Managing personal finances can often seem overwhelming, but understanding key financial ratios can simplify the process. These ratios serve as benchmarks to help assess your financial health and guide you in making informed financial decisions. In this article, we will explore seven essential personal finance ratios, explain their significance, and show how to calculate them.
1. Savings Ratio
The savings ratio reflects the portion of your income that you save. It is essential to ensure you are setting aside enough for future financial goals, such as retirement, emergency funds, and investments.
Formula:
Savings Ratio = (Savings / Gross Income) × 100
Example:
If your annual income is ₹10,00,000 and you save ₹2,00,000 annually, the calculation would be: Savings Ratio = (₹2,00,000 / ₹10,00,000) × 100 = 20%
Ideal Range:
Experts recommend maintaining a savings ratio of at least 20%. If you are below this mark, consider revisiting your budget to increase your savings.
| Insight: The household saving rate decreased from 23.6 percent of GDP in 2011-12 to 18.42 per cent of GDP in 2022-23.Source: National Accounts Statistics, CSO |
2. Debt-to-Income (DTI) Ratio
The Debt-to-Income (DTI) ratio compares your monthly debt payments to your monthly income. It helps determine whether your debt burden is manageable or overwhelming.
Formula:
DTI Ratio = (Total Monthly Debt Payments / Gross Monthly Income) × 100
Example:
If your monthly income is ₹1,00,000 and your debt obligations (loan EMIs, credit card payments, etc.) total ₹40,000, your DTI ratio would be:
DTI Ratio = (₹40,000 / ₹1,00,000) × 100 = 40%
Ideal Range:
A DTI ratio below 30% is generally considered healthy. If your DTI exceeds 50%, it may signal financial strain, and you should consider paying down your debt.
| Insight: As per a Nov 2023 report named “Global Debt Monitor” by the Institute of International Finance (IIF), household debt in India has been steadily increasing, reaching a peak of 41.1% of GDP in Q3 2023. |
3. Emergency Fund Ratio
This ratio indicates how long you can sustain your expenses if your income suddenly stops. It compares your emergency fund to your monthly living expenses.
Formula:
Emergency Fund Ratio = (Emergency Savings / Monthly Expenses)
Example:
If you have ₹3,00,000 in an emergency fund and your monthly expenses are ₹50,000, the calculation would be:
Emergency Fund Ratio = ₹3,00,000 / ₹50,000 = 6 months
Ideal Range:
A minimum of 3 to 6 months’ worth of expenses is considered sufficient. However, for higher financial security, especially for families or freelancers, 6 to 12 months is recommended.
| Insight: Around 75% of Indians do not have an emergency fund, according to a survey by personal finance platform Finology. |
4. Net Worth Ratio
Your net worth is a snapshot of your overall financial position. It is calculated by subtracting your total liabilities from your total assets.
Formula:
Net Worth Ratio = (Total Assets – Total Liabilities)
Example:
Suppose you own a house worth ₹50,00,000, investments worth ₹10,00,000, and have liabilities (such as loans) totaling ₹20,00,000. Your net worth would be:
Net Worth Ratio = (₹50,00,000 + ₹10,00,000) – ₹20,00,000 = ₹40,00,000
Ideal Range:
A positive and growing net worth is ideal. You should aim for increasing assets over time while reducing liabilities.
| Insight: On average, wealth per adult in India has risen at an annual rate of 8.7% since the year 2000 and was USD 16,500 at the end of 2022.Source: Global Wealth Report 2023 | Credit Suisse AG |
5. Investment-to-Net Worth Ratio
This ratio assesses how much of your net worth is allocated toward investments. It helps track whether you’re investing enough to grow your wealth over time.
Formula:
Investment-to-Net Worth Ratio = (Total Investments / Net Worth) × 100
Example:
If you have ₹10,00,000 in investments and a net worth of ₹40,00,000, your ratio would be:
Investment-to-Net Worth Ratio = (₹10,00,000 / ₹40,00,000) × 100 = 25%
Ideal Range:
The ideal percentage can vary based on your age and risk appetite, but a minimum of 20-30% is often considered healthy. Younger individuals should aim for a higher ratio to ensure long-term growth.
| Insight: Retail investors are increasingly channeling a portion of their net worth into mutual funds. The mutual fund industry’s AUM surged by nearly ₹14 lakh crore, reaching a record ₹53.40 lakh crore by March 2024, compared to ₹39.42 lakh crore in March 2023. This growth in industry assets was mirrored by a rise in investor participation.Source: Association of Mutual Funds in India (AMFI) |
6. Inflation hedge ratio
The Inflation Hedge Ratio measures how much of your investments are allocated toward assets that typically perform well during periods of inflation. This ratio is essential for ensuring that your wealth maintains its purchasing power in times of rising prices.
Formula:
Inflation Hedge Ratio = (Total Inflation-Protected Assets / Total Investment Portfolio) × 100
Inflation-Protected Assets include investments like real estate, commodities (such as gold or oil), and stocks in sectors like utilities or consumer goods, which tend to outperform during inflation.
Example:
If you have a total investment portfolio of ₹20,00,000, out of which ₹5,00,000 is invested in inflation-protected assets (real estate and gold), your inflation hedge ratio would be:
Inflation Hedge Ratio = (₹5,00,000 / ₹20,00,000) × 100 = 25%
Ideal Range:
There isn’t a one-size-fits-all recommendation, as this ratio depends on economic conditions and personal risk tolerance. However, maintaining at least 10-20% of your portfolio in inflation-hedging assets during periods of high inflation can protect your wealth. In times of anticipated inflation, a higher ratio (30-40%) may be appropriate.
| Insight: Retail inflation in India surged to 7.44% in July, the highest since April 2022. |
7. Solvency Ratio
The solvency ratio provides a long-term view of your financial stability by comparing your total assets to your total liabilities. It shows your ability to cover long-term obligations.
Formula:
Solvency Ratio = (Total Net Worth / Total Assets) × 100
Example:
If your total assets are ₹80,00,000 and your total liabilities (such as home loans, car loans, etc.) amount to ₹25,00,000, the calculation would be:
Solvency Ratio = (₹80,00,000 – ₹25,00,000) / ₹80,00,000 × 100 = 68.75%
Ideal Range:
A solvency ratio of 20% or higher is typically considered healthy. The higher the ratio, the more secure your long-term financial position. A ratio below 20% may indicate that you are too leveraged, and you might struggle to meet financial obligations in the future.
| Insight: Lenders often assess the solvency ratio before approving long-term loans. A higher ratio may lead to favorable loan terms, while a lower ratio could increase borrowing costs. |
| Ratio | Formula | Ideal Range |
| Savings Ratio | (Savings / Gross Income) × 100 | 20% or higher |
| Debt-to-Income Ratio (DTI) | (Total Monthly Debt Payments / Gross Monthly Income) × 100 | Below 30%, critical above 50% |
| Emergency Fund Ratio | Emergency Savings / Monthly Expenses | 3-6 months’ expenses, ideally 6-12 months |
| Net Worth Ratio | Total Assets – Total Liabilities | Positive, and growing over time |
| Investment-to-Net Worth Ratio | (Total Investments / Net Worth) × 100 | 20-30%, higher for younger individuals |
| Inflation Hedge Ratio | (Total Inflation-Protected Assets / Total Investment Portfolio) × 100 | 10-20%, higher during inflationary periods |
| Solvency Ratio | (Net Worth / Total Assets) × 100 | 20% or higher |
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Conclusion
By consistently monitoring these seven personal finance ratios, you can track your financial health and make data-driven decisions about saving, investing, and spending. Remember, financial management is an ongoing process, and regularly reviewing these ratios will help you stay on course to achieving your goals.
Tracking these ratios doesn’t have to be complex. Start by calculating your current ratios, set realistic goals, and make adjustments as needed to ensure long-term financial success.
