Ratio vs rands
Most of us tend to focus on the rand amounts we save and spend each month, but over time it becomes hard to know whether you are doing better or worse than before.
For example, you get an increase at work.
After your increase you continue saving the same rand amount, so you feel good about where you are financially. However, because you’re earning a larger salary, you are actually saving less than before.
Or perhaps the rand amount you spend on rent and groceries go up due to inflation. If you don’t consider the increases you got over the same period, it might seem like your spending is out of control.
Ratios help you to better understand trends in your personal finances.
What trends should I look for?
Ideally, you want to become more financially healthy over time.
Just like you monitor your weight and heart rate to keep an eye on your physical wellness, your savings and spending ratios will give you sense of how you’re doing financially.
If you can get your spending ratio down at the same time as getting your savings ratio up, you are becoming more financially healthy.
The spending ratio
As Sam Beckbessinger explains in her book Manage Your Money Like a F*cking Grownup, the spending ratio represents the percentage of your time you are working to give other people money.
This is the percentage of your income that is lost to you forever.
To get this ratio, divide your monthly expenses by your after-tax income and multiply it by 100.
For example, your income after tax is R15,000. You spend R5,000 on rent and electricity, R2,000 on groceries, R600 on transport, R400 on clothes and R400 on eating out. Your savings ratio calculation would be:
That means over half your salary will never work for you again. Your mission is to get this number as low as possible.
The savings ratio
The savings ratio is the number you want to increase over time.
This is money that will continue to work for you in the future; it can be money in the bank, share investments, debt repayments (but only in months that you don’t make new debt) and contributions to your pension fund.
To calculate your savings ratio, add up all the money going towards your future, divide it by your after-tax income and multiply by 100.
For example, your after-tax income is R15,000. You contribute R2,250 to your retirement annuity, R2,750 to your tax-free savings account and R200 to your emergency fund. Your savings ratio calculation would be:
This means only 34.6% of the time you spend working is really for your future. Over time, you want this number to increase.
Each time you do, you take one step closer to financial independence - when you stop working for money and rather have your money work for you.
How to use these ratios
Our One Lapper and his partner can use these two ratios to work out when they are financially ready to get married.
These ratios will help them shift their focus from the cost of a wedding to a more stable long-term financial situation.
They can look at how their individual ratios change when they combine them and identify areas for improvement.
A financial advisor can help them find ways to be more efficient with their shared finances.
While a wedding is a single financial event, a marriage will tie their financial lots together for the rest of their married life.
These two ratios will ensure they build a healthy financial future.
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This article does not constitute financial advice as it does not take into account one’s personal financial circumstances. Please contact OUTvest before implementing any financial plan or advice to ensure that you make an informed decision.