There is none better way to look at simple ratios to evaluate your financial situation. Companies and analysts are much more comfortable using ratios rather than actual figures for better understanding and decision making.Nothing binds us as normal investors to speak of our own financial situation in terms of ratios. We are sure that the practice would not only make it simpler to evaluate and understand situations but also interesting enough for you to engage in the exercise.

In this article, we present you with few personal finance ratios that can use used to evaluate your financial health. Assessing these the personal finance ratios and fixing your own targets or benchmarks will also go a long way in bringing prudence and control in your own financial situation. It can thus open a new world of possibilities for you...

The following few ratios have been devised based primarily upon common sense. These are not standard, academically defined ratios and you may change the composition of the ratios according to your own needs. Further, you may even devise new ratios that may better suit your unique needs. The objective is to incorporate the use of ratios in our personal financial lives to make more interesting!

Savings Ratio = Actual Savings / Post-tax Income
Savings Ratio indicates how much you are saving out of your post-tax income for any period. The higher this ratio, the better it is. However, merely savings is not enough. The savings should be in a right asset class. Money kept ideal in bank accounts or other non-productive avenues do not qualify as savings. One may however cover asset building EMIs, like for home loans, insurance premiums, mandatory savings from salary, etc in savings. The idea is understand how much you are saving in building assets and securing your future. A good savings ratio is anything over 25%, The more it is, the better.

Expense Ratio = Actual Expenses / Post-tax Income
The Expense Ratio indicates how much you are spending out of your post-tax income for any period. The lower this ratio, the better it is. Typically Expense ratio should not be beyond 75% of your income. Expenses can be further broken into fixed expenses & variable expenses where fixed expenses would cover expenses like car / personal loan EMIs, rent, tuition fees of children, salary to servants, utility payments, etc. Variable expenses would include expenses on grocery, shopping & entertainment, etc. One can then also look at the proportion of fixed and/or variable expenses to post-tax income to better understand your spending pattern. Typically for any households having higher Variable expense ratio would mean that more unnecessary expenses are likely being made which needs to be controlled.

The relationship between Savings & Expense Ratio is also interesting since Savings + Expenses = Post Tax Income. One should ideally treat Expenses as net of Income & Savings rather than treat Savings is the residual after meeting all Expenses. By this approach we can limit & control our Expenses while making required Savings.

Debt Repayment Ratio = Debt payments / Post-tax Income
As the name suggests, the Debt Repayment Ratio can be used to understand the portion of your post-tax income that you are spending on payments of loans. Such loans would typically consist of home, car, personal or private loans. This ratio should be ideally below 40%, the lesser it is, the better. If it crosses over 50%, one can consider oneself in sort of some debt crisis and should act to minimise the debt portion.

Debt to Assets Ratio = Total Liabilities / Total Assets
You must be familiar to the Networth concept which is the balance after deducting all liabilities from the assets of an individual or a company. The Debt to Assets Ratio is on similar lines and speaks about the relative proportion of debt to the assets of an individual. The lower this ratio, the better it is. Typically, 100% or above of debt, as proportion of your assets, is unhealthy. However, due to liabilities of home loan and car, it is not unusual to find even higher proportions of Debt to Assets Ratio. While considering assets, one can either consider only disposal assets or total assets or derive ratio for both. Disposal assets can be considered better since liabilities can be paid off from such assets only and not those assets which are currently used for personal consumption, like for instance your residential home. A lower Debt to Assets (disposal) ratio would mean that you have greater flexibility to manoeuvre your financial situation.

Liquidity Ratio = Liquid Assets / Net Worth
The Liquidity Ratio indicate what percentage of one's net worth is invested into liquid assets. In liquid assets, one may consider cash, bank balances and investments in cash & equivalent investments of very short maturity period. Networth, as said earlier, would be the balance of your assets after deducting all your liabilities. This ratio should not be either too high or too low and depending on your situation, a comfortable range can be between 5% to 15%. A higher ratio would indicate that you are not making productive use of your capital and that money which can is invested for better returns are lying ideal. A lower ratio would indicate that you run a risk of going short of cash to meet normal expenditures or to meet any emergency needs.

One can also view this as Emergency Ratio and can keep a few months of expenses in liquid assets in absolute money terms. This is more recommended it cases of individuals having high networth.

Conclusion:
The above ratios with ideal figures are for broad guidance. Typically, depending upon your life stage, there can be acceptable deviation from the ideal figures given above. For eg., for an unmarried person or a working couplel, the Savings ratio can be higher as compared to a family with one working spouse and children. We also need to consider special cases like in case of retired persons, where there is no post-tax income. Thus in such cases, low Savings ratio and high Liquidity ratio is acceptable while Debt to Assets Ratio and Debt Repayment Ratio will be a must.

Although the above personal finance ratios cannot be used for complete financial planning but they can definitely serve as a valuable reference points for better insights to your personal financial world. We encourage all readers to undertake such exercise at regular intervals of time and set benchmarks to be met with the help of your financial advisors, if felt necessary.

From the time one decides to invest their money, they come across a world which offers them a variety of options to invest in. We would always want our hard-earned money should provide us with the ‘maximum returns’ which could satisfy our needs and wants.

Every investor has a different risk profile, financial history and different expectations about the future and they expect a return according to these criteria. They search for an asset class which resonate with their investment objectives. But the question arises whether a particular class of asset could help the investor in every situation of the investment journey?

The saying, ‘don’t put all your eggs in one basket’, has become a valuable metaphor for explaining why we should not direct our investments in only one asset class and why diversifying through asset allocation is important.

What do we mean by Asset Allocation?

Asset allocation could be defined “as an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.” The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.

Asset allocation establishes the framework of an investor’s portfolio and sets forth a plan by specifically identifying where to invest one’s money. The theory behind asset allocation is to spread your investments across different asset classes to help protect your portfolio from downturns in any one asset. Since different investments are affected differently by economic events and market factors, owning different types of investments helps reduce the chances that your portfolio will be adversely affected by a particular risk type.

As already mentioned, the investments can be in the following asset classes:

• Stocks/Equities – Stocks, or equities, have historically offered the highest risk and highest returns.

• Bonds & Fixed Income – Bonds have historically had less volatility than stocks, but the trade-off is that they offer more modest returns.

• Cash & Cash Equivalents – Cash and equivalents are the least risky asset class since there’s very little risk of losing capital. In addition to cash, these investments might include certificates of deposit, Treasury bonds, or other cash-like securities.

Benefits of Asset Allocation:

Asset allocation is very important as it serves various benefits as against having a concentrated portfolio of just one basket. Buy a mix of things like shares and commodities for higher potential growth and bonds and property for some stability. And avoid being too biased towards one market. Thus, asset allocation is essential to ensure that you reach your financial goals.

1. Optimal Return: In the absence of proper asset allocation, many individuals invest in an ad-hoc manner. This, in turn, makes it difficult for them to determine whether the return on investments is sufficient enough. Thus, proper asset allocation will help you determine how much return you can expect on your investments based on investment risks you are taking.

2. Risk Minimization: Based on your past investment experience or your willingness to take the risk you will make your future investments decision. If you want to earn higher returns by taking more risk, you can have the majority of your asset allocated in equity. But if you are in your retirement age and want to earn less volatile returns, investment in bonds or money market securities is the better option

3. Help investments align as per Time Horizon: Along with the risk profile, your time horizon is also a key factor to decide the asset allocation, while you endeavour to achieve your financial goals. Your time horizon will determine in which asset class you should invest a dominant portion of your investible surplus.

4. Minimize Taxes: If you happen to be under 30% tax bracket and invest all your savings in fixed deposit to keep your investments safe, then you are making a big mistake by paying a huge amount in taxes, which otherwise could have been legitimately saved. Tax consequences are different for every individual and every scenario so you should always view investment returns for post-tax returns on investments rather than pre-tax returns as the post-tax return is the return which you get in your hand

5. Diversification: ‘Put your eggs in different baskets’. One way to lower your risk without sacrificing the potential for higher returns is to spread your money more widely. Historically, the returns of stocks, bonds, and cash haven’t moved in unison. Market conditions that lead to one asset class outperforming during a given time frame might cause another to underperform. The result of diversifying is less volatility for investors on a portfolio level since these movements offset each other. This ultimately leads to “egg-cellent” returns.

How much to allocate?

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make and the principal determinant of the returns from the portfolio.

A majority of financial advisors advice asset allocation based on the age profile and/or life stage. Typically one can use a crude formula of 100 (-) current age to derive at the proportion of investment into equities. Thus if your age is 40, investment into equities will be 60%. the figure of 100 may even be considered as 110 or 120 depending on your life expectancy or risk orientation. However, the proper asset allocation suitable to you and your needs should be decided in consultation with your financial advisor.

In one of our recent articles we talked about how the individual investors are investing in India and the changing pattern of the investments over the years. As we saw, there was a visible change in the individual preferences for different asset classes and investment avenues with the trend clearly towards more of financial assets away from physical assets. Mutual funds, although still small, is making an impressive progress in gaining increasing share of the wallet.

The mutual fund industry today appears to have emerged stronger after going through challenging times of high volatility in equity markets and the fallout of the credit events in the debt market in recent years. One of the biggest positives for the mutual fund industry has been the huge surge in the retail investor participation in the equity markets especially through the systematic investment plan (SIP) route, primarily in equity-oriented funds.

In just about 3 years, the SIP accounts (not individual investors) have increased in the industry to approximately 2.84 crore from just 1 crore. In September 2019, the monthly SIP contribution to the industry was at Rs.8,263 crores, up from about Rs.3,700 crores exactly 3 years ago. The average SIP size stood at Rs.2,900 per SIP last month. The industry has been making quite a effort in promoting mutual funds and the "mutual fund sahi hai" campaign also has made a visible impact in spreading awareness.

The interesting part though is that the SIP registrations and the inflows have been steady inspite of the recent volatility in the markets. This shows that the investors are now increasingly looking at SIPs with a long-term view and are over-coming their behavioural instincts to react to less pleasant numbers /returns in short term. This is indeed a welcome thing in the industry and investors need to be appreciated and congratulated for this. The growing size of SIPs and the number of SIP investors showcases the habit of disciplined investing.

What is a SIP?
If you are wondering what an SIP is and what are it's advantages, read on... "Little drops of water make the mighty ocean" – this line holds very true for SIP. As the name suggests, Systematic Investment Plan or SIP, is an investment plan (methodology) offered by mutual funds wherein one could invest a fixed amount in a mutual fund scheme periodically at fixed intervals - say once a month instead of making a lump-sum investment. SIP is similar to a recurring deposit where you deposit a small /fixed amount every month.

Advantages of SIPs:
SIPs are often spoken by experts as the ideal way to invest in the equities. Here are a few basic advantages of investing in SIPs. Note that these advantages of only of the SIP methodology and we are not talking of the advantages of mutual funds here, which is something we would like to talk about someday later.

1. Convenience: SIP is a very convenient method of investing in mutual funds through standing instructions to debit your bank account every month, without the hassle of having to write out a cheque or making payment each time. One can also start (or stop) a SIP online at the comfort of your home at any time with any of the distributors offering the online service.
2. Flexibility: The SIPs are opened for a fixed tenure. However, one is free to stop, pause or register the SIP again at any point of time. One is also free to withdraw (redeem), in full or partial, your investments and take back money whenever you need it, even during the SIP tenor. Further, one can select any frequency for the SIP – from daily SIPs to even once every quarter to suit your need. One can also choose any particular date available for the monthly debit to your bank account. One can also choose to periodically and automatically increase the SIP instalment amount to match your contribution with your growing income /salary over many years.
3. Suitability: The SIP instalment amount could be as small as ₹500 per month. There is however practically no upper limit on the amount of instalment or the number of SIPs or the number of funds to have SIP into. You can also choose to have an SIP in debt mutual fund schemes not just equity funds. Thus, needless to say, it can match up to the investment objective, needs and the pocket size of virtually every investor.
4. Rupee Cost Averaging: Perhaps the most commonly quoted advantage of SIP is the Rupee Cost Averaging. Since the investors are investing in a disciplined manner they need not worry about market volatility and timing the market. With market volatility, there comes times when underlying stocks are either expensive or cheap. Since, one is investing regularly, automatically one buys more mutual fund units when there is a market correction. When the unit price goes up, he tends to gain. Over time, a SIP investor, while investing every month would end up buying more units when markets go down and buying less units when market goes up. Thus, his/her average cost of purchase of a unit would be relatively lower – this is phenomenon of rupee cost averaging.
5. Long-Term Wealth Creation: The key to building wealth is to start investing early and to keep investing regularly. A small amount of money invested regularly can grow to a large sum. With SIP, one can potentially create a substantial amount of wealth with returns compounded over the years. When we look at the corpus accumulated at the end of the tenor, the wealth accumulation is at its best in the long run. As the time given to investment increases, the wealth builds at an accelerated pace because of compounding effect.

How to make best use of SIP:
Few things in short. First, have a SIP which is long-term in its tenor. The minimum horizon should be at least 5 years. One can have it for even 10 /20 /30 years. Relax, there is no commitment and one can switch scheme or stop SIP at any time. Second, one can have a Step-up / growing SIP which keeps adjusting itself to match your growth in income. Next, it is always preferable that you map or link or just consider your SIP to any life goal like child education or retirement and think on lines of goal achievement instead of just SIP.

Lastly, do not put all your eggs in one basket. It is advised that you have mutiple SIPs in different types of schemes if you are investing a sizable amount – say Rs.30,000 can be spread into 3 schemes of Rs.10,000 each. If all this sounds a bit too much, we strong advise you to contact a financial planner / mutual fund distributor to plan for your life goals and advice you on your wealth creation journey. If you still haven't started your SIP, what are you waiting for?

The biggest financial challenge most of us facing is retirement. Unfortunately, retirement planning has not received the same level of importance and urgency which other life goals have traditionally received in India. The result, most of us are under-prepared for our retirement.

There are many things virtually wrong with the way Indians approach their retirement planning. Here are a few things which you find most common in the name of retirement planning for Indians...

1. Some X amount of pension drawn from a pension fund

2. Property rentals to support expenses

3. Hoping kids would take care of you...

However, there are things that one must be aware of regarding retirement.

1. What would be your expenses at the time of retirement and even later years?

2. How much nominal returns and 'real' returns should you expect from your retirement kitty?

3. What will be my retirement kitty based on my present savings?

4. How long will your retirement kitty last?

The most important question to ask is, how much retirement kitty do I really need?

Again, for all these very critical questions, we rarely do have an answer. So let us directly jump to answering these questions. Please note that we are only attempting to show you a broad picture and you have to take it in that spirit.

What would be your expenses at the time of retirement and even later years?

Let us assume that you have present expenses of Rs.50,000 and the inflation rate is 6%. Can you guess the amount of expenses required in future? Here is the table.

As you can see, a person of the age of 30 today would be needing Rs.3.8 lakhs monthly at the age of 60 and an astounding Rs.14.7 lakhs at the age of 80 to maintain the same standard of living. These figures are truly an eye-opener for many.

Your expenses will keep on growing due to inflation. It will not see if you are retired, earning or not. The scary thing is, most of us thing only expenses at the time of retirement. However, the expenses will continue to grow every year after retirement too, sometimes these years can stretch to 20-30 years easily with growing life expectancy.

How much nominal returns and 'real' returns should you expect from your retirement kitty?

For any retirement planning, this is the real deal here. Most Indians believe in risk-free returns after retirement. But why? Because everyone says so.

Agree that you need to worry about preserving the money you have left. But does it mean that you will be happy if it is all spent in just a few years due to rising expenses? Is it smart? Risk-free returns should only be expected to be sufficient to fund your retirement if the kitty is huge! Given that is not the case most often, you will be advised to also look for 'real returns' and invest in growth assets like equity.

We all know that the risk and volatility of returns reduce with time and since your retirement may stretch over 20-30 years, surely there is a strong case to invest some portion of your wealth in equities and make sure your kitty doesn't dry up earlier.

How much retirement kitty do I really need?

Let us just jump to the most important question. Based on assumptions, we have derived the following estimated retirement kitty amounts. The kitty makes sure that your growing expenses are taken care of from your conservative investments till the time you live. We assume that life expectancy is 85 Yrs, inflation is a constant 6% and returns on retirement kitty is 7%. Since few of us would like to retire early, we have given 3 age options as your retirement age.

What should be the required savings needed?

Well, assuming returns on investments of 12%, we have derived the mutual fund SIP amount required to be saved till retirement. As you delay the savings, the SIP input value will increase more and more. Better to start as early as possible.

Conclusion:

Retirement is fast emerging as the biggest financial challenge for most of us. Today we see that education loans can be easily acquired, alternative and new careers are emerging, dowry system is no longer prominent and late marriages by working children are often funded by themselves. On the other hand, children are unlikely to stay in one city or with parents for long, families are getting nuclear and distant, costs of medical are rising and life-style diseases are also rising. All these put together say only one thing to you – FOCUS ON YOUR RETIREMENT PLANNING, TODAY!