings Rate is the percentage of your income that you set aside for the future. It reflects how much you prioritize saving over spending and is a crucial indicator of your financial discipline and readiness for future needs.

How to Calculate

To calculate your Savings Rate, use this formula:

Savings Rate = (Total Monthly Savings / Total Monthly Income) × 100

For example, if you save and/or invest $1,000 per month and your monthly gross income is $8,000, your Savings Rate would be 12.5%.

Benefits

A healthy Savings Rate ensures that you are setting aside enough for retirement and other future goals. Savings rate includes savings into bank accounts and contributions to retirement or investment accounts. So one thing to keep in mind is that the metric itself won't tell you everything. You might have a healthy savings rate but if it's all going into a regular bank account then you are leaving potential growth on the table. You generally want to have most or all of your savings rate going toward investments.

How to Measure

So what's a "good" savings rate? It will vary depending on your circumstances, but for most people who are in the working and accumulating stage of life, the following ranges may apply:

• < 5%: Atypically low
• 5% - 10%: Low
• 10% - 20%: Typical
• 20% - 30%: High
• > 30%: Atypically high

If you are in the "typical" range, this can be an indicator that you are saving and investing enough to be on track for your future. If you are in the "low" ranges, it might be a signal to try to increase your savings rate. If you are in the "high" range, you may be on a FIRE path and could be planning to retire early.

Improvement Tips

• Automate Savings: Set up automatic transfers to your savings account to ensure consistency.
• Reduce Expenses: Identify and cut unnecessary expenses, redirecting those funds to savings.
• Set Goals: Establish specific savings goals, such as building an emergency fund or saving for a vacation, to motivate yourself.

Metric 2: Understanding Liquid Term

Definition

Liquid Term refers to how much of a "runway" you have to operate on your liquid assets. It’s crucial for meeting immediate financial needs and handling unexpected expenses.

How to Calculate

To determine your Liquid Term, assess the liquidity of your assets and compare that to your monthly expenses. Cash, checking accounts, and savings accounts are highly liquid, while real estate and certain investments are less liquid.

Use the following formula:

Liquid Term = (Total Liquid Assets / Total Annual Expenses)

For example, if your total liquid assets are $50,000 and your annual expenses total $100,000, then your Liquid Term would be 0.5. Put another way, you could operate for 0.5 years (6 months) on your liquid assets if your income were interrupted.

Benefits

Having a good Liquid Term means you can quickly access funds for unexpected emergencies or large purchases.

How to Measure

So what's a "good" Liquid Term? As expected, it will vary depending on your circumstances, but for most people who are in the working and accumulating stage of life, the following ranges may apply:

• < 0.25: Atypically low
• 0.25 - 1: Low
• 1 - 5: Typical
• > 5: High or atypically high

If you are in the "typical" range, this can be an indicator that you have enough in liquid assets to weather any financial storms that may come your way. If you are in the "low" ranges, it might be a signal to try to increase your savings and liquid assets to improve your financial stability and insure against unexpected events. 

Improvement Tips

• Build an Emergency Fund: Aim to save three to six months' worth of living expenses in a liquid account.
• Balance Investments: Maintain a mix of liquid and non-liquid investments to ensure accessibility without sacrificing growth.
• Use Accessible Accounts: Keep a portion of your savings in accounts that allow easy and penalty-free access.

Metric 3: Understanding Debt Rate

Definition

Debt Rate is the ratio of your debt payments to your income. It shows how much of your income goes toward paying off debts and indicates your level of financial stress due to debt.

How to Calculate

Calculate your Debt Rate using this formula:

Debt Rate = (Total Monthly Debt Payments / Total Monthly Income) × 100

For instance, if your monthly debt payments are $2,400 and your gross income is $8,000, your Debt Rate is 30%.

Benefits

A manageable Debt Rate ensures you can meet your debt obligations without compromising your ability to save or cover essential expenses.

How to Measure

So what's a "good" Debt Rate? As expected, it will vary depending on your circumstances, but for most people who are in the working and accumulating stage of life, the following ranges may apply:

• < 5%: Atypically low
• 5% - 15%: Low
• 15% - 30%: Typical
• 30% - 45%: High
• > 45%: Atypically high

In this case, a lower debt rate is better. The closer you are to zero, the "healthier" your debt rate is.

Improvement Tips

• Prioritize High-Interest Debt: Focus on paying off high-interest debt first to reduce overall interest payments (or use the debt snowball).
• Consider Consolidation: Look into debt consolidation or refinancing options to lower interest rates and simplify payments.
• Create a Repayment Plan: Develop a structured plan to systematically reduce your debt over time.
• Avoid New Debt: If your debt rate is already in the typical or "high" range, this is a signal to avoid new debt until you can lower your debt rate by paying off existing debt.

 Integrating the Metrics for Overall Financial Health

Savings Rate, Liquid Term, and Debt Rate are interconnected. Improving one metric often benefits the others. For example, reducing your Debt Rate can free up income to increase your Savings Rate and enhance your Liquid Term.

Maintaining a balance between these metrics is key. Allocate funds strategically to ensure you are saving adequately, maintaining liquidity, and managing debt effectively.

Take the time to assess your current financial situation using these metrics. Implement the tips provided to enhance your financial health and work towards a stable financial future.

Continuous monitoring and improvement of these metrics are essential. By staying proactive, you can navigate financial challenges and build a secure financial foundation.