In today's fast-paced world, managing personal finances can be a challenging task. Whether you are seeking professional guidance or prefer a do-it-yourself approach, understanding your financial situation is crucial. One effective way to gain insights into your financial strengths and weaknesses is by utilizing financial ratios. These ratios provide a quantitative analysis of your financial health and can guide you in making informed decisions regarding the different aspects of your personal finances. In this article, we will explore six common financial ratios that can help you evaluate your current financial standing and create a solid foundation for financial well-being.

1. Emergency Fund Ratio:

Having an emergency fund is a vital component of financial stability. It acts as a safety net, providing you with readily available funds in case of unexpected events such as job loss or other emergencies. The emergency fund ratio measures the number of months your cash savings can cover your monthly non-discretionary (unavoidable) expenses. The idea is simply how many months can you continue to live comfortably in absence of any income.

To calculate this ratio, divide your cash/liquid savings or investments by your monthly non-discretionary expenses, which include utility bills, rent, educational fees, EMIs and other household expenses. Financial experts generally recommend maintaining an emergency fund equivalent to at least three to six months of these expenses. The higher the emergency fund ratio, the better prepared you are to handle unforeseen circumstances.

2. Savings Ratio:

Saving and investing the money for the future financial goals is a very crucial aspect of personal finance. Your savings ratio represents the portion of your income that you save and invest aside for your financial or life goals like retirement, education for child, purchase of home /car and so on. It is generally recommended to save at least 10% and 15% of your income each month to build a healthy savings cushion. However, the ideal savings rate may vary depending on your specific goals and age and the amount of savings you can manage. When one is young, the income can be less and expenses /liabilities more since you are in the consumption phase and thus the savings can be less. However, when you are accumulating phase of your life, with higher income you should aim for as much as you can possible manage. Evaluating your savings rate regularly can help you stay on track and make adjustments as needed. By prioritizing savings and managing expenses effectively, you can build a strong financial foundation for the future.

3. Debt to Total Assets Ratio:

The debt to total assets ratio provides insight into the portion of your assets that your lenders own. These debts would include your home loan, car loans, personal loans, credit card outstandings and so on. As you repay these debts your ratio decreases. This ratio is typically high in younger individuals and gradually declines with age as one builds assets and pays off debt. A lower debt-to-total assets ratio indicates a healthier financial situation, especially as you approach retirement. This can be also a good indicator of personal financial well-being and the debt burden on the lines of the Debt to Equity ratio for companies that research analysts track. The ratio is calculated as your total debt divided by your total assets. The aim should be to have a lower ratio here and is indicative that the debt burden is less.

4. Net Worth to Total Assets Ratio:

Your net worth is the difference between your assets and liabilities. It represents the value of what you own after deducting what you owe. The net worth to total assets ratio, also known as the solvency ratio, measures the percentage of your total assets that you own. Tracking this ratio over time allows you to monitor your wealth accumulation and provides motivation during debt repayment. This is similar to the earlier ratio but the perspective is different as we are evaluating your actual networth here and not the debt against total assets.

Younger individuals commonly have a net worth to total assets ratio of around 20%, while individuals in retirement should aim for a ratio closer to 90% to 100%. Achieving a higher ratio indicates significant progress in eliminating debts and building wealth.

5. Liquidity of Portfolio

The liquidity of your portfolio refers to the proportion of your total net worth held in liquid and disposable assets. This ratio depends on your financial goals and should be evaluated accordingly. If you have short-term goals or goals nearing maturity, a higher proportion of liquid assets is recommended. Quite often we have seen that the wealth or net-worth is locked in assets such as land, property, gold and so on which cannot be disposed off in times of emergency. Further, for properties used for consumption, like residence, there is some debate as to whether it should be considered at all when calculating this ratio.

To assess the liquidity of your portfolio, divide your liquid assets by your total net worth. It is essential to strike a balance between financial and non-financial assets or liquid and illiquid assets, considering your specific financial objectives. There have been many cases where people have suffered and had to borrow money even though they had sizable money locked up in illiquid assets.

6. Debt Servicing Ratio:

The Debt Servicing Ratio is a measure of your ability to repay your debt obligations. It is calculated by dividing the monthly debt payments by the monthly income. A good Debt Servicing Ratio is generally considered to be one-third or less. This means that your monthly debt payments, like your EMIs, should not ideally exceed a third of your monthly income. A higher ratio indicates that there exists the risk of financial problems, as one may have difficulty in making debt payments. A higher ratio also means that not enough is left for savings and for meeting discretionary and non-discretionary household expenses. However, the ideal ratio is subjective and will change with time and usually would be higher when one is young and falls when one has higher income levels.

Conclusion:

In brief, understanding and utilizing personal finance ratios can provide valuable insights into your financial situation and guide you in making informed decisions. By regularly monitoring these ratios and making necessary adjustments, you can create a solid financial plan to achieve your goals. Whether you decide to seek professional advice or take a DIY (Do-It-Yourself) approach, these ratios will help you gain a better understanding of your financial health and focus on areas that require attention. Start evaluating your personal finance ratios today and pave the way for a brighter financial future.

Have we reached all of the goals that we've set for ourselves in life? Leaving other goals aside, let's talk about our growing list of financial goals that we set and try to achieve through our investments. Despite estimating that a huge amount may be required to fulfill our needs, we hardly take any actions required to make them a reality. Most of us adopt a laid back approach and do not match the savings required for achieving those goals. In fact, the question we should ask is whether have we even identified our goals and found out how much we need to save? Unfortunately, we end up compromising on our precious life goals like retirement, higher education for children and so on just because we cared a little less even though things would have been very different, had we taken this up on priority with all seriousness.

The fact of the matter is that people who have identified their financial goals and planned their investments around these goals are more likely to achieve them. It is very obvious isn’t it? We can see a substantial difference even when we compare the outcomes with 2 persons having the same goals and who are saving an equal amount of money today, the only difference being, one has identified his goals and mapped investments to the goals and one who hasn’t done so. What can be the possible reasons for the success of the first person in our example? Let’s see…

1. Identification/ Setting of objectives: Financial objectives are directly related to a person's or a household's lifestyle preferences and needs. It is important to consider that your financial needs align with your desired lifestyle and income levels. Quantification of the needs helps clear this for us. For example, if you aim to retire early, you need to quantify the amount of savings required and establish a clear timeline. Adapting financial objectives to align with evolving lifestyles and needs may require adjustments and flexibility. This is the reason why identifying financial goals early on and then tracking them helps you as you know what is required and whatyou need to do about it.

2. Clarity/ Purpose of Investment: It is not sufficient to just identify needs. Determining your financial objectives and needs in detail might therefore have a stronger influence. These can include both immediate needs (like saving for a trip or a down payment) and long-term needs (like planning for retirement or paying for children's education). You will now more accurately decide on your investment's time horizon, the risk tolerance levels and the required asset allocation if you have specific objectives in mind. With limitations on saving funds, you would be forced to prioritize investments and to cut back or delay non-crucial goals like say upgrade of cards or exotic holidays. Your investments will have a specific purpose and will be best channelised to achieve them.

3. Focus on the right place: Clarifying your investment objectives is crucial given that they should be your primary emphasis rather than product or scheme selection. All that really matters is not what the market is doing or what other people are saying. What matters for you is whether you are on your way to achieve your goals or not. That’s important and rest everything is noise. Once you make a list of your financial goals and keep focus rightly on those things, you are less likely to make mistakes or act irrationally or let your behavioural biases impact your goals. You would be less likely to redeem your investments and make unnecessary expenses. Your focus would be where it actually should be. 

4. Course Correction: One ought to begin by reviewing his investments and determining whether they still line up with his financial goals. Check to see if any adjustments to your goals are necessary due to changes in your personal situation or the state of the market. Regular evaluation and review of your financial plans and your investments is required - either at a fixed frequency or as necessitated by sharp market movements, helps you to stay ahead of the outcomes and identify corrective actions. This naturally means that you would be more likely to invest when markets have corrected or to change asset allocation when the markets are at highs. Doing these small adjustments over time ensures that your financial goals are much more likely to be achieved.

5. Investment Behaviour and Discipline: With the need-based investments and financial planning, your entire approach to investments would change. You would likely see markets in a different light and start evaluating the impact and outcomes not today but in the distant future for any action that you take. This change in approach automatically eliminates any impulsive behaviour and emotional decision making based out of greed, fear or hope. Decisions instead would likely be more based on logic and research. With time, you shall create your own style, rules and principles of investing, helping your transition to a wise and experienced investor. 

6. Achieving Future Financial Needs: Clear defined goals and saving for them are prerequisites for achieving them. You have a much lesser chance of reaching your needs and objectives without clarity and a proactive strategy for saving. The last link in the circle of financial stability and wellbeing is indeed achieving future financial objectives. You can feel secure and at ease knowing that you have the means to support yourself and achieve the financial goals that you had set out for yourself, years ago. That sense of pride, peace and satisfaction for your family and yourself, is indeed priceless.

Bottom Line

Overall, the need-based investment approach or the financial planning approach for planning your savings is how all investments should be. A structured and goal-oriented method of managing your finances offers a lot of benefits and advantages and holds the promise of transforming your financial journey in life. However, to do so just by yourself would be difficult. We would encourage you to talk with your financial products’ distributor or advisor to know more and seek expert guidance.

"A father is a banker provided by nature." When we were kids, we often saw our fathers doing the best in terms of managing the finances and providing the best for our education and other needs. We often wondered how did our father do such a good job with limited finances? Well, the financial practices and behaviour of our older generations have evolved and some old-school finance ideas used by our forefathers have stood the test of time and continue to be effective. Some of these are:

1) Maintain a cash-flow diary: 

Many of us have noticed that our father would keep a cash-flow book where all our inflows and outflows were noted. We frequently tend to keep incurring expenses without keeping track of them. As a result, a lot of us find ourselves broke before the end of the month. Thus, we should keep a cash-flow journal so that our consumption can be tracked and carried out appropriately to avert this. The availability of numerous digital diaries for free can make maintaining records easier. Further, keeping a record and filing all of our utility bills, bank statements /passbooks, invoices & warranty cards of purchases and other basic things is also an age-old practice that probably most of us would have learned and followed from generations. This could serve as an important way to maintain track of your expenses.

2) Envelope budgeting:

Envelope budgeting is a concept that has been practised for several generations now. Many of our materialistic expenditures are planned even before we make a budget at the beginning of the month. We have a history of following the trends to keep our social status. Because of this, we frequently overspend, which causes us to reduce our savings and investments. Since an expensive purchase today could cause us to fall behind on our financial goals, this issue needs to be remedied. Therefore, budgeting should be done methodically and rigorously. Envelope budgeting is a simple practice whereby we put money into different envelopes or categories at the start of the month and then start spending on our relevant expenses by withdrawing from the related envelope. You may sometimes have some money left by the end of the month i.e., you have spent less than what you have budgeted for, you can make use of this by adding an extra amount in ongoing investments. You can carry this practice of budgeting either by using physical envelopes, or this can nowadays be maintained in the form of digital accounts, budgeting apps or simply having different bank accounts or wallets used for different expenditures.

3) "Out of sight, out of mind" strategy:

Any savings left idle in our bank account causes our hands to itch. The equation, “Income (less) Expenses = Savings’ is often true for us. Any income balance available to us makes us feel rich and we tend to spend it on shopping, entertainment or crossing items down the bucket list. We often make impulsive decisions on our expenditure in the mistaken belief that we have enough money. So it's best that we change this equation to, ‘Income (less) Savings = Expenses’ as early as possible. A SIP in mutual funds schemes can make this happen easily whereby SIP investments would be deducted at the start of the month. Transferring your income towards an investment, which is the best possible way to make it useful. This will also put your unplanned and impulsive spending in check. This simple approach of keeping money out of sight or reach, if aggressively practised, can do wonders for your financial well-being and could help you in bringing discipline towards your investments. 

4) Protect your health, protect your wealth:

In today’s hasty world, work stress, erratic sleep patterns, bad eating habits, consumption of alcohol & tobacco have become common in our social lives. With rising disposable income, social life revolves around get-together parties on most weekends with outside food & drinks. This not only cuts pockets but more importantly, has an impact on our health. In contrast, a different form of social life is still enjoyed by the older generation. Meetings at parks during walks, discussing topics at the tea stall corner, samosa parties and an occasional home visit for a regular lunch or dinner with home-cooked food is more healthy, saves money and more importantly sounds possible and meaningful. A balanced diet, good sleep, and exercises are all necessary to safeguard one's health and we all would agree, health is wealth. 

5) Be patient:

Being patient is a key virtue for success in financial investments. With the right asset class, it allows you to harness the power of compounding interest. Patience is required not only in financial decision-making but also in our daily routine. Like, taking the “Buy and hold” investment position takes a lot of patience, but the fruit that one gets out of it is sweeter than being impatient. One has to give reasonable time for their investments to perform. Being patient also does not mean being idle. One has to make sure that important decisions are not procrastinated and that regular monitoring and periodic adjustments to your portfolio are still necessary.

Bottom Line

While these old-school ideas remain evergreen when they are combined with modern financial techniques, they can help everyone to survive and grow in today’s financial world. Perhaps most of us would also like to explore the old ways, the simple and slow-paced life where the focus was more on quality of life, relationships, emotional stability, savings, living within means and where the display of wealth and acquisition of possessions and being too greedy and materialistic was looked down upon. We may have gotten educated and rich, but there may still be a long way until we become wise and wealthy.

Do you love to have junk food and want to have it every day? But practically, you cannot have it daily because it can never grab all the nutrients required for your body making it risky for your health. Hence, there should be a proper balance of nutrients for making a healthy lifestyle. Likewise, the same logic works for your investments. A single asset class could risk your overall portfolio so, there needs to be a proper balance between different asset classes to reduce risk in your investments. Therefore, one should maintain balance by choosing the right asset allocation strategy according to his investment objective and risk profile. 

Before moving forward with asset allocation strategies, let's first understand asset allocation. 

Asset allocation and its’ benefits: 

Asset allocation is the process of dividing an investment portfolio among different asset classes such as equity, debt, real estate, commodities and cash. The purpose of asset allocation is to create a diversified portfolio that maximizes returns while minimizing risk. Asset allocation is recommended to be followed by investors because it can provide several benefits such as:

• Goal Setting: Asset allocation allows you to set clear investment goals, objectives and expectations. By determining your investment goals and the time horizon for achieving them, you can create an asset allocation strategy that aligns with your financial objectives. 
• Balancing Risk & Returns: Asset allocation can help manage risk by spreading investments across different asset classes (diversification) with varying levels of risk and return potential. The idea is that by allocating assets among different asset classes that have low correlations with each other, it is possible to minimize portfolio risk while maximizing returns
• Decision-making: By maintaining an asset allocation strategy, investors can avoid making emotional decisions based on short-term market movements and help reduce the risks of wrong decision-making and benefit from market opportunities. 
• Portfolio performance: Asset allocation has been found as the most important determinant of long-term portfolio performance as against investment /fund selection and market timing. It helps the investors achieve more consistent and better returns over the long run.

It would be interesting for investors to know to what extent does asset allocation determine the long-term performance of the portfolio? A few of the important studies done in the years 1986, 1992 and 2011 found that asset allocation accounted for approximately 93.6%, 91.5% and 95% of the variation in returns. As investors, we should not be concerned about the exact percentage. What is important for us is to understand the simple fact that following an asset allocation strategy religiously would determine how well our own wealth creation journey will take shape in life. 

The main asset allocation strategies: 

1. Strategic Asset Allocation: This approach involves setting a long-term target allocation to a mix of different asset classes and periodically rebalancing the portfolio to maintain that target allocation. The target allocation is based on the investor's goals, risk tolerance, and investment horizon. This strategy involves periodic rebalancing of the portfolio to maintain the target allocation and the allocation here does not change with the influence of the market. Say, for example, you have chosen 50:50 asset allocation, so you allocate Rs.50 in equity and Rs.50 in debt. A year later, the investment of Rs.100 grew to 114, Rs. 60 in equity, and 54 in debt. Now the portfolio will be rebalanced to the original portion of 50-50, i.e. Rs. 57 in equity and debt respectively. 

2. Tactical Asset Allocation: Tactical asset allocation is a short-term approach to portfolio management that involves making adjustments to the portfolio based on changes in market conditions or economic outlook. The goal of this approach is to take advantage of short-term opportunities or mitigate potential risks. Unlike strategic asset allocation, tactical asset allocation does not have a fixed target allocation. Instead, the allocation to different asset classes is adjusted based on the investor's expectations for future market conditions. For example, if an investor expects interest rates to rise in the near future, they may reduce their allocation to debt and increase their allocation to equity. The idea is to make adjustments to the portfolio that are not necessarily based on the long-term outlook for the asset class, but rather on short-term fluctuations in market conditions.

3. Dynamic Asset Allocation: Dynamic asset allocation is a combination of strategic and tactical asset allocation. This approach involves setting a target allocation to different asset classes, but with the flexibility to make short-term adjustments based on market conditions. The adjustments are typically based on a set of rules/logic that takes into account market conditions, economic indicators, and other factors. A dynamic asset allocation strategy may increase or decrease the allocation to equity and debt from time to time as per some rules & logic. This strategy can be more responsive to market conditions than strategic asset allocation, but it can also be slightly more complex and difficult to understand and implement on our own.

Deciding upon an asset allocation strategy:

Each of the asset allocation strategies has its advantages and disadvantages, and the choice of strategy largely depends on the investor's risk profile and investment expectations. However, while determining any strategy, one should understand that the asset allocation is for the entire portfolio, including all your investments in traditional avenues like bank FDs, PPF, small savings, real estate & gold, i.e., anything which has been made for investment purposes. Thus, deciding and following an asset allocation just for your mutual fund portfolio is meaningless as it should be at the overall portfolio level. Investors who are following a financial plan are a step ahead as they have a clear target and time horizon in mind. Thus, the asset allocation can now be decided for each financial goal on the basis of the investment horizon, the required returns for the savings available and the risk you can take on it. 

The Bottom Line 

Determining an asset allocation strategy and the discipline to follow it should be the basic, core activity in your wealth management journey. This is not a one-time decision, but a continuous process that requires monitoring and periodic adjustments to ensure that the asset allocation strategy and the actual asset allocation remain aligned with the investor's objectives. It would be best if one approaches the experts who can help simplify all these things and help you manage your asset allocation in an effortless manner.