Being broke and being poor are two different things.

Robert Kiyosaki wrote about this in what is probably the most well-known book on personal finance and entrepreneurship in the world, "Rich Dad, Poor Dad."

His take was that broke and wealthy are just snapshots of your current state.

Your mindset, either rich or poor were what ultimately determined everything. This is how the rich bounce back from going broke, only to make more money than they had before. Those with a poor mindset were conditioned to stay in it.

Psychology of "Broke-ness"

Now that we've cleared up the difference between broke and poor, what does it actually look like to be functionally broke?

By merit of living in a western nation, you are likely in the top 2% of global earners, all the more because you are reading this on LinkedIn. Plenty of data shows LinkedIn users and Wall Street Journal readers are among the most affluent of readers.

So putting aside the reality that you are much less broke than the rest of the world, how do you even begin to measure such a status?

I posit that the most popular barometer is subjective feeling. You feel broke, and thus think you are. You are illiquid, cash-poor, and have no money sitting around because it is tied up in your investments, thus you feel crunched.

Popular doesn't always mean "right" but I think it is an important starting point. If we go with the cultural flow and trust our feelings that we are lacking, then we really aren't making a financial analysis, but an emotional one. It is hard to imagine yourself as thriving financially when your lifestyle falls woefully short of what you hope for.

A More Helpful Measuring Stick

If lifestyle isn't a good indicator, what should we use? I argue that a truly rational approach starts with the basics. Can we afford a shelter, food, and water? Are we in a safe situation or trying to survive the slums without getting mugged? Are we growing in our net worth through our work and spending habits, or are we barely scraping by in a state of perpetual stasis? Or worse, are we consuming ourselves financially by not earning enough above the subsistence level? For young people in particular, that's a struggle.

Once that baseline level of subsistence is reached, then you can get more technical. Say that level is $50,000 for someone. Everything they earn above that can either grow their net worth or grow their lifestyle. They can compound it or consume it. They can deceive themselves into thinking it needs to be $100,000 instead.

You need to get really clear about what this "need number" is. In personal financial planning, we call this your Non-Discretionary Spending number. It simply tells us what you need to survive. With this keystone in place, we can build out the structure in much more detail.

Ratios Using Non-Discretionary Spending

• Emergency Fund Ratio = Cash/Monthly Non-Discretionary ExpensesThis ratio simply measures the adequacy of your cash reserves. If you spend $10k per month on needs and have $60k in the bank, then congratulations, you have an emergency fund ratio of 6. This means you have 6 months worth of resources to live off of in the event your income ceases. For stable careers with readily available job options, three months usually suffices. Business owners with fluctuating incomes should aim for 6-12 months.
• Liquidity Ratio = Liquid Assets/Non-Discretionary ExpensesThis is a different take on the prior point. Here we are not only measuring cash, but much more. Let's take the previous example. If you have $60k in the bank which is six months of reserves, you probably feel pretty good. Unless you also have a business worth six-million dollars. All of the sudden, $60k feels rather small when compared against your other assets. In the event your business has some kind of large expense, you have to sell assets to fund your expense. This is not a fun place to be. This more speaks to assets than income, but you really want to maintain at least a 10% liquidity ratio, depending on your other assets. If your assets are leveraged and/or risky, you need more liquid capital. This is all because you do not want to have to be a forced seller.
• Debt to Income Ratio = Monthly Debt Payments/Monthly Gross IncomeRelated to the idea of non-discretionary expenses is debt. It gets lumped in because it must be repaid, but unlike your utility and grocery bills, having debt is usually optional. Debt is certainly not always bad (in fact, it can be really good! ) but too much of it can severely crimp your income and savings potential. Back in the day, we used to recommend that people shoot for their monthly debt to account for 36% of their income. Nowadays, since housing is included in this figure, up to 50% is pretty normal unfortunately. This robs from somewhere though, as we have seen savings rates go down.

All of these ratios start by knowing your "need number," the amount you need each month to live on. Everything flows from that.

In financial planning, we use something called a "Monte Carlo Analysis" to calculate retirement questions. It runs 1,000 different simulations and gives you the probability of success based on the variables you input. Most of the time, the "goal" is to not run out of money until after age 100, but everyone's situation is a little different.

At the end of the day, all that we can really control in these variables is expenses, income, savings rate, and rate of return (to an extent). We can't control how long we will live, or if we will need long term care in a nursing home. A healthy lifestyle is a great insurance policy here though.

In this example, some proposed recommendations increased the probability of success by 14%. Those changes were related to expenses, income, and savings strategy. It really is simple to get started, live on less than what you make, and save intelligently.

Great, but..... am I broke but don't know it?

Again, this question really begs for a psychological answer like, "if you don't feel broke, then you aren't," but this isn't the whole truth. Our feelings are important and have value, but we have to recognize we don't know what we don't know.

We don't know just how stretched thin we are, because we don't know our Liquidity Ratio is out of whack.

We don't know that we are in over our skis if we feel fine but have a terrible Debt-to-Income ratio.

And we don't know that our car's engine is four days away from self-destructing by eating its own timing belt until it happens. Only then do we realize our emergency fund is insufficient, and then we take on more debt to buy another car with interest rates at an all time high in our lifetime.

It is ok to reach out and ask for help. Find somebody safe, competent, and economically motivated to give you helpful advice in these areas. You may be feeling broke for no reason. And you may be feeling wealthy for no good reason. Our feelings are valid, but we need to have the humility to know that our perceptions at the root of our feelings may be wrong.