AAR67 - Our Ratio Rulebook - Solid Financial Starting Points

0:00A calculator is going to be required for today's episode TI 84 or equivalent for all you nerds out there. Nothing graphing. It could be TI 84 C or plus I don't even remember anymore. But anyways, today, Andrew and I are going to be looking to cover some of the pivotal ratios for you to set as your financial north stars, so to speak, to be fancy. I hope today's episode is helpful for you. So let's get started. There's a huge misconception that to start a business, you need to invent some revolutionary product. But the truth is you really don't. Some of the best businesses start as a simple side hustle.

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2:17Good day, everyone, and welcome back to At Any Rate. My name is Evan and we are here to help you make sustainable financial changes without breaking a sweat so please say hello again to our radiant master of ratios andrew say the good morning andrew i am the sticky note king on the side of the microphone yeah do you like to do a little bit of background for the listeners andrew works his life revolves around sticky notes i think all of the info he's ever needed work life yeah it sounds more dramatic if we just say life though okay Okay, fine. Yeah, life revolves around sticky notes. I actually just remembered putting a sticky note somewhere that's really embarrassing, and I'm not going to say it out loud.

3:00I have literally no idea what that could mean, but that doesn't sound like a good thing. Do you keep ratios on your sticky notes? You're tracking ratios on your sticky notes? Maybe after today I can. That would be a good idea. We've just exponentially increased the number of sticky notes in my office, so that's fantastic. Episode is canceled until further notice. We will not be finishing this. A little question off the top of my head. What is your favorite investing or financial ratio? Yeah, something we probably don't talk about enough on the other side of the podcast. But like calculating expected returns.

3:39So there's two components to buying an individual stock and getting a return. One side is buying something that the market doesn't realize is cheap. So you get the upside when the market realizes it. The other side is the business growing. And so I have a little fancy thing on my spreadsheet that shows how much do I expect to earn from both the market and the business. And then it comes out like a fancy number, like 11 % a year or 15 % a year, whatever the number is. And so I like to use that to decide. because sometimes you know you have a stock that's like wow this is amazingly cheap but this thing is like the business isn't growing at all and so you really need both components if you're buying stocks and holding them for a while yeah and you'd say that using that ratio has helped you make the right decisions or make decisions easier or less complex or anything yeah i think it just kind of helps recalibrate my brain but like any ratio i think i've definitely abused it and let it justify poor decisions.

4:46Yeah, that's a really good way to put it. And I also like how you said recalibrate because I think that, and this goes for picking stocks, this goes for anything else in your financial life, but we get so caught up in the weeds. Like if we talk about just a random thing, probably the first point we'll touch on will be budgeting. If we think about budgeting, the second you get caught in the weeds of, you know, where exactly am I spending my food or where exactly am I spending, you know, how much exactly is my phone bill and what is the data plan on there, blah, blah. You just get so caught up in these details of individual expenses on those lines, and you can just kind of lose a frame of reference for where everything else needs to be.

5:22And I know that the same thing that's happened to me in the past with individual stocks. You get caught up in just a few details or the minutia of something or trying to maybe justify a certain ratio because you feel like it's not representative or whatever. And either you lean on them too much or too little, and it can just kind of, I don't know, throw you off. So like you said, you have no good frame of reference for anything. Any other, as we approach these personal finance ratios for yourself, any other considerations to make before we dive into our own rabbit hole? I mean, just that anything that we discussed today is meant to be, they're meant to be good starting points.

5:59We just kind of want to use these as exactly like we're talking about, just a frame of reference to move forward with financially, not something to say, I'm not hitting this ratio or I'm on the bad end of this ratio, so I'm screwing up and that means that I'm in the wrong place. That is not what it means. And it also doesn't mean that if you're on the quote unquote good side of the ratio, that that's necessarily the right place for you to be either in the place that you have to be. it's all personal just like all personal finance and it can ebb and flow and fluctuate depending on your financial situation and that is entirely okay so if something if something on here is seems way off for you and you work it out and you decide that that's the right place for you to be and that's where you're okay with being then by all means cross it off the list and absolutely ignore it um just meant to be kind of general guidelines especially meant to be helpful for anybody who's entering into financial space and says, you know, I'm starting to budget or I'm, you know, paying this much for my car or whatever.

6:54Is it okay that I'm paying that much? And the second you ask that kind of a question, that's what this is supposed to help you try and figure out. So as we hinted at before, first topic here we have is budgeting. So budgeting ratios, what we're talking about is the very common guideline of 50, 30, 20. And that is basically 50 % of your income towards needs, 30 % towards wants, and 20 % towards savings. I think personally that this is a fantastic place to start at in your budgeting journey. I think it puts you in a realistic place while also requiring you to do enough that you're going to have to likely push a little bit.

7:31Not very many people out there, there will be some people, but not very many are going to just wander into hitting this ratio on accident, especially trying to save 20 % of your income. If you just kind of put a little bit towards your 401k, set a little bit of cash aside or whatever, you're not going to hit 20 % more than likely. And so I think that this ratio does a good job of, again, having people push a little bit while not expecting people to save 70 % of their income and live way below their means and retire in five years. This isn't something crazy unrealistic like that. This is, I think, a very good again, starter ratio to try and aim for.

8:07But how do you feel about this ratio, Andrew? Yeah, I like it a lot. And I like kind of having a baseline level. So if you end up having like a higher needs or a lower wants, then you can kind of understand, hey, maybe I should make some decisions here. So I actually have two questions for you on this. So first one real quick, like the savings, that's where the retirement bucket goes as well? Yes. Yeah, we're including retirement savings in the savings bucket. Okay, cool. And then let's say somebody's at, you know, rather than 50 needs, 30 wants, 20 savings, maybe they're at like 80 or 90 needs.

8:47Does that kind of, what are the lessons there or what are the action items that somebody could take if they find themselves there? yeah i think that the needs being far above 50 is going to be a very difficult line to accept so to speak i think that's something that that should change um again trying not to have too many hard lines here but the second the needs goes much higher than like 60 or so 60 percent of your income you're going to be in a very tight spot not only just financially living at that at that very given moment right then but also if your needs jump for some reason if you have a medical issue that now you have you know ongoing medicine or doctor's visits or if you took on a pet and now you have more pet expenses every single month whatever it is if your expenses increase by much at all past that then you're either going to be squeezing even further or you're going to bust past the roof and you're not going to even be able to afford it anymore and you're going to have to be living off credit cards or something so i think that something needs to give at that point and i would say the first thing i would say is i would question not because it has to be true but because a lot of the times i i think it is true are you including everything in your needs that you should be including i think that it's very easy for us to get used to living with something and i'm not talking about electricity food or water i'm talking about subscriptions or you know if you're including some new clothes in there or trips or you know hair care something like that um and again hair care not shampoo or conditioner but like you know going out and getting it done or something um if you include these kinds of things in your needs i think that's lying to yourself and and and putting something where it shouldn't be um and so i would say take a really hard look at what you've included in your needs if you've if you've done a good thing and gone through you know each of these columns needs wants and savings and broken everything down line by line not too granular but you know um kind of general line by line take a very good hard look at the needs column and make sure that everything that's in there should be there and if there's anything that shouldn't be then i would say immediately relabel it as wants that's obviously not going to immediately save you money just by doing that but but um recategorize it into the wants column and what that'll do for you is make it much easier to try and cut it because you will realize and put it in front of you you know on on excel or google sheets or a piece of paper whatever you're using put it in front of you that oh my spending on blank is a want and I can live without it and I'm going to have to for the time being.

11:22Um, and there's really not much you can do other than just cutting it. The other option of courts, that's much easier said than done. So I'm not going to spend too much time on it is increasing your income that can also solve pretty much all these issues. Um, so if you have an opportunity to increase your income, swap jobs, go get a certification, they'll get you a raise or something like that. Then that's basically the solve all to all of your financial issues, obviously so moving past that um make sure everything's properly categorized and start cutting wants wherever possible um the order i would try and cut these in would be trying to cut wants first i think that's pretty much always the easiest place to cut and of course that's where the relatively unnecessary items are immediately start cutting wants and anything extra you're able to cut try and put it into savings um but also don't over save and over commit yourself second option would be cutting down savings and i would say third option is cutting down needs that's assuming the way you have categorized as needs is actually needs um and not wants yeah um makes makes for some tough decisions potentially and like a hard look at yourself in the mirror but um it's going to be for a good reason and get you to a better place so would love if you could start on potentially the most divisive just straight out of the gate your vehicle like um is that a need or a want i i would say vehicle is a need having a vehicle i would say depending on where you live there are definitely places that you live um that you could live that you could categorize a vehicle as a want um if you can easily get around on public transit then i definitely think there's an argument to put a vehicle as a want um it might be very nice to have it might make things some things a lot easier for you but you just don't need it you could you could get by relatively easily without it and a lot of people around you probably do get by without it um but i would say that even if you live somewhere car centric like i live in daytona beach very car centric i there's not a bus stop within a mile of me basically um even if you live somewhere like that i think that it's very important to not overspend on the vehicle just because you can or just because you need a vehicle of some kind.

13:37I wouldn't say there's some specific threshold when it becomes that, but I would say that a good ratio to aim for to try and keep the expenses below would be something around 15 % of your income. Anything that you're spending much past that either means your income is quite low and maybe you're just scraping by to hit this and that would be more understandable. Or I would say for most people, it's because your income is relatively reasonable, you know, average income or whatever, but you're just overspending on your vehicle and you've convinced yourself that you need a fancier vehicle than you actually do.

14:08And this is meant to include all of your car expenses, which is the part that makes it not fun. And I think is the part of it that people very easily miss is everybody includes car payment. Boom. Easy peasy. If my car payment is below 15 % or if I don't have a car payment, then I'm already winning in this ratio. I think it's very important to include anything else that goes with that vehicle that you wouldn't have to pay if you didn't have it. So car insurance, gas, maintenance, you know, anything that you have to spend on the car on a regular basis, not monthly necessarily, but on a semi-regular basis should be included in this 15%.

14:42And anything that pushes you over that, you should look at trying to find some way to cut down. Of course, the best target is to have no car payment. That's an option for you. I'm not the kind of person out here that's telling you to go drive a beat up car just to drive a beat up car um but if that's the kind of car you need to get to guarantee yourself no car payment and bring down all the other costs as much as possible then by all means go do that um does 15 sound kind of reasonable for you is that something that that um that you're hitting right now yourself i would say probably because i don't have a car payment um but i am watching that maintenance line quite closely.

15:23And it's like, as soon as that maintenance line gets outside of what I am comfortable with, then I'm looking to upgrade. But yeah, it is a very... It definitely limits your budget when you start to include insurance and maintenance, and even gas. I mean, I used to drive this V8 SUV back in the day. 10 miles a gallon on a good day, and I was driving it a 45-minute work commute. You got to get a V8, right? So anyway. For the highway. For the nice humdrum on the highway. Right. So yeah, it does. If you're a car guy, you probably hate this part of it, but I like the idea, again, going back to your 50-30-20.

16:15Maybe there's a minimum that goes towards the needs and then like if i'm spending this much more because i really want the car like i'm allocating this part of my wants you know that could be maybe one way to work around it yeah that'd be totally reasonable yeah like let's say hypothetically you're spending the 30 percent of your income on your car or car related expenses i think it would be perfectly reasonable if it all fits inside your budget to budget 15 of that towards you know your needs and say hey i could go get a vehicle that would fit into this 15 so i know that i need that 15 but i'm also going to spend another 15 here to try and get a fancier car and spend way more on the car if you can afford that and fit into your budget and still save elsewhere and still hit the other parts of the ratio then i don't think there's anything wrong with that there's obviously a lot of car people out there um and if that's the decision for you then i don't i don't see any issues with it um i I do definitely think that it's so easy to overspend on your car because the, how would I kind of phrase this?

17:19The price of cars is so skewed compared to income when you compare it to so many other things we spend money on. Maybe not houses. I think houses are also skewed in a similar way. But, you know, if you look at food or something, food has gone up, but food is still, you know, in general, in the grand scheme of things, affordable for most people. People can go afford food. but I think the cars you know the average price what did we say the average sale price of a new car was it was like 49k or something like that 45 to 49k a ton of money which if you go do the math on it which I don't have in front of me that is not affordable for the vast majority of people you know the the amount of income you need to afford a 50 ,000 car is a lot more than the average person is earning and yet that is the average that people are going out and spending and so So what I'm trying to say is I think that the price of cars gets skewed so much higher than is actually affordable.

18:10And so it's easy to go out and say, oh, well, the average car is 50K. I'm only spending 40K. Look at how affordable I'm being. I'm spending so much less than other people. But if you actually compare that 40K to your income, it is still unaffordable and still more than you should be spending. It can still push you above this 15 % very easily. The number of people out there that go, you know, get a$40 ,000,$50 ,000 car and put 0 % down on it and then have, you know,$1 ,200 car payments is actually relatively common. And again, a$1 ,200 car payment is not affordable for the average person. So just because you're spending money on something, especially a car or a house, and you look at the averages and you're well below the averages or how much you could be spending on it, do not assume that that means that it's affordable for you.

18:55go do the math for yourself and go figure out some of these ratios and that'll tell you a much more accurate true story for your finances of whether it's affordable or not love it september is world alzheimer's month but most people never check their brain health until something's feeling off or wrong way down the road i wanted to stop waiting and look at my own data ahead of time i highly prioritize long-term cognitive health i mean you can feel everything going right in your body, but if you've already set yourself down a road mentally that you don't even realize you're on, it can be difficult or impossible to recover later on.

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20:35I hit a button on Carvana.com once. Okay, that's fair. It's like the lottery, except you always win. Not like the lottery at all, actually. Exactly. inexplicably good. Offers worth bragging about. Sell your car today on Carvana. Pickup fees may apply. What's the best way to get started in the market? Download my ebook for free at stockmarketpdf.com. Awesome. So we've got vehicle expenses, 15 % of income. Next big bucket would be what, in your opinion? Next big bucket is going to be housing. Now, housing expenses, I'm going to say, and again, this is similar to the car. This is including everything that goes into it.

21:16So if you rent, it's pretty much just your rent and then electricity and water. That's more or less also insurance. If you have some kind of renter's insurance, if you have a house and you're a homeowner is when it becomes a good bit more complicated. And there's a lot you need to include, including all expenses house related. So it could be mortgage or rent taxes, insurance, lawn, you know, again, electricity, water, utilities, everything, everything that's, that's related to that house. That basically how I think about it is if you didn't own that house right now and you started living at your parents or something, everything that you wouldn't be paying anymore is everything that should be included in housing.

21:50We don't want to give anything an exception. The target that I would like to aim for for that is 30 % of income. And again, similar to the vehicle, I think that this can be difficult for people to hit, not because there aren't necessarily affordable places to live out there, although less and less nowadays, But to hit this kind of a target, it can happen for a lot of people, especially if you split rent with somebody. But it's very easy to overspend, especially on houses, I think, because, again, you go look at the average sale price of a home. It's much more than the average person can actually afford.

22:25And so we kind of get lured into thinking, well, a friend bought a$700 ,000 home and they don't make that much more than me. And I only bought a$550 ,000 home. So look at how much more affordable I'm being. When, if you actually did the math, maybe you should have only bought a$350 ,000 home. Um, and I also don't with this topic, I don't want to just assume that there's affordable homes near everybody because there absolutely are not, especially nowadays. Um, that's becoming more and more difficult over time, but I would say that 30 % is still a good place to aim for and hit if at all possible.

22:57And I think that that'll put you in a reasonable place to be able to do basically do stuff with the rest of your money. What we want to afford is you becoming essentially house poor or the same thing with rent. I guess you could say rent poor, where all of your money is sucked up into just where you're living. It can become very, very difficult to do anything else with your money. We're not just talking about, you know, going and buying things or doing trips or whatever, but also just savings. It's very difficult. You run out of money basically to go anywhere else. And if you're doing the math here, if we include these two needs, if we include housing and vehicle, that totals up to 45.

23:33And we said before that the total budget to aim for is 50, 30, 20. So that would be 50 % towards your needs. You can see that we're not leaving much headroom for the left, for the rest of your needs. The way that I see this, the 50 % is a good thing to aim for, for your overall needs and the 30 % and 15 % for housing and vehicle, I think are more, again, none of these are hard lines that you need to hit, but I would say those are more so approaching the maximums that I feel should be spent on those kinds of things. so if you're currently at the maxes here you're probably going to struggle to be able to hit that 50 total on your needs and that's okay nothing wrong with that i would say that at that point you're not drastically overspending on either of these items um but they're they're going to be on the high end and therefore make it difficult to hit that overall 50 target um but again the goal here is just to not be sinking so much income into something that that doesn't necessarily need to be that you're not going to have any money left over anywhere else.

24:33Is this the kind of ratio that you've ever struggled to hit yourself or has this always been kind of a comfortable target for you to hit? It depended on like what life stage I was in. So one of the things I wanted to add to this conversation is don't underestimate the ability to look at this as a staircase. It's not saying that you'll never get that home that you've always wanted. It's that, hey, maybe I need to take a step before I get to the home I wanted. And so think of it this way, right? The places that are the most expensive are going to be the ones where people want to move there. And so I'm not a real estate expert, so maybe I'm just completely not saying anything that's true, but I would wonder if people wanting to move there, then if you buy a starter home, the chances of that going up in value are maybe better than a place where people don't want to live.

25:38So if you take that step rather than like, I'm going to make this huge leap to be my first home as whatever the number is way above my budget, maybe you start with a starter home and that equity that builds up. That's something that maybe this is obvious for everybody else, But for me, the equity buildup of a starter home is actually kind of incredible. And so when you do go into like, all right, maybe I'm stretching my budget for my dream home. But if you've got like 20 % to put down because you lived at a starter home for three, four, five years, now it's like, okay, we're getting rid of PMI.

26:14Our loan is now 80 % instead of 100 % of the value. just a lot of things start going for you if you can get a starter home and then also we nobody knows where interest rates are going to go but if you're kind of like in the game at least maybe maybe a refinance is in the future as well which gets you to your step faster than you thought so trying to frame it like not this prison cell of oh my goodness like we just have to live a miserable life it's like no you can still get to where you want to go but maybe it's a staircase instead of a leap. Yeah, I absolutely really, really love that mindset.

26:53It's kind of similar to how I know we both see budgeting. It initially feels like nothing but a restriction. It's just saying, hey, you need to go spend less. You can spend less on things. Screw you. You know, you're in a bad situation. That's what budgeting initially feels like. And then what you realize, the more you use it and the more it sort of honestly saves you financially over and over again, the more you realize that it really gives you freedom and options and long-term sustainability and it takes away stress and all this sort of stuff hitting these other rules like the 30 towards housing again can feel like a strict restriction initially you can't get that that dream home that you wanted to have but the number of people that get a dream home or dream car or whatever it is and commit a ton of their finances to something like that and then struggle afterwards they are not having a good time it doesn't matter what home they come to or what what car they drive to get to that home if when they arrive they're doing nothing but trying to to balance checkbooks to try and scrape by and make things happen or they're they're massively massively in debt into an unsustainable degree and they have crazy high monthly payments yada yada whatever the situation is they are not having good time they are not happy and again it won't be sustainable they They might be able to scrape by forever, but they're never going to build much of anything.

28:13Whereas if you set the structure for yourself initially, figure out what is actually affordable, then I mean, what's the saying? Like we underestimate or overestimate what we can do in a year and underestimate what we can do in 10 or five or whatever the exact number is. It's very easy to say, well, I won't if I if I get a starter home now, it's not like I'll suddenly be able to easily afford this this fancy home in a year. And I would say, no, that won't be true. But if you invest what you're able to say, what you're able to build up that equity in that starter home five, 10 years from now that you will have so much more money than you ever expected to have.

28:48You're not going to suddenly be a billionaire, but you're going to have a lot more money than you would have expected and way, way more money than you would have had if you had just gone straight to that home. And now five, 10 years down the road, you can suddenly afford that home. And now when you step into that dream home and it is yours and you can afford it and the payments make sense and you're hitting these ratios, that's a completely different life for you and a completely different outlook going forwards, completely different retirement situation, completely different situation for your kids.

29:16I mean, everything just stacks up in the positive direction the second that you just set the structure for yourself initially. So I would definitely push you to not see these as hard restrictions that are going to hold you back, but instead guidelines that are going to keep you on a good path. And everything, all of those positive changes, not just financially, but in life, those positive changes that you're making at that point right now are just going to compound over time and make everything so much better and easier in the long run. Okay, you said the C word. Now I'm getting all excited. We better move on.

29:51Compounding. It's like a Pavlovian response. Heartbeat. Heartbeat. okay well we're gonna we're gonna ride that high into a topic that isn't as fun which is going to be the next ratio which is credit card debt ratio and i'm going to say straight up front credit card debt ratio should be zero percent top top priority over anything else on this list pretty much anything else we're going to be discussing today zero percent towards your credit card debt this doesn't mean that you're not using a credit card this doesn't mean you don't have a credit card balance right now if you logged into one of your apps or you know your credit card company that doesn't mean you would have zero percent there but it it does mean that you're not carrying anything going forward next month anything that you open your credit card app for right now you should be able to pay off by the end of the month or whenever it's due and shouldn't carry any of it going forwards this is this is this is number one priority over everything else because of how high the interest rate is you know interest rates basically 20 to 30 percent essentially you're not going to get 20 to 30 percent realistically anywhere else so you're not going to be able to out earn that you're not even going to be able to try to catch up to it you're barely going to make a dent in it wherever you put your money and so the highest return thing that you can do for yourself is just pay that off as quickly as possible and i know that that's easier said than done i would just say that that the most important thing is to have some kind of a plan and set up a structure to do it and so just immediately start setting up some kind of amount of money you're paying it down by, and just start doing it right now.

31:25It doesn't all have to be paid off at once. If it can be, then fantastic. Do that right now. If it can't be, that's okay. Just set up some kind of a monthly payment, start paying towards it, and get it paid off as quickly as possible. And for this ratio, I have a lot less wiggle room than on pretty much anything else. Do you agree with that? I know you do, but do you agree with that little bit of wiggle room on this? yes and i'm okay laying the hammer down on that yeah there's no there's no sweet way to go around it yeah everything else you can kind of reprioritize for yourself you know housing you're like well i really want to spend 40 because i can afford it and i've done the math and i can hit all my other targets and i just want to live in a fancier home and i've sacrificed elsewhere where needed cool congratulations 40 towards housing isn't going to financially ruin you or you know ruin you more and more over time credit card debt does financially ruin people and does financially ruin people more and more over time the longer that that sits the more you build up uh interest on it the harder it becomes to pay off not only financially but also emotionally i mean the more you just see that stack up and realize it's been sitting there for six months or whatever it is the harder it is uh to deal with emotionally and financially so just get it paid off to zero percent as soon as you're able.