Monday, August 24, 2009

Be Happy – Diagnose Your Financial Health

Once we cross our mid-thirties, our doctor starts prodding us to go for routine medical tests regularly just to be on the safe side. As we inch closer to those euphemistically called advancing years, health check ups increasingly become a part of our life. However, when it comes to our financial health, most of us have no idea how to run a check. Unfortunately, we don’t have financial doctors to help us out. That is why we ask our financial advisers what they would recommend as the financial equivalent of a health check up to determine our financial health – a few easy-to-answer queries that can either reassure us about our financial health or help diagnose problems early.

These queries are generally called ratios and which can be easily replied by the person concerned. 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. We may discuss the ratio as below:

1. The first ratio is called liquidity ratio. This ratio helps us figure out how much liquid cash we have if we need the money in urgency, like we may loose our job, someone of our family members falls ill or hospitalized suddenly due to some accident etc. We must have liquid assets worth of three to four months’ expenses at least.

2. The next question is how much we can save from our monthly income/salary. This one is easy to answer. It is savings ratio – a rough idea whether you are saving sufficiently to meet your future needs. It differs from culture to culture. In US, 10% savings ratio is considered good but in India, it should be around 30 to 40% of monthly income. This ratio has become more important for the new generation of work force who tends to confuse financial well being with higher salaries. You may be earning a lot but you are heading towards trouble if you do not save sufficiently in time.

3. The next question is how much part of your monthly income is used up in clearing your old debts or equated monthly installments against the loan you might have taken for various purposes like house loan, capital items etc. People are increasingly falling into the debt trap without even realizing it because banks have been wooing them never before. Generally, if you have taken a house loan, your monthly payment against all the debts including housing loan should not exceed 35% of your monthly income. In case house loan is not there, your monthly payment towards old debts should not go beyond 15%. You can have insurance cover to take care of your liabilities.

4. Do you know how much you are worth? Please do a rough mental calculation. Add up all of your assets to figure out your net worth. After accounting for all the assets, make its comparison with your total liabilities to get solvency ratio. This exercise may look futile at first glance, but it is not. For example, when listing your assets for your net worth, you may have included the house with bank loan. But that is not your asset unless the loan is fully repaid. A solvency ration of 50% is considered healthy. In other words, your liabilities must not exceed 50% of your assets.

5. Now, the next question is what your assets are doing for you. You have created a number of assets but are they generating any income? At present you may not be in need of extra income but at the time of your retirement, you need it. For this purpose, it is essential that 50% of your assets must be able to generate further income. Ideally, you should not include house you live in. But in exercise you can include it by reverse mortgage to generate income after retirement.
These are simple tools to know about financial well being. If you continue to check it, you may need not to go for any finance related advice. If you do not undertake such exercise, you must start immediately and keep constant check over your financial health.

Be Happy – Diagnose Your Financial Health.

No comments:

Post a Comment