How much of your income should you invest?
The financial year 2008-09 is in progress and the investment opportunities are as many as ever! Are you thinking about how much to save and where to invest? For some ratios that may change the way you look at savings and investments, read on.
How to make money!
The longer you put off saving, the more you stand to lose, so to make more money start investing today! Look at the figures below for some insight:
Time Horizon
25 Years | 20 Years | |
Amount invested (Rs) | 10,000 | 10,000 |
Rate | 10% | 10% |
Amount at Maturity (Rs) | 9,83,471 | 5,72,750 |
One can easily comprehend the loss of income by a delay of 5 years!
A = P (1+R) ^n is a simple formula to calculate compound interest. Here, A is the interest accrued, P is the principal amount, R is the rate and n is the tenure of investment.
So how much should one save and invest?
There are no magic numbers or percentages to be saved and invested. A few financial ratios will augment your decision-making ability.
Liquidity Ratio: (Spare Cash+ Savings Account) / Average Monthly Expenses.
You should have the bare minimum as per the above ratio to meet sudden emergencies in life. A value of 3 for this ratio is appropriate i.e. money 3 times your monthly expenses should always be parked for liquidity!
You should have the bare minimum as per the above ratio to meet sudden emergencies in life. A value of 3 for this ratio is appropriate i.e. money 3 times your monthly expenses should always be parked for liquidity!
If you earn 20k per month and have expenses to the tune of 8k, then it will be prudent to have at least 24k (8k * 3) in ready available cash.
Opportunity Ratio: (Spare Cash+ Contingency Fund) / Net Salary
This ratio calculates the idle cash lying with you, which in turn relates to the missed opportunity of investment! 10-15% of Net Salary lying as idle cash is optimum. Anything over and above it needs to be invested. Say with a take home pay of 20k you should not keep more than 3k (15% of 20k) in idle cash.
Savings Ratio: (Amount Invested Per Month / Net Salary)
This formula will be a guide for your investment needs. Taking inflationary factors, retirement corpus, illnesses, etc. into consideration, one has to set one's expectations. Age and financial liabilities after the earning potential dwindles will be the issues to ponder over.
Savings to the tune of 20 to 25%, i.e. 4k to 5k per month on a take home of 20k, depending upon your age and financial liabilities, are worthwhile. Maximize this number!
Solvency Ratio: Total Assets / (Total Loan + Other Liabilities)
Last, but not least, in case some exigency arises and you have to pay off all your liabilities, this ratio will help you determine your financial health. Solvency ratio >1.5 indicates a relative comfort zone. Anything close to 1 or < 1 indicates a red flag!
Example:
A person has credit card liabilities to the tune of 80k and personal loans of 40k with an Asset Value of 1.5 lakhs. The Solvency Ratio for such a person is 150,000/(80,000+40,000) = 1.25
Do you know of other ways to determine saving needs for the future? Are you a self-made financial analyst with some smart maney making acumen ? If so, then please share your invaluable experiences with our readers
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