How to check your financial health: I
How to check your financial health: II
After checking for your own solvency and liquidity in your portfolio you are now ready to face any emergency situation and are up-to-date on the risk-management front. Today we shall move forward and have a look at another important parameter of financial health: savings as determined by the savings ratio.
Savings ratio
What is savings? A very wise elderly gentleman once gave me some million-dollar advice for free even before I had started earning.
His advice was, 'Whenever you start earning; even if you are earning Re 1, first keep 10 paisa aside in your piggy bank and do whatever you please with your remaining 90 paisa.'
I know many youngsters find it extremely difficult to digest this logic.
The first picture that springs in the mind of today's youth when they see their first paycheck would most probably be a shopping list of all the things that they had always wanted. Savings take a back seat to luxuries.
But just by following the above-mentioned rule diligently, they will see how the amazing power of compounding (go through this link to understand the topic better: http://specials.rediff.com/getahead/2009/mar/24slide1-the-power-of-compounding.htm) can turn their small amounts of meagre savings into fortunes.
While it is accepted that savings should be an integral part of your life here's why you need to save money. There are various reasons: for your child's education or marriage; your retirement; for buying a house or a car; for going on a world tour; for medical and other emergencies...
The list goes on. As human wants are endless, no sooner does one goal gets fulfilled there is another goal knocking hard at your door. Some goals are foreseen whereas others are unforeseen.
But if you have saved regularly from the start, you will be well prepared for all foreseen and unforeseen expenses.
Enough of gyaan? Now let's come to the heart of the subject. So what is the precise amount that you need to save?
Typically, savings depends on what goals you want to achieve in life. But a minimum amount of savings is a must, goals or no goals. Let us have a look:
Savings ratio = Savings / Gross income, where
Savings include all your regular form of savings such as any systematic investment plan (SIP) of mutual funds, recurring deposits of post office, or any banks or any other form of regular savings.
Gross Income includes
- Business/ professional income
- Salary
- Bonus
- Employer's Provident fund contribution
- Interest/ Dividend
- Rent
- Any other form of income
All the above add up to your income.
Assuming that you are saving Rs 60,000 yearly, that is, Rs 5,000 every month and assuming your gross yearly income from different sources of income comes to Rs 7 lakh then your savings ratio would be calculated as: 60,000/70,0000 * 100= 8.57 per cent.
This simply means that you are saving 8.57 per cent of your gross income.
But is it good?
No. The ideal ratio is 10 per cent. At least 10 per cent of your income should go towards investing. It can increase based on the goals to be achieved but 10 per cent is a must.
What does it signify?
It signifies the importance of savings, even small amount, on a regular basis.
Just as Paul Clitheroe, an Australian television presenter, financial analyst and financial advisor wisely says, 'I don't think investment is that hard. It's doing simple things on a regular basis.' So true!
Once you develop this attitude, saving money becomes a matter of habit.
Also, the power of compounding (go through this link to understand the topic better: http://specials.rediff.com/getahead/2009/mar/24slide1-the-power-of-compounding.htm) works wonders for your savings. Small amounts saved from the beginning will start earning on its own as it grows.
Eventually as and when you can, increase the amount of savings to reap greater benefits.
Next week: Debt to asset ratio
How to check your financial health: I
How to check your financial health: II
