Our Equity Ratio
Part 1 of 2-Part Series
Here at Kismet, we treat wealth management a little differently from others. We believe that managing your wealth involves more than your stock portfolio and should account for all aspects of your life. Your financial life operates much like a business. There are many moving parts which are independent of each other, however they all affect each other. This is precisely how we view your wealth management, and is why we use indicators and metrics which are traditionally reserved for businesses. One of these metrics which takes front and centre is the Equity Ratio (ER). Again, it’s not often used in personal wealth management, but it’s very valuable.
Traditionally, the equity ratio is calculated by dividing the shareholders equity by the total assets. This ratio shows whether a company is leveraged or conservative. Companies with a ER of more than 50% or 0.5 are generally considered conservative because their ER is higher than their DR (debt ratio), or it uses more equity than debt to fund. Conversely when the DR is higher than the ER, or the ER is less than 50%, the company is leveraged. Ultimately, companies with higher equity ratios are lower risk.
However, there are no shareholders with equity in your personal wealth and so we’ve tweaked the formula for it to apply more appropriately:
In this case, your equity investments equate to money which you invested in a company or companies, by buying shares on the stock market and simply put are your stocks. The total investments which is the divisor in this ER formula is your equity investments plus your fixed income and alternative investments. Common examples of fixed income and alternatives investments include bonds, fixed income ETF’s and fixed income mutual funds, real estate and debt investments.
Part 2 continued next week.