Like medical tests, these simple ratios can help prevent a problem, or detect it before it gets too bad to fix
ONCE you cross your mid-thirties, your doctor will start prodding you to go for routine medical tests regularly, just to be on the safe side. As you inch closer to those euphemistically called “advancing years”, health check ups increasingly become a part of your life. However, when it comes to financial health, most of us have no idea how to run a check. Unfortunately, most of us also don't have financial doctor who can help us with the job. That is why we asked some financial advisors what they would recommend as the financial equivalent of a health checkup, to determine the financial health of an individual—a few easy-to-answer queries that can either reassure us or our financial well being, or help diagnose problems early on.
“Yes, you can find out about your financial health by answering a few questions yourself. We call them ratios, but they are essentially questions which an individual can answer easily,” says Gaurav Mashruwala, a Certified Financial Planner. “However, before starting the ratio analysis, one must have a family budget in place. One should also have a list of assets and liabilities they have ready.”
The first ratio Mashruwala suggests is called liquidity ratio. This ratio will help you figure out how much liquid cash you have if you need the money in an emergency. Says Kartik Jhaveri, director, Transcend Consulting, “You should have cash for at least four months’ expenses. This will come in handy if you have an emergency like, say, unexpectedly losing your job.” Mashruwala recommends that one should try to have at least three months’ household expenses in cash.
The next question is: how much do you save from your salary? This one is easy to answer. What it yields is the savings ratio, which would give you an rough idea of whether you’re saving enough for your future needs. Mashruwala notes that, although a 10% savings ratio is considered good in the US, it’s not enough in India. Here, if your savings ratio is 30-40%, you are doing fine. The ratio, say financial advisors, has become very important for the new generation of wage earners, who tend to confuse financial wellbeing with higher salaries. You may be earning a lot, but you’re heading for trouble if you aren’t saving enough.
The next step is to find out how much of your income is used up to pay off any loans that you may have taken for various purposes. Financial advisors say that people are increasingly falling into the debt trap these days without even realising it, because banks have been wooing them like never before. Mashruwala says that with a housing loan, a debt service ratio of 35% is considered healthy. He also says if the debt doesn't include a housing loan, you shouldn't need more than 15% of your income to repay loans. Jhaveri underscores the importance of also making sure you have enough insurance cover to take care of your liabilities.
Do you know how much you are worth? Do a rough mental calculation. Add up all your assets to figure out your total worth. Now compare your total net worth to total liabilities to get your solvency ratio. The exercise may look futile at first glance, but it is not. For example, when listing your assets, you may have included the house you bought with a bank loan while calculating your total net worth. But it is not an asset till you have repaid the loan completely. A solvency ratio of 50% is considered healthy by financial advisors. In other words, your liabilities shouldn't be more than 50% of your total assets.
Now, the next question is what your assets are doing for you. You may have created a lot of assets, but are they generating any income? Perhaps you don’t need the extra income now, but it becomes crucial as you near retirement. Ideally, says Mashruwala, at least 50% of your assets should start generating income for you as you get closer to retirement. He also adds that, ideally, you shouldn't include the house you live in, in the exercise. However, you can include it if you are considering a reverse mortgage to generate income after retirement.These simple steps can give you a rough idea of your financial wellbeing. If you find everything is in order, there’s no need for you to rush to see a financial doctor. Otherwise, don't waste time. Run!
