- February 1, 2021
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You’ve probably heard it before – health is wealth. This African proverb suggests that health is the most valuable asset a person can possess. It's not hard to imagine that a person free of diseases or illnesses, who maintains a good stress balance and is overall physically, emotionally, mentally and socially healthy would enjoy a good quality of life. While ‘health is wealth’ has more of a connotative meaning, in a more literal sense, your financial health can really equal wealth.
This is according to Paulette Lozaique, Manager of Investment Advisory Services and an RF Investment Specialist. Paulette says that keeping a watchful eye on your financial health is paramount in ensuring your money keeps working for you. “There are some key things you should be monitoring as part of your financial strategy,” Paulette said. “In financial services, we look at certain ratios that tell us how financially healthy a person is. Creditors, for example, determine whether someone qualifies for credit based on some of these ratios. There is no reason why individuals shouldn’t keep them in mind as well. In fact, we recommend that persons monitor these ratios closely to keep their finances in check.”
Assets-to-debt ratio
This ratio measures your level of financial solvency. Assets are simply the things you own that have a dollar value. This includes stock or bonds, real estate and cash. Debt refers to what you owe like a home mortgage, credit card balance or personal loan. To determine your asset-to-debt ratio, divide your assets by your debt. For example, if the value of your assets equal $50,000 and your total debt equals $100,000, your asset to debt ratio would be 0.50 or 50%. This means that you owe twice as much as you own and are considered financially insolvent – or in financial distress. It signals to creditors that you are likely unable to meet your financial obligations. A rule of thumb is to keep this ratio at 1 or 100% meaning you own more than you owe.
Basic liquidity ratio
This ratio measures the length of time you can make it without an income or how long your money will last. To calculate your basic liquidity, divide your total savings by your monthly expenses. The total will be the number of months you can live off your savings. So if you have $12,000 in savings and your monthly expenses are $2,000 each month, your basic liquidity ratio would be 6 months. You should have enough in emergency savings to cover at least 3 months of your living expenses.
Debt service to gross income ratio
You use this ratio to determine whether your debt payments are too high. It takes into account all your monthly debt payments compared to your monthly salary. This is particularly related to mortgage payments. To calculate this ratio, add up your monthly mortgage payments and divide the total by your monthly gross pay. If your gross pay is $3,000, for example, and your total monthly debt payments are $1,000 per month, your debt service ratio would be 0.33. In other words, 33% of your gross income is needed to pay your mortgage debt each month. It is important to manage your monthly mortgage payment to ensure that it does not exceed 30% of your income.
Debt payments to take-home pay ratio
Like the debt service to gross income ratio, this ratio determines if your monthly debt is too high. This is not including mortgage payments. To calculate this ratio, you compare your take-home pay to your non-mortgage debt payments. For example, if your monthly take-home pay is $2,000 and you have a monthly debt of $400 without your mortgage, the ratio is 0.20 or 20%. You want to keep this ratio under 20% as the closer you get to this percentage, the more expensive and more difficult it would be to obtain credit.
Savings ratio
This ratio is important, particularly when planning for major financial events like your retirement. While it is important to build up your assets for these kinds of events, it is even better when you are saving the right amount to meet your individual needs. To find out if you are saving enough, divide your monthly gross income by the amount you're saving each month. If your monthly gross pay is $2,000 and you're saving $200 a month, your savings ratio 10%. It is recommended that you save between 15% and 20% of your gross income to ensure you meet your future obligations.
What is key here is that you should not leave your financial circumstances up to chance. For you to maintain your financial health, you will need to pay close attention to your money, how much you earn, how much you owe, how much to spend and how much you save and invest. One of the benefits of being in optimal financial health is that you’ll have greater opportunities to grow your wealth. Meet with an investment manager who can show you how. Schedule an appointment at invest@rfgroup.com.