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By Tanita Conradie*
It’s easier to master life’s big responsibilities if you understand what you’re doing and why you’re doing it. After raising a family, retirement planning is probably the biggest financial responsibility we all have yet it remains challenging in view of the information overload around retirement and the wide range of options to consider.
This can be very dangerous if you feel overwhelmed because you might then decide to do nothing about your retirement. This means that your future will remain uncertain until you take active steps to be better prepared.
The first step to becoming better prepared is to educate yourself around basic concepts that will influence the type of retirement you have.
To help you get to grips with key numbers around your retirement, here are 4 calculations and ratios that will help you have a clearer view of how you’re doing. These can guide you to a better understanding and take control of your personal finances so that you can achieve your goals.
Retirement savings ratio
How much of your gross salary are you saving every month? Do you know?
The percentage of your monthly income that you should be saving for retirement varies. It’s easier, for example, to commit a larger portion later in life compared to when you’ve started your first job. But as an average, it’s recommended that you try to save 15% of your pre-tax salary for your retirement.
Your goal should be to accumulate 20x your final annual salary at retirement age to see you through.
Dedicating this amount every month is easy if your employer offers a pension fund that you can contribute to. If you have no formal pension fund, then you can still plan for your future by contributing to a retirement annuity or an investment fund that will deliver long-term growth.
The formula to calculate your retirement savings ratio = savings/gross income. Any number above 15% is ideal, and if you’re below this level then maybe it is time to re-evaluate your priorities.
The importance of an emergency fund took on new meaning when the COVID pandemic struck, with many unprepared households left financially stranded.
The pandemic may have been an extreme event, but even much smaller crises can upset your long-term planning. A natural disaster, a medical emergency, job insecurity and many other unplanned emergencies threaten to derail your retirement if you’re not careful.
And the best way to protect yourself is to build up an emergency fund to draw on in these times of crisis. How much should you have set aside? That depends on many factors, although six months’ expenses is considered a good mark to aim for.
Calculating how much you need is simple: multiply your monthly expenses by six to get to the amount you need to tide you over for that long.
This formula forms part of your emergency fund. Should you need funds for an emergency, this ratio will look at how easily your assets can be converted into cash. Assets such as our home, car or retirement savings should not be included in this calculation.
You can calculate this ratio by taking your liquid assets, for example, cheque account and money market funds and dividing it by your monthly expenses. A preferred ratio should be between 3 – 6 months.
If you want to get a better sense of how well you’re managing your finances, you can calculate your personal debt-to-income ratio. This is a number that lenders typically look at when assessing your ability to afford new debt.
What this ratio tells you is how much of your income you spend on servicing debt. It’s recommended that your short-term debt (credit cards and loans) be kept to around 30%, although lower is always better if you can manage it.
Another important ratio that falls into this category of affordability calculations is your housing-to-income ratio. This shows how much of your income you spend on housing every month, whether you’re paying off a home loan or renting a property. In an ideal world, this number should be no more than 30% of your income.
You can calculate these ratios by dividing your debt or your rent by your pre-tax income. If possible, try to include property taxes and home insurance when calculating this ratio.
Calculating your net worth is a great way to keep tabs on how well you’re doing in accumulating assets.
You get to this number by using the formula: total assets – total liabilities = net worth. What that number should be will depend on your goals and where you are in your journey.
However, this number takes on greater relevance if you want to calculate the ratio of liquid assets to net worth.
You calculate this ratio by dividing cash or equivalents by your net worth. It’s suggested that you keep at least 15% of your assets in a liquid or easily accessible form.
Keeping regular, but not obsessive, tabs on these numbers can help you navigate your path to a comfortable retirement. By checking in once or twice a year you can rest assured that you’re still on track or make changes to ensure that you get back on track.
There are many components to include in a comprehensive financial plan. It is recommended that you engage with an experienced, qualified advisor to get the best insights to make informed decisions on what changes to make, suited to your specific requirements and goals.
- Tanita Conradie, CFP® professional, is a Financial Advisor at Brenthurst Pretoria [email protected]
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