How liquid are you??

A friend, whose blog I track regularly for his insights on stock markets and other related matters, published this article. Couldnt resist posting it on my blog as well :)

For how many months will your money last if all your sources of income stopped today? This is a question financial planners ask to figure out if you have an emergency cushion that can keep you going if your regular income sources dry up, without having to sell your family gold, art collection, property or equity.

Basic liquidity ratio = liquid assets / monthly expenses

The basic liquidity ratio (BLR) works out the number of months you can live off your cash and near cash assets if your source of income suddenly stopped up due to a job loss or an accident that causes disability. To calculate this ratio divide your ‘liquid assets’ by your monthly expenses. In ‘liquid assets’ include all that is cash or as near to cash as possible like the money you usually keep at home, the cash in all the savings bank deposits, the cash in money market mutual funds and the money in fixed deposits. Direct equity holdings and equity mutual funds are not counted as ‘cash’ even though they are very liquid today because their value is market determined and subject to sharp changes, unlike a bank deposit or a money market mutual fund, where capital preservation is the main aim. Some planners use half the present value of the stock market holding of a person to add to the ‘liquid assets’.

Now estimate your average monthly expense. Take into account the usual suspects of expense in a month – rent, EMIs, travel, school fees, groceries, entertainment – and average out the periodic spends – insurance premium, vacations, annual charge of clubs – to get a fix on what you spend out each month. Now divided the first number by the second number.

3-6 BLR is good -- Suppose you had liquid assets of Rs 2 lakh and your monthly expense was Rs 50,000, then your BLR is 4. A BLR of 3 to 6, or three to six months of living money with no income flowing in, is considered to be good by financial planners. Of course, this ratio will vary across income categories, age groups and individual circumstances. For example, people with more stable incomes or those with a large gap between income and expenses will need a lower ratio as compared to those with erratic incomes. A film maker who earns in lumps through the year will need a higher ratio as compared to a government servant who is in a pensionable job. A BLR of between 1 and 2 brings a person close to the danger zone of being financially unsteady in the face of an emergency. A sudden pink slip can cause trauma for such a person. A ratio of 1 or less is an alarm bell and a sign of quick corrective action – either to reduce expenditure or to bring more assets near liquidity.

So, how liquid are you are you guyzzz?


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