Assessing Your Financial Health

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I achieved financial independence in my early 40’s, when I was still mostly ignorant of traditional ways of assessing financial health. A high savings rate can cover for a lot of mistakes and ignorance.

In my CFP coursework, I recently learned a number of measurements of financial wellness. Much of this information is new to me. 

As our family enters a new phase of life with less income and thus less margin for error, I’m going to start tracking some of these metrics. They include assessments of total wealth, liquidity, debt burden, savings rate, and retirement preparedness.

Others in a similar position may want to do the same. Understanding and tracking these metrics may also be helpful to those earlier on the path to financial independence.

Determining Net Worth

Net Worth = Total Assets – Total Liabilities (at a specific point in time)

A net worth statement is easy to prepare. Yet in my personal finances, I’ve never bothered to create one. 

I’m very debt averse, so I never had many liabilities to worry about. Our primary concern was amassing invested assets that could support our living expenses. I accounted for our daughter’s college savings separately. We mostly ignored the value of our home, cars, jewelry, etc.

Related: What Are the Financial Advantages of Home Ownership?

Going forward, I will do an annual net worth statement. 

Net worth is a good measure of your overall financial health and is the way to measure total wealth. Tracking your net worth periodically demonstrates how much your wealth is growing (or not) over time. Our net worth statement is also where we obtain information for other measures of our financial health.

To determine your net worth, first determine:

  1. Liquid assets (checking, savings, money markets, etc.), 
  2. Investment assets (taxable, retirement, college savings, etc.),
  3. The fair market value of personal use assets (home, car, jewelry, collectibles, etc.) 

List these assets from most to least liquid. Sum the subtotal of each of these three subcategories of assets. Then add these values to determine your total asset value.

Next determine total liabilities. They consist of the sum of:

  1. Current liabilities
  2. Long-term liabilities. 

Current liabilities are debt payments and estimated taxes due in the next year. Long-term liabilities are any debt obligations that will take longer than a year to pay off (the remainder of mortgage, car loan payments, student loans, etc.)

Assessing Liquidity

Liquidity has two components. They are the ability to convert an asset to cash:

  1. Quickly
  2. Without the potential for a price concession.

A checking account is very liquid. An ETF or mutual fund in a taxable account is less liquid. It could be sold quickly, but with risk that you may have to sell when its value is down. Your primary residence is not liquid because it could take months to years to sell and market conditions at that time make the exact value you would receive unknowable.

Two useful measures of liquidity are the current ratio and the emergency fund ratio.

Current Ratio

Current Ratio = Liquid Assets / Current Liabilities

The recommended target ratio is 1.0 to 2.0.

Using this ratio forces you to look at your liabilities. It allows you to better customize your planning as opposed to following general rules of thumb such as having an emergency fund of 3-6 months expenses when working or holding 1-3 years of cash in retirement to ride out bear markets. 

As noted earlier, we are debt averse. We have no debt other than credit cards which we use to earn travel rewards. We pay them off monthly. Property taxes on our home are relatively low. Our current ratio is several multiples of what is considered healthy, even though we don’t hold a lot of cash.

In contrast, some people argue for not paying off a mortgage and using debt to finance cars with low interest rates, even heading into lower income retirement years. Assessing liquidity suggests that if following these strategies, you should hold more liquid investments and accept the paltry interest associated with them. The alternative is to accept more risk that you will have to sell assets at depressed prices.

Emergency Fund Ratio

Emergency Fund Ratio = Liquid Assets / Monthly (Non-Discretionary) Living Expenses

The recommended ratio depends on your circumstances. A general rule of thumb is to have 3-6 months expenses in an emergency fund. A family with dependent children and a single high earner may want to have 12 months of expenses saved. A retiree may want to have several years in liquid assets.

I appreciate the emphasis on non-discretionary expenses in this definition. I encourage you to put serious thought into that as you look at your spending.

Related: Budgeting or Expense Tracking — How Much is Enough?

If a large percentage of your spending is on luxuries (travel, restaurant meals, charitable giving, etc.) that you could temporarily eliminate or do for less cost, you may need less liquid assets in an emergency fund. 

If most of your spending goes to necessities and liabilities you’ve committed to, you need more liquid savings or be willing to accept more risk of having inadequate liquidity.

Assessing Debt Levels

Our household has always been debt averse, maybe to a fault. So I won’t be spending much time with the following measures in our personal planning unless our approach evolves over time.

I realize that our approach is rare in today’s world, and possibly extreme even in the population of financially literate people reading this blog.

So let’s review a couple of measures to help you assess whether the amount of debt you hold is healthy. We’ll also examine one debt metric that is important for all of us to understand.

Debt to Asset Ratio

Debt to Asset Ratio = Total Liabilities / Total Assets

There is no recommended “healthy” ratio. Rather, this is a good number to monitor over time to track your progress. Generally a ratio that is trending lower over time is desirable.

This could be a helpful measure of your progress if you are investing while simultaneously paying off debt because this measure, like net worth, incorporates both assets and liabilities.

It is also a useful measure for those who will maintain debt into retirement. You likely will have less income than in your working years, and assets will be needed to pay any liabilities.

Long Term Debt Coverage Ratio

Long Term Debt Coverage Ratio = Annual After Tax Income / Annual Payments Due On Total Long-Term Debt Payments (Mortgage, Car loans, Student loans, etc.)

If it is more practical and intuitive, you could also use monthly income and debt expenses.

A ratio of <2.5 is considered a red flag that if income is disrupted, you may quickly have a hard time covering your debt obligations. The higher the ratio, the better equipped you are to manage your debt.

Total Long-Term Debt as a Percentage of Gross Income

Your total debt as a percentage of gross income is calculated as:

Long Term Debt % = Total Monthly Payment for Long-Term Debt Obligations / Total Monthly Gross Income

This measurement is important for several reasons. First, this ratio determines “how much house you can afford” in the eyes of a lender.

On FreddieMac’s website you will find the recommendation that “you should spend no more than 28% of your monthly gross (pre-tax) income on your mortgage payment, including principal, interest, taxes and insurance.” Similarly, there is a widely accepted recommendation that your total monthly debt payments should not exceed 36% of your gross income.

It is important to understand that these are not hard and fast rules meant to protect you! They come from lenders. These recommendations of “how much you can afford” protect them. They have the statistics and want to limit the number of people who default on their loans.

If you are looking to build wealth quickly, limit your biggest expenses which are typically housing and transportation funded by debt. So you want these percentages to be as low as possible while providing a satisfactory lifestyle.

There is a second implication of understanding these “rules” related to debt percentage. If you are approaching retirement and are considering purchasing a home or opening a home equity line of credit, it will likely be easier to get credit prior to retirement when you have more income.

Related: Getting a Mortgage When You Have Assets But No Income

Finally, understand that there are advantages to using debt, particularly when rates are extremely low. You may want to take more debt than these income focused rules would suggest is prudent if you have the assets to pay the debt when necessary.

Measuring Savings Rate

Savings Rate = Annual Savings / Annual Gross Income

If it is more intuitive, you could use both monthly savings and income.

The commonly accepted recommendation is to have at least a 10% savings rate.

I recently wrote about why understanding the concept of saving rate is so important, the psychological benefits of having a high savings rate, and specific tactics that enable achieving a high savings rate. I regularly share that in our household we had a 50% savings rate.

Conceptually, this is an extremely important concept to understand. Here is our dirty little secret. I’ve never actually calculated our savings rate. I’ve read and listened to FIRE bloggers who get very focused on optimizing their savings rate, seemingly at the expense of joy at times.

Early on, we didn’t understand tax planning. So we roughly saved 50% of our after tax income, which is actually less than a 50% savings rate when factoring in taxes we paid. In later years, we eliminated our mortgage and were fully utilizing all tax-advantaged investment accounts we had available, so we saved well over 50% of our gross income. 

Some years, we traveled internationally, attended Super Bowls, or purchased big ticket items like outdoor gear, home improvements, or even cars with cash. Those years, we saved less. 

Other years, we went backpacking locally and didn’t make any big purchases. Those years we saved more. 

Bottom line: we kept structural expenses low and saved a lot more than 10%.

If you’re struggling with saving, calculating and tracking your savings rate over time can be extremely beneficial.

If you already have a very high savings rate, I don’t think it much matters if you’re saving 60.4% vs. 63.2% of your income. There is a risk of losing sight of what is important.

Assessing Progress Towards Financial Independence

The one measure we‘ve used in the last decade to assess our financial health was not taught in my CFP coursework. It is rarely discussed outside of FIRE blogs. Like savings rate, I think it is extremely valuable conceptually.

We regularly track our investments as a multiple of our annual expenses. This is expressed as:

Investments as a Multiple of Expenses = Total Investment Value / Total Annual Spending

This is simply the inverse of the idea that you are financially independent when you can take a percentage of your assets from your portfolio indefinitely without exhausting the portfolio. For example, the inverse of the “4% rule” shows you need to accumulate 25 times your annual spending. 

The advantage of this metric over net worth is the perspective provided by understanding how long your money may last, based on your spending. Every dollar you won’t spend in retirement is 25 dollars you don’t need to accumulate if you are assuming a 4% safe withdrawal rate.

Most recommendations regarding how much you need to retire use a percentage of your income in your working years. Rules based on income are fairly accurate for many people, because most people, regardless of income, spend most of what they make and save little. But those guidelines ignore the fact that…. you have the choice to not do that!

There are downsides to tracking your investments as a multiple of spending. Seeing the impact spending has can encourage you to focus too much on frugality, cutting spending to a fault. 

Overemphasis on minimizing spending can also lead you to put on blinders as to how much you will spend in the future on things like health care. This can lead to poor assumptions that can come back to bite you.

How Do You Measure Financial Health?

Clearly there is no one perfect measure of financial health. Each of those I chose to discuss highlights one component of financial wellness and ignores others. None is perfect.

Still, it is worth having a few metrics that measure those things that are important to you and that do so accurately.

What metrics do you use to monitor your financial health? Which metrics have you found most valuable and why? Let’s talk about it in the comments.

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. Now he draws on his experience to write about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. You can reach him at]

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