Introduction

“Your Money Ratios: 8 Simple Tools for Financial Security” by Charles Farrell is a comprehensive guide aimed at helping individuals achieve financial security by adopting a structured, ratio-based approach to personal finance. Published in 2010, this book belongs to the Financial Planning category and offers a straightforward framework using eight essential ratios to evaluate and guide financial decisions throughout different stages of life. Farrell simplifies complex financial concepts, making them accessible to a wide audience.

Concept:
The Capital to Income Ratio helps determine how much capital (or savings) a person should have relative to their income to ensure a comfortable retirement.

Example:
Farrell suggests that by age 40, you should have 2 times your annual income saved. By 65, this should be about 12 times your income.

Action:
Calculate your current savings and annual income. If at age 50, you have an income of $100,000 and current savings of $400,000, you are short of the recommended 6 times income ($600,000). Create a plan to increase your savings rate or find additional income sources.

Concept:
This ratio examines the amount of debt relative to your income. Keeping debt levels low is crucial for long-term financial security.

Example:
Farrell advises that by the time you retire, your Debt to Income Ratio should be zero.

Action:
If you are 35 with an income of $80,000 and debts totaling $40,000, your ratio is 0.5 (40,000/80,000). To meet Farrell’s guideline, prioritize paying down debts before making significant new purchases or investments.

Concept:
The Savings Rate Ratio outlines what percentage of your income you should save each year to meet your retirement goals.

Example:
Farrell recommends saving at least 12-15% of your income annually.

Action:
If you earn $60,000 annually, aim to save $7,200 to $9,000 each year. Cut discretionary spending or automate your savings to ensure consistency.

Concept:
This ratio helps you understand how much of your income should go toward mortgage payments, ensuring you don’t become house-poor.

Example:
Farrell’s guideline is that your mortgage payment should not exceed 2 times your annual income.

Action:
If your household income is $90,000, aim for a mortgage of no more than $180,000. If you’re spending beyond this, consider refinancing or downsizing your home.

Concept:
This ratio offers guidance on the composition of stocks and bonds in your investment portfolio based on your age.

Example:
The standard advice is to subtract your age from 100 to get the percentage of your portfolio that should be in stocks. For a 40-year-old, this means 60% stocks and 40% bonds.

Action:
Review your investment portfolio to match this guideline. If you’re 50 and currently have 70% in stocks, adjust by moving some investments into bonds to align with the 50% stock recommendation.

Concept:
This ratio provides a guideline on how much of your accumulated savings you can withdraw annually in retirement without depleting your resources too quickly.

Example:
Farrell suggests a safe withdrawal rate is about 4% per year.

Action:
If you have $1,000,000 saved for retirement, you could withdraw $40,000 annually. Re-evaluate your spending to make sure you don’t exceed this amount and consider part-time work if you need more income.

Concept:
This ratio helps to assess whether the cost of education is justified relative to the expected post-graduation salary.

Example:
Farrell advises keeping the cost of education to no more than your first year’s gross salary. If you expect to start at $50,000, avoid taking on education debt exceeding this amount.

Action:
Calculate your expected entry-level salary in your chosen field. Compare this with the total cost of your education. If the latter exceeds your first year’s income, explore scholarships, attend a less expensive institution, or pay for part of your education through work-study programs.

Concept:
This ratio ensures that you have adequate insurance protection to safeguard your financial future.

Example:
Farrell stipulates that your life insurance coverage should equal 8 to 12 times your annual income.

Action:
If you earn $70,000 annually, you should have between $560,000 and $840,000 in life insurance coverage. If currently underinsured, consult with an insurance advisor to adjust your coverage suitably.

Charles Farrell’s “Your Money Ratios” offers a clear, ratio-based roadmap for achieving financial security. By adhering to these eight simple ratios, individuals can make informed financial decisions, minimize debt, adequately prepare for retirement, and ultimately achieve peace of mind regarding their financial future. Users of the book are encouraged to regularly review and adjust their financial plans to stay on track with these guidelines, ensuring long-term financial stability.

Applying Farrell’s advice involves concrete actions – from recalibrating investment portfolios to ensuring adequate insurance coverage, each ratio serves as a guideline to reach specific financial milestones. Regular assessment against these benchmarks, adjustments as needed, and a disciplined approach to saving and investing are pivotal for achieving the envisioned financial security.