Thursday, June 4, 2009

Using stock market like ratios in personal finance.

Came across an interesting personal finance article which evaluates a person’s financial health using personal financial ratios similar to those used to analyze companies.

Just as stock ratios are primarily based on a company's earnings, the personal financial ratios are based on an individual's income. There are three ratios: savings to income (S/I), debt to income(D/I), and savings rate to income (SR/I). Benchmarks are then created for each ratio at different ages. The ratios are designed to serve as a road map so that investors can compare their individual ratios with the benchmarks to determine whether they are on track to retire by age 65, or any other desired retirement age. The ratios are derived from a series of assumptions including household budgets, post-retirement income replacement, rates of return, and retirement distribution rates.

Kind of shows you where you need to be at different stages of life to fund a retirement income. The ratios are designed to reasonably move people through their lives.

Households or advisers may design their own tables using whatever assumptions they believe are reasonable. The foundational theory for the ratio table, however, would remain constant, which is that there is a fundamental relationship between one's earnings, debt, and savings rate, and these ratios must change over time.

More here!