The two wonders of personal finance "Saving" and "investment" are often perceived as same by most of us. But, both these terms are distinct and have a very important role to play in our financial life. An investor must understand the difference and relevance of both the elements. And we have to participate in both activities to secure a sound financial future for ourselves.

To begin with, let's understand the meaning of the terms "saving" and "investment". Saving is nothing but the excess of income over expenses. So, if your monthly income is Rs 50,000 and your expenses are Rs 30,000. So your saving is Rs. 20,000.

This Rs. 20,000 helps you in meeting your upcoming family emergencies, buying clothes for a cousin's wedding, or buying gifts for your family this new year, or meet other unexpected expenses, etc.

This saving can be in the form of cash at home or money lying in your savings bank account. When this saving is put to use with a view to generate a return, this process is called investment. So, when you use your saving and buy a mutual fund, or an FD, or put it in real estate, you do it because you want to generate an income on your money. So, these are investment activities.

Although your money lying in your saving account is also giving you a return of about 4%, but it isn't your investment, because the return is not even able to cover the cost of inflation. If Rs. 2000 can get you a third AC train ticket from Mumbai to Delhi today. Five years later, you would need around Rs 2800 for the same ticket. Now if you deposit Rs 2000 in your saving bank account today, it would give you around Rs 2500 after 5 years, which will not be enough to provide for the ticket. Therefore, money kept in a saving bank account is not enough to cover the cost of inflation and hence is not an investment.

This means money looses its value over time because of inflation, and in order to combat with the evil of inflation, we must Invest. A major differentiating factor between saving and investment is the purpose behind engaging in each. And that is where we shall give a deep thought and decide if the goal for which we are saving, will be met by simply saving or if we need to put in more efforts and "invest that saving" and actualize our goals.

Saving is generally not backed by a goal. The money is being saved because that money is not in use today, or is saved for meeting any uncounted expenses. Or even if there is a purpose it isn't a defining factor of your life, it can be saving for buying a mobile, or a dress, etc. On the contrary, there is a specific purpose behind investing which has a significant impact on your life. We invest for buying our dream house, we invest for our children's education, we invest for our children's marriage, we invest for our retirement or may be we invest simply to create wealth. These goals can not be achieved by just saving. Imagine saving Rs 10 Lacs in a bank account @ 4% interest for meeting your daughter's wedding expenses which is planned 10 years hence. There will be a huge mismatch between the funds you have in your saving account then and the funds you require. And this gap can only be filled with investment.

Therefore, it is important that in order to achieve our life goals, we invest. And each goal must be aligned with an investment. For each goal, a particular type of investment is required which is determined by the investment horizon, amount required, your financial position, risk taking ability and various other factors. Your financial advisor will help in selecting the investment products ideal for your goals.

The bottomline is it is important to save and to invest the saving. Both of them are independent as well as interdependent. You must be able to draw a boundary between saving and investment, and not just save for your future. Saving & Investment is an ongoing process and should not be disrupted. So, if you are saving and not investing or worse not saving at all, then you must get your act together as your financial health is dependent on these exercises.

There is none better way to look at simple ratios to evaluate your financial situation. Companies and analysts are much more comfortable using ratios rather than actual figures for better understanding and decision making.Nothing binds us as normal investors to speak of our own financial situation in terms of ratios. We are sure that the practice would not only make it simpler to evaluate and understand situations but also interesting enough for you to engage in the exercise.

In this article, we present you with few personal finance ratios that can use used to evaluate your financial health. Assessing these the personal finance ratios and fixing your own targets or benchmarks will also go a long way in bringing prudence and control in your own financial situation. It can thus open a new world of possibilities for you...

The following few ratios have been devised based primarily upon common sense. These are not standard, academically defined ratios and you may change the composition of the ratios according to your own needs. Further, you may even devise new ratios that may better suit your unique needs. The objective is to incorporate the use of ratios in our personal financial lives to make more interesting!

Savings Ratio = Actual Savings / Post-tax Income
Savings Ratio indicates how much you are saving out of your post-tax income for any period. The higher this ratio, the better it is. However, merely savings is not enough. The savings should be in a right asset class. Money kept ideal in bank accounts or other non-productive avenues do not qualify as savings. One may however cover asset building EMIs, like for home loans, insurance premiums, mandatory savings from salary, etc in savings. The idea is understand how much you are saving in building assets and securing your future. A good savings ratio is anything over 25%, The more it is, the better.

Expense Ratio = Actual Expenses / Post-tax Income
The Expense Ratio indicates how much you are spending out of your post-tax income for any period. The lower this ratio, the better it is. Typically Expense ratio should not be beyond 75% of your income. Expenses can be further broken into fixed expenses & variable expenses where fixed expenses would cover expenses like car / personal loan EMIs, rent, tuition fees of children, salary to servants, utility payments, etc. Variable expenses would include expenses on grocery, shopping & entertainment, etc. One can then also look at the proportion of fixed and/or variable expenses to post-tax income to better understand your spending pattern. Typically for any households having higher Variable expense ratio would mean that more unnecessary expenses are likely being made which needs to be controlled.

The relationship between Savings & Expense Ratio is also interesting since Savings + Expenses = Post Tax Income. One should ideally treat Expenses as net of Income & Savings rather than treat Savings is the residual after meeting all Expenses. By this approach we can limit & control our Expenses while making required Savings.

Debt Repayment Ratio = Debt payments / Post-tax Income
As the name suggests, the Debt Repayment Ratio can be used to understand the portion of your post-tax income that you are spending on payments of loans. Such loans would typically consist of home, car, personal or private loans. This ratio should be ideally below 40%, the lesser it is, the better. If it crosses over 50%, one can consider oneself in sort of some debt crisis and should act to minimise the debt portion.

Debt to Assets Ratio = Total Liabilities / Total Assets
You must be familiar to the Networth concept which is the balance after deducting all liabilities from the assets of an individual or a company. The Debt to Assets Ratio is on similar lines and speaks about the relative proportion of debt to the assets of an individual. The lower this ratio, the better it is. Typically, 100% or above of debt, as proportion of your assets, is unhealthy. However, due to liabilities of home loan and car, it is not unusual to find even higher proportions of Debt to Assets Ratio. While considering assets, one can either consider only disposal assets or total assets or derive ratio for both. Disposal assets can be considered better since liabilities can be paid off from such assets only and not those assets which are currently used for personal consumption, like for instance your residential home. A lower Debt to Assets (disposal) ratio would mean that you have greater flexibility to manoeuvre your financial situation.

Liquidity Ratio = Liquid Assets / Net Worth
The Liquidity Ratio indicate what percentage of one's net worth is invested into liquid assets. In liquid assets, one may consider cash, bank balances and investments in cash & equivalent investments of very short maturity period. Networth, as said earlier, would be the balance of your assets after deducting all your liabilities. This ratio should not be either too high or too low and depending on your situation, a comfortable range can be between 5% to 15%. A higher ratio would indicate that you are not making productive use of your capital and that money which can is invested for better returns are lying ideal. A lower ratio would indicate that you run a risk of going short of cash to meet normal expenditures or to meet any emergency needs.

One can also view this as Emergency Ratio and can keep a few months of expenses in liquid assets in absolute money terms. This is more recommended it cases of individuals having high networth.

Conclusion:
The above ratios with ideal figures are for broad guidance. Typically, depending upon your life stage, there can be acceptable deviation from the ideal figures given above. For eg., for an unmarried person or a working couplel, the Savings ratio can be higher as compared to a family with one working spouse and children. We also need to consider special cases like in case of retired persons, where there is no post-tax income. Thus in such cases, low Savings ratio and high Liquidity ratio is acceptable while Debt to Assets Ratio and Debt Repayment Ratio will be a must.

Although the above personal finance ratios cannot be used for complete financial planning but they can definitely serve as a valuable reference points for better insights to your personal financial world. We encourage all readers to undertake such exercise at regular intervals of time and set benchmarks to be met with the help of your financial advisors, if felt necessary.

From the time one decides to invest their money, they come across a world which offers them a variety of options to invest in. We would always want our hard-earned money should provide us with the ‘maximum returns’ which could satisfy our needs and wants.

Every investor has a different risk profile, financial history and different expectations about the future and they expect a return according to these criteria. They search for an asset class which resonate with their investment objectives. But the question arises whether a particular class of asset could help the investor in every situation of the investment journey?

The saying, ‘don’t put all your eggs in one basket’, has become a valuable metaphor for explaining why we should not direct our investments in only one asset class and why diversifying through asset allocation is important.

What do we mean by Asset Allocation?

Asset allocation could be defined “as an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.” The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.

Asset allocation establishes the framework of an investor’s portfolio and sets forth a plan by specifically identifying where to invest one’s money. The theory behind asset allocation is to spread your investments across different asset classes to help protect your portfolio from downturns in any one asset. Since different investments are affected differently by economic events and market factors, owning different types of investments helps reduce the chances that your portfolio will be adversely affected by a particular risk type.

As already mentioned, the investments can be in the following asset classes:

• Stocks/Equities – Stocks, or equities, have historically offered the highest risk and highest returns.

• Bonds & Fixed Income – Bonds have historically had less volatility than stocks, but the trade-off is that they offer more modest returns.

• Cash & Cash Equivalents – Cash and equivalents are the least risky asset class since there’s very little risk of losing capital. In addition to cash, these investments might include certificates of deposit, Treasury bonds, or other cash-like securities.

Benefits of Asset Allocation:

Asset allocation is very important as it serves various benefits as against having a concentrated portfolio of just one basket. Buy a mix of things like shares and commodities for higher potential growth and bonds and property for some stability. And avoid being too biased towards one market. Thus, asset allocation is essential to ensure that you reach your financial goals.

1. Optimal Return: In the absence of proper asset allocation, many individuals invest in an ad-hoc manner. This, in turn, makes it difficult for them to determine whether the return on investments is sufficient enough. Thus, proper asset allocation will help you determine how much return you can expect on your investments based on investment risks you are taking.

2. Risk Minimization: Based on your past investment experience or your willingness to take the risk you will make your future investments decision. If you want to earn higher returns by taking more risk, you can have the majority of your asset allocated in equity. But if you are in your retirement age and want to earn less volatile returns, investment in bonds or money market securities is the better option

3. Help investments align as per Time Horizon: Along with the risk profile, your time horizon is also a key factor to decide the asset allocation, while you endeavour to achieve your financial goals. Your time horizon will determine in which asset class you should invest a dominant portion of your investible surplus.

4. Minimize Taxes: If you happen to be under 30% tax bracket and invest all your savings in fixed deposit to keep your investments safe, then you are making a big mistake by paying a huge amount in taxes, which otherwise could have been legitimately saved. Tax consequences are different for every individual and every scenario so you should always view investment returns for post-tax returns on investments rather than pre-tax returns as the post-tax return is the return which you get in your hand

5. Diversification: ‘Put your eggs in different baskets’. One way to lower your risk without sacrificing the potential for higher returns is to spread your money more widely. Historically, the returns of stocks, bonds, and cash haven’t moved in unison. Market conditions that lead to one asset class outperforming during a given time frame might cause another to underperform. The result of diversifying is less volatility for investors on a portfolio level since these movements offset each other. This ultimately leads to “egg-cellent” returns.

How much to allocate?

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make and the principal determinant of the returns from the portfolio.

A majority of financial advisors advice asset allocation based on the age profile and/or life stage. Typically one can use a crude formula of 100 (-) current age to derive at the proportion of investment into equities. Thus if your age is 40, investment into equities will be 60%. the figure of 100 may even be considered as 110 or 120 depending on your life expectancy or risk orientation. However, the proper asset allocation suitable to you and your needs should be decided in consultation with your financial advisor.

In one of our recent articles we talked about how the individual investors are investing in India and the changing pattern of the investments over the years. As we saw, there was a visible change in the individual preferences for different asset classes and investment avenues with the trend clearly towards more of financial assets away from physical assets. Mutual funds, although still small, is making an impressive progress in gaining increasing share of the wallet.

The mutual fund industry today appears to have emerged stronger after going through challenging times of high volatility in equity markets and the fallout of the credit events in the debt market in recent years. One of the biggest positives for the mutual fund industry has been the huge surge in the retail investor participation in the equity markets especially through the systematic investment plan (SIP) route, primarily in equity-oriented funds.

In just about 3 years, the SIP accounts (not individual investors) have increased in the industry to approximately 2.84 crore from just 1 crore. In September 2019, the monthly SIP contribution to the industry was at Rs.8,263 crores, up from about Rs.3,700 crores exactly 3 years ago. The average SIP size stood at Rs.2,900 per SIP last month. The industry has been making quite a effort in promoting mutual funds and the "mutual fund sahi hai" campaign also has made a visible impact in spreading awareness.

The interesting part though is that the SIP registrations and the inflows have been steady inspite of the recent volatility in the markets. This shows that the investors are now increasingly looking at SIPs with a long-term view and are over-coming their behavioural instincts to react to less pleasant numbers /returns in short term. This is indeed a welcome thing in the industry and investors need to be appreciated and congratulated for this. The growing size of SIPs and the number of SIP investors showcases the habit of disciplined investing.

What is a SIP?
If you are wondering what an SIP is and what are it's advantages, read on... "Little drops of water make the mighty ocean" – this line holds very true for SIP. As the name suggests, Systematic Investment Plan or SIP, is an investment plan (methodology) offered by mutual funds wherein one could invest a fixed amount in a mutual fund scheme periodically at fixed intervals - say once a month instead of making a lump-sum investment. SIP is similar to a recurring deposit where you deposit a small /fixed amount every month.

Advantages of SIPs:
SIPs are often spoken by experts as the ideal way to invest in the equities. Here are a few basic advantages of investing in SIPs. Note that these advantages of only of the SIP methodology and we are not talking of the advantages of mutual funds here, which is something we would like to talk about someday later.

1. Convenience: SIP is a very convenient method of investing in mutual funds through standing instructions to debit your bank account every month, without the hassle of having to write out a cheque or making payment each time. One can also start (or stop) a SIP online at the comfort of your home at any time with any of the distributors offering the online service.
2. Flexibility: The SIPs are opened for a fixed tenure. However, one is free to stop, pause or register the SIP again at any point of time. One is also free to withdraw (redeem), in full or partial, your investments and take back money whenever you need it, even during the SIP tenor. Further, one can select any frequency for the SIP – from daily SIPs to even once every quarter to suit your need. One can also choose any particular date available for the monthly debit to your bank account. One can also choose to periodically and automatically increase the SIP instalment amount to match your contribution with your growing income /salary over many years.
3. Suitability: The SIP instalment amount could be as small as ₹500 per month. There is however practically no upper limit on the amount of instalment or the number of SIPs or the number of funds to have SIP into. You can also choose to have an SIP in debt mutual fund schemes not just equity funds. Thus, needless to say, it can match up to the investment objective, needs and the pocket size of virtually every investor.
4. Rupee Cost Averaging: Perhaps the most commonly quoted advantage of SIP is the Rupee Cost Averaging. Since the investors are investing in a disciplined manner they need not worry about market volatility and timing the market. With market volatility, there comes times when underlying stocks are either expensive or cheap. Since, one is investing regularly, automatically one buys more mutual fund units when there is a market correction. When the unit price goes up, he tends to gain. Over time, a SIP investor, while investing every month would end up buying more units when markets go down and buying less units when market goes up. Thus, his/her average cost of purchase of a unit would be relatively lower – this is phenomenon of rupee cost averaging.
5. Long-Term Wealth Creation: The key to building wealth is to start investing early and to keep investing regularly. A small amount of money invested regularly can grow to a large sum. With SIP, one can potentially create a substantial amount of wealth with returns compounded over the years. When we look at the corpus accumulated at the end of the tenor, the wealth accumulation is at its best in the long run. As the time given to investment increases, the wealth builds at an accelerated pace because of compounding effect.

How to make best use of SIP:
Few things in short. First, have a SIP which is long-term in its tenor. The minimum horizon should be at least 5 years. One can have it for even 10 /20 /30 years. Relax, there is no commitment and one can switch scheme or stop SIP at any time. Second, one can have a Step-up / growing SIP which keeps adjusting itself to match your growth in income. Next, it is always preferable that you map or link or just consider your SIP to any life goal like child education or retirement and think on lines of goal achievement instead of just SIP.

Lastly, do not put all your eggs in one basket. It is advised that you have mutiple SIPs in different types of schemes if you are investing a sizable amount – say Rs.30,000 can be spread into 3 schemes of Rs.10,000 each. If all this sounds a bit too much, we strong advise you to contact a financial planner / mutual fund distributor to plan for your life goals and advice you on your wealth creation journey. If you still haven't started your SIP, what are you waiting for?