Investing is not just about choosing and buying assets in the hopes that they turn valuable in the future. It is also about keeping a check on your existing portfolio and weeding out investments that aren’t working in your favour. Consider this the personal finance version of the ratios you use to measure corporate profitability.
Here are three key measures to use:
The most basic of the personal finance ratios is the Savings Ratio. It is a simple ratio of all your savings/investments with your total income. Mind you, ensure you add the cash in your bank accounts to your total savings. Similarly, add all non-salary income like bonuses, bank interest payments, etc to your total income. This gives you an idea of how much you save. The more you save, the better will be the state of your finances. Experts also recommend that you save more in the early years of your working life when your expenditures and responsibilities are lower.
One of the first dreams of almost every working individual is to buy a car or house. Unfortunately, though, this involves borrowing money from banks. Even on a day to day basis, it is easy to pile on debt by extensive use of credit cards. Done right, debt can enhance your finances. However, too many borrowings and you could waste a big chunk of your income in paying off the interests. It’s important to draw the line. The Debt to Income ratio comes handy here. Simply add all your loan and credit card outstandings to calculate your total debt. Divide this by your total income like in the previous case. Borrowers usually borrow if your Debt to Income ratio is below 43%. Some even take into account your prior investments and assets. In this case, your debt should ideally amount to half of your total income and assets.
Liquidity is a very important part of your finances. After all, what’s the point in building a big corpus and yet not have money handy to pay for your expenses? This is more so in a case of emergencies, when you may have to sell some investments on a short notice to arrange for funds. You check how ready you and your investments are by using the Solvency ratio. For this one, you need to first take into account and sum all the investments that can be sold at a short notice like the cash in your bank accounts, short-term or liquid mutual funds, bank deposits, Exchange-Traded Funds (ETFs) and even stocks. Divide this by your total savings. Ideally, experts recommend that you create a separate emergency fund that can be used in such cases. It should cover your expenses for 3-6 months. In its absence, your liquid investments can be used.
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