Personal finance metrics refer to the various means used to evaluate the health status of our finances. As investors, it is essential that we examine the performance of our finances on a regular basis in order to continuously improve on them. In fact, the list of personal finance metrics can be numerous- some interesting, others complex. Selecting a few, but practical key metrics to track your finances, would therefore be in the right direction. Below are five of the key personal finance metrics that you can take advantage of.
Living expenses (LE)
Living expenses appear to be one of the basic personal finance metrics known. Nevertheless, its key role in personal finance management cannot be understated. Living expenses encompass the general expenditure that we make on a daily, monthly, and annual basis. We all spend (whether directly or indirectly) to sustain the life that we live. In reality, living expenses vary from one month to the other depending on the nature of the expenses. Thus, it is practical to use average living expenses instead. The average of at least 6 months expenses can be fairly good. This can be estimated by tracking your expenses over some months. (Refer to this post on budgeting for further information)
Evaluating your living expenses can be of great benefits. You need to have a clear idea of your living expenses in order to estimate how long your investment can last. For instance, assuming the value of your investment is GH¢3000 (with no debt), a monthly living expenses of GH¢500 would imply that the GH¢3000 worth of investment may be able to cover your expenses for 6 months.
There is also a relationship between your living expenses and your savings rate, another personal finance metric discussed below.
Savings rate refers to the percentage of one’s income reserved in the form of savings or investment for future use.
In mathematical form, Savings rate = (Reserved income/Total income) × 100
For example, if your total monthly income is GH¢500 and you reserve GH¢100 as savings, your savings rate will therefore be (100/500) × 100 = 20%
As mentioned earlier, your savings rate is affected by your living expenses. The lower your living expenses, the higher your savings rate and vice versa. Honestly, I don’t believe in any rule of thumb that defines the percentage of income one must save. I only believe in one principle: “Save as much as you can, even if it is 80% of your income.” Refer to the post below for further details:
It is important to regularly evaluate your savings rate as it impacts the continuing growth of your investment. Higher savings rate can facilitate the rate at which your investment grow. If you realise a decline in your savings rate, you may fine-tune your expenses to get back in track. Consider taking a keen look at some taken-for-granted habits such as food waste to reduce cost. Finally, resist any attempt of falling prey to lifestyle inflation.
Personal inflation rate
Do you realise that most of the inflation figures reported by the Ghana Statistical Service vary from the actual rise in cost of your expenses? Well, some even argue that it is due to the institution being politically aligned. You must not forget one thing though- The basket of goods used by the statistical service for the inflation calculation could differ from your spending pattern. For instance, they may have utilised the cost of beans, which is not your favourite staple food, in their computation. They may have also neglected the cost of flaxseeds which is rather what you buy most (if you have a foreign taste). That is why estimating your own inflation (personal inflation rate) is vital- You get to know the true reflection of your increase in cost.
Personal inflation rate compares your present living expenses to a previous one. Ideally, it must be annually based. That is, you compare your average living expenses in the present year to that of the preceding year. A positive personal inflation rate shows an increase in expenses in the current year while a negative rate denotes a decline in expenses.
Personal inflation rate = [(LE2/LE1) × 100]-100, where LE2 is Present living expenses and LE1 is previous living expenses.
For example, if your average living expenses in 2016 was GH¢450 while that of 2015 was GH¢400, your personal inflation rate for the year 2016 would be [(450/400) × 100]-100, which is 12.5%. What this means is that your expenses in 2016 exceeded that of 2015 by 12.5%
Personal inflation is inevitable, although can be kept under control. Knowing your personal inflation rate can serve as guidance to suppress your lifestyle inflation.
In simple terms, Net worth = Assets – Liabilities
Net worth is also considered as one of the most vital personal finance metrics. It expresses your overall material wealth which can serve as a guide in your financial decisions. Net worth is explicitly discussed in the link below:
Freedom Ratio (FR)
Freedom ratio = Passive Income/Living expenses (PI/LE)
Passive incomes are earnings solely gotten from investments and include dividends, interests, rentals, royalties, and businesses of which one is not actively engaged. The regular interest you receive on your Treasury bill investment, the annual returns you get on your mutual fund investment, as well as that monthly (or probably annual) rental you collect from your tenants can be considered as a passive income.
Freedom ratio seems to be one of the most important personal finance metrics for individuals seeking financial independence. It actually spices up the usefulness of the net worth for people who dream to live off passive income alone. That is, individuals who plan to switch their income from an active source to a passive source. By knowing your freedom ratio, you would be able to determine how close you are to financial independence.
As depicted in the equation, in order for your passive income to cover much of your expenses as possible, your freedom ratio must be closer to 1. If your freedom ratio is exactly 1, it implies that the passive income from your investments exactly matches your expenses.