Ideal Debt Ratio

[Reporter]

In business, it is considered good to have some gearing (or leverage), and there are acceptable levels of gearing for different industries.

What about for individuals and households? What is the ideal debt ratio for families?

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From What is ideal debt to equity ratio :

"It's common for large, well-established companies to have Debt-to-Equity ratios exceeding 1. For instance, GE carries a Debt-to-Equity ratio of around 4.4 (440%), and IBM around (1.3)130%."

[whizzard]

Originally Posted by Reporter

In business, it is considered good to have some gearing (or leverage), and there are acceptable levels of gearing for different industries.

What about for individuals and households? What is the ideal debt ratio for families?

-

From What is ideal debt to equity ratio :

"It's common for large, well-established companies to have Debt-to-Equity ratios exceeding 1. For instance, GE carries a Debt-to-Equity ratio of around 4.4 (440%), and IBM around (1.3)130%."

There is no one magic number as an ideal debt ratio. Even for businesses, their debt ratio varies according to the type of industry. For example, a utility company would necessarily have a higher debt ratio than a computer manufacturer. A utility company needs to invest heavily in capex which will last a long time and generates comparatively low margins but very stable and recurring over a long period of time. A computer manufacturer on the other hand, generates higher margins but needs to provide for product obsolescense and upgrades in machinery and their earnings are much more volatile and cannot be assumed to be recurring.

The ratio you used is not relevant for individuals because debt/equity just tells how much equity you have to buffer agst the drop in the underlying networth. A better gauge for individuals would be debt/cashflow (for companies, it is debt/EBITDA). This shows how much debt you have relative to your cashflow. Again, there is no single magic number here because a civil servant with good job security obviously can afford to have a higher debt/cashflow vs a person working in the frontline finance industry where retrenchments are par for the course. Even within the finance industry, a credit officer may be able to carry a higher debt/cashflow vs a trader due to the relative job security of a credit officer vs a trader.

In summary, a person with a higher job security and brighter job prospect can afford to carry higher debt vs the person with lower job security. That's my two cents worth of opinion anyway.

Originally Posted by whizzard

There is no one magic number as an ideal debt ratio. Even for businesses, their debt ratio varies according to the type of industry. For example, a utility company would necessarily have a higher debt ratio than a computer manufacturer. A utility company needs to invest heavily in capex which will last a long time and generates comparatively low margins but very stable and recurring over a long period of time. A computer manufacturer on the other hand, generates higher margins but needs to provide for product obsolescense and upgrades in machinery and their earnings are much more volatile and cannot be assumed to be recurring.

The ratio you used is not relevant for individuals because debt/equity just tells how much equity you have to buffer agst the drop in the underlying networth. A better gauge for individuals would be debt/cashflow (for companies, it is debt/EBITDA). This shows how much debt you have relative to your cashflow. Again, there is no single magic number here because a civil servant with good job security obviously can afford to have a higher debt/cashflow vs a person working in the frontline finance industry where retrenchments are par for the course. Even within the finance industry, a credit officer may be able to carry a higher debt/cashflow vs a trader due to the relative job security of a credit officer vs a trader.

In summary, a person with a higher job security and brighter job prospect can afford to carry higher debt vs the person with lower job security. That's my two cents worth of opinion anyway.

thanks for sharing your thoughts. so, suppose one is holding a semi stable job, say between civil service and MNC middle management in non-sales, and has a cashflow of 100k and net worth of 1m. is a debt of 500k ok? how about 1m? or even 2m?

An ideal debt amount a person can take depends on his ability to service the debt as well on his current net worth position. A person with a net worth of $3m and another person with a net worth of $300k should see a $1m mortgage differently, even though both have the same salary, job stability and are of the same age. In the worst case scenario, the person with higher net worth can easily sell off his assets to pay off the $1m mortgage.

So, a rich person can have a higher debt than a poor person.

The problem with today's young professionals is they take on too much debt, justifying their actions based on their income. Since young people nowadays are paid highly, they become over confident and start buying condo, sports car, branded goods, go for expensive holidays, etc. Many find themselves unable to manage their debt and end up declaring bankruptcy.

If you are young and has a household income of $200k, the best is to stay in a 3 room HDB flat. Save up enough cash. Then when you sell your flat, make sure if you are buying a $1m condo, your downpayment should be $600k. Borrow only $400k.

I vary mine between 20-30%. 20% when I think markets are peaking and 30% when they are crashing. I have about $20m

Originally Posted by Reporter

"It's common for large, well-established companies to have Debt-to-Equity ratios exceeding 1. For instance, GE carries a Debt-to-Equity ratio of around 4.4 (440%), and IBM around (1.3)130%."

GE has a large financial services component that takes deposits. Most banks have debt to equity of 5-10 because of that. So you can't compare financial services type companies to normal industrial companies.

IBM is an asset light company. It generates remarkable net income for it's balance sheet size, hence debt/equity is not relevant. If you look at its debt/free cash flow, it's less than 2x and it has interest coverage of debt of over 50x.

If you are a loanshark, then you would have an incredibly high debt/equity ratio like GE

If you are a a fresh Harvard MBA who just got a job earning $500K out of college, but your only asset is a $200K BMW, now depreciated to $140K, that you took a $180K loan for. Your debt/equity is 1.3x but you are in an excellent position.

Originally Posted by Unregistered

thanks for sharing your thoughts. so, suppose one is holding a semi stable job, say between civil service and MNC middle management in non-sales, and has a cashflow of 100k and net worth of 1m. is a debt of 500k ok? how about 1m? or even 2m?

Nowadays, earning $100k pa is nothing, having net worth of $1m is also nothing.
You should only take a loan of $300k the max.

For me, my net worth is $5m and I have no debt at all.

Originally Posted by Unregistered

Nowadays, earning $100k pa is nothing, having net worth of $1m is also nothing.
You should only take a loan of $300k the max.

For me, my net worth is $5m and I have no debt at all.

$5m is nothing. no debt is also nothing.

Do you know generally how much debt do normal graduate couples have as a percentage of their net worth? Eg for a couple with combined net worth of 3m, is a debt of 1m normal or too much?

[mchan]

Originally Posted by Unregistered

$5m is nothing. no debt is also nothing.

Very profound !