Introduction:
Financial stability and likelihood to achieve long term solely depends on the ability to manage personal finance. Personal finance depends on a lot many factors like income levels, living costs, taxation policies and economic environment. A fair enough knowledge about the key financial ratios and factors that influence these ratios can provide an edge in decision making and optimizing the expenses and investments which will ultimately lead to financial security. Income can only be best utilized to achieve the financial goal if an individual knows how optimize the expenditure, optimize investments and plan for uncertain times.
Savings Ratio:
In simple words it is just the money saved divided by the total income of an individual. This ratio is an excellent indicator for the financial well-being of an individual as a person with a higher savings ratio would have better savings and reserves to capitalize on any investment opportunity along with the back up to tackle emergencies and prepare for retirement. Recommended value of the savings ratio is 20% of the income, however the ideal ratio may vary depending on individual’s situation.
Factors influencing the savings ratio include:
Disposable Income: This is just simply the money left after taking out expenses and taxes from your salary. This has the direct correlation with your savings ratio, greater disposable income means higher savings ratio. Disposable income can be increased by effective budgeting and controlling unnecessary expenses. It clearly reflects how efficiently and consistently you are managing your finances.
Lifestyle Choices: Understanding the impact of lifestyle choices on the savings ratio does not require knowledge of finance. It is just simply common sense that having a lavish lifestyle will affect your savings badly. The mantra here is to live under your means and make sure that you are spending on the things that you need not what you want.
Economic Conditions: These are the external factors that really influence the savings ratio for an individual, factors like inflation, interest rates and job stability will have an effect on your savings ratio as they will define your expenses. In a sense these factors will have an impact on your expenses and as your expenses will increase your savings will decrease and hence there would be a decrease in your savings ratio.
Tips for improving the savings ratio:
Budgeting: A good budget just not only tells you what you can spend out of your income it also helps you in prioritizing saving goals and also keep track of expenditure to help you monitor how efficiently you are following your budget.
Automated Savings: The best way to be disciplined to save monthly is to set up automatic transfers to a savings account. It not only ensures that you are saving each month but with proper selection of the savings account your savings can really grow with the interest rate provided with the saving account.
Reduce Discretionary Spending: A simple logical way to increase the savings ratio is to increase the savings each month and reducing the non-essential expenses can really push your savings up. To start with you can make a list of essential and non-essential expenses each month and stop spending money on the things you don’t need. Reducing discretionary spending by adapting a minimalist lifestyle is actually the key to save more each month and progress towards financial stability.
Debt-to-Income Ratio:
This ratio can be understood as the percentage of your total income that goes towards various debt payments. It is net amount you pay towards your debts divided by your total income. The amount of debt paid includes mortgage payments, credit card debt, and loan repayments. This one ratio tells a lot of information about your financial status and stability. For an example if you are making 10,000 pounds and your debt-to-income ratio is .40 it means that 4,000 pounds are going towards debt, what we can conclude is that not a lot of money is left after taking out mandatory expenses like rent, groceries, utilities, transportation etc. The more the debt-to-income ratio is lesser is the amount left for savings and investments and hence it proves that your personal finance management is not efficient and needs to be changed.
Factors influencing the debt-to-income ratio include:
Level of Debt: The net money dedicated for debt repayment is the numerator part in the fraction to calculate the debt-to-income ratio, hence level of debt impacts this ratio directly. So, if the level of debt increases the amount left for savings and investments decreases.
Interest Rates: As the debt income ratio is total amount reserved for repaying debts to the total income. Higher rates of interest not only impact the affordability to repay but as higher rates of interest increase the amount of instalment increases and hence the debt-to-income ratio and hence less amount is left for savings and hence lowering your financial stability.
Income Stability: Now if the total income from which you will be paying your debts is fluctuating not only it impacts the ability to repay but impacts the debt-to-income ratio decrease and hence your savings go for a toss. So, income stability is the main factor to maintain debt to income ratio as you are paying out of your income.
Tips for managing the debt-to-income ratio:
Prioritize High-Interest Debt: Prioritizing the debts to be repaid according to the rates of interest will not only reduce the interest costs each month but will also eventually reduce the debt-to-income ratio and eventually will lower the debt-to-income ratio.
Debt Consolidation: Debt consolidation is a great way merge multiple debt with varying interest rates in to one debt with a lower interest rate, it will not only save money in terms of the interest but will also gradually reduce the debt-to-income ratio by reducing monthly obligations.
Increase Income: Reducing the expenses is an effective way for sure to lower the debt-to-income ratio but increasing income has way more benefits apart from just reducing this ratio. By increasing your income, you can definitely increase the opportunities to save and invest in addition to not sacrifice the things that you like. But it takes discipline and hard work to generate a steady passive income. There are many ways to create a steady secondary passive source of income through freelancing, additional projects, digital marketing, online tutoring etc.
It takes a lot more than just understanding these ratios and factors to streamline your finances and achieve financial freedom. The most important thing which is required is the discipline and dedication towards your financial goal. Your knowledge about these metrics and discipline combined with the awareness and hard work can completely transform your financial outlook. Knowledge alone without dedication and perseverance is not enough to succeed.
