There are a lot of important aspects of personal finance, and each of us places greater emphasis on certain things rather than others. I talked before about the importance of knowing your expenses and that it would be a good idea to have the number memorized.

Today I want to emphasize another key number, or ratio, that you ought to be aware of. It’s known as your expense ratio. Not only should we know what are expenses are costing us every month, but we should also know what percentage of our income is tied to our expenses. They are very similar, but the ratio provides key information that will help us improve our financial information.

It should be obvious that the lower the expense ratio, the better. If your ratio is somewhere around 80%, it means that your discretionary income is only about 20%. In order to lower your expense ratio, we come back to the two ways to increase your free cash flow.

It’s a great exercise to calculate what this ratio is for your personal situation. If you find out that it’s around 90% or greater (hopefully not more than 100%), you may want to consider some ways to bring it down.

Reducing this ratio has a couple of key benefits of which you should also be aware. The lower this ratio, the more you will have to save and invest. You can build your emergency reserves quicker and greatly increase your investment portfolio. You may also note that your emergency fund won’t need to be as big so you’ll be able to assemble it that much quicker.

By lowering this ratio, you’ll also have less of your income to replace by investment income. So many financial gurus tell us to try and have about 70% of our income in retirement. I would say that you should strive to have enough income to replace all your expenses and then some. If you can manage an expense ratio of about 40%, you should be able to replace this income in relatively short order.

If you can’t quickly put your finger on this ratio, maybe you should try calculating it for your particular situation. It’s a very telling number and one that you should work to decrease as best you can.

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