8 basic ratios to measure your personal finance health
Ah, ratios. They might call to mind painful math classes and complex problem-solving. However, in the world of personal finance and investments, knowing a handful of these financial ratios can make you a smarter investor.
The beauty of these financial ratios is that they can help you to: a) quickly check on the health of your finances and b) analyse the areas you’re performing (or underperforming) in. Much like we’re advised by our doctor to do regular health check-ups, the same can be said for checking up on your financial health. Below, get familiar with 8 financial ratios everyone should know!
1. Liquidity ratio
Liquidity Ratio = (Cash Assets / Monthly Expenses)
Also known as an emergency fund ratio, this ratio refers to your ability to sustain your monthly expenses with your current liquid or cash reserves. It indicates how many months you can continue paying your fixed expenses, should you lose your current source(s) of income.
Monetary assets are the most liquid of assets. They can be quickly converted to cash with little to no loss of principal. These include your cash or cash-equivalent securities like fixed deposits, cash management accounts and Singapore Savings Bond (SSBs). Experts usually recommend having at least 6 months’ worth of expenses as monetary assets to cover any emergency needs.
2. Liquid asset to net worth
Liquid Asset to Net Worth = (Cash / Net Worth)
This ratio measures the percentage of your assets that is in the form of cash or cash equivalents. This number can also determine if you are in an “asset-rich, cash-poor” position. Having a high liquidity ratio ensures you have a bigger buffer against temporary loss of income. However, if your liquidity ratio is too high, you may potentially be keeping too much of your assets in cash and not enough in investments.
Ideally, you should have at least 15% of your net worth in liquid assets or assets that can be easily converted into cash. This can be used to cover short-term debt obligations or other emergency scenarios where you’ll need to raise funds quickly.
3. Savings ratio
Savings Ratio = (Monthly Savings / Monthly Gross Income)
This ratio indicates the proportion of your monthly income that is channelled towards savings. If you adopt a “Pay Yourself First” philosophy (also known as the 50-30-20 rule) you should be setting aside at least 20% of your monthly gross income for savings to meet your financial goals. The higher the savings ratio, the better.
4. Debt to asset ratio
Debt to Asset Ratio = (Total Liabilities / Total Assets)
Also known as the Personal Gearing Ratio, this ratio measures how much of your assets are financed by debt. In turn, it also highlights your ability to borrow. As a rule of thumb, you should have no more than 50% of your assets leveraged through debt. Having a high debt ratio means having a high debt level which may expose you to greater risks when interest rates rise.
5. Debt servicing ratio
Debt Servicing Ratio = Total Debt / Monthly Net Income
This ratio measures how much of your net income is used to pay for your debt obligations. This is a critical ratio for home buyers, as lenders (banks) determine your borrowing limits based on how much debt you are servicing and how much more debt you can take on comfortably based on your current “take-home pay”.
The Monetary Authority of Singapore (MAS) has given a guideline that no borrower should exceed the Total Debt Servicing Ratio (TDSR) of 60%. This means that no more than 60% of your gross income should go into repaying your monthly debt obligations. In general, the guideline is to have your debt servicing ratio fall under 35% of your net income. Having a low ratio ensures you do not become enslaved by debt.
6. Non-mortgage debt servicing ratio
Non–Mortgage Debt Servicing Ratio = Total Monthly Non–Mortgage Debt Repayments / Monthly Net Income
This ratio measures how much of your net income goes into paying for all your debt obligations, excluding mortgage repayments. Some of these debt obligations include your credit card debt, personal loan, car loan and other non-mortgage related debts. Personal finance gurus advocate paying off these types of debts as quickly as possible as they charge the highest effective interest rates. Hence, it is good practice to first identify and rank these non-mortgage debts by their interest rates, so that you can work effectively in paying down your debts.
Given these debts are usually not “good debts” to take on, it is advisable to have no more than 15% of your net income paying off your non-mortgage debts.
7. Net Investment Assets to Net Worth Ratio
Net Investment Assets to Net Worth Ratio = Total Invested Assets / Net Worth
This ratio measures how much of your net worth is invested in assets (excluding place of residence) and whether they are deployed efficiently to income generating asset classes. In short, it reveals you how well you’re using your money to work harder for you. We should be looking to accumulate investment assets throughout our life. These include stocks, bonds, unit trust, endowments or even robo-advisor funds. Aim to have at least 50% of your assets invested in some form of capital to put you in good stead for your retirement years.
8. Solvency ratio
Solvency Ratio = Total Net Worth / Total Assets
This ratio measures if you have the means to cover all your liabilities using your existing assets. (To calculate net worth, subtract your liabilities – debts- from your assets.) We sometimes acquire assets by taking on debt – At times, this amount of debt could exceed the amount of assets. Simply put, we calculate the solvency ratio to gauge our risk of getting bankrupt due to our inability to pay the debts taken. The higher the solvency ratio, the stronger your financial position.
Looking for tools to better understand your financial health?
Use these 8 financial ratios as a starting point to understand your financial health and what to improve on. If you need help keeping tabs on your personal finance health you can lean on Autumn to consolidate your finances across different bank accounts, CPF accounts and investment platforms, in one single Finance Dashboard.
That said, these ratios are in no way a substitute to a sound financial plan. If you’re looking for tools to better understand your financial health, Autumn can help. Our Retirement Graph shows how much you need to save by the time you retire and whether you’re on track for your retirement needs, based on your current lifestyle and spending.
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The information in this article is not intended to be and does not constitute financial advice, investment advice, trading advice, or recommendation of any sort offered or endorsed by Autumn.
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