The Capital to Income Ratio

The following is an excerpt from Your Money Ratios: 8 Simple Tools for Financial Security.

The concept of moving from laborer to capitalist sounds like a nice theory, but what you probably want to know most of all about retirement is this: “How much savings (capital) will I need to retire?” A good estimate is that you will need to accumulate capital worth about 12 times your income. If you have capital worth about 12 times your gross annual income at age 65, this should put you in a
position to live on about 80% of your preretirement income. I will explain how this works, later in the chapter.

This is the transformation from laborer to capitalist. You start out with zero capital when you are young, save a portion of your income each year, and ultimately try to accumulate capital worth 12 times your pay. To help you track and benchmark the accumulation of your capital, I have developed the Capital to Income Ratio, or CIR. The CIR tells you how much capital you should have accumulated at various points between ages 25 and 65 so that you stay on track to reach 12 times pay at retirement. This time frame covers the
general working years for most people, and lets you know if you are on track at a particular time. The CIR is the most important ratio in Your Money Ratios because it provides the framework for your transition from laborer to capitalist. All of the other ratios are designed to help you meet your CIR.

Figuring Your CIR

To begin, look up your age and the corresponding Capital to Income Ratio fi gure in the chart below. Then multiply your household income by the Capital to Income Ratio. This tells you how much capital you should have accumulated at your age. If you are adequately saving (we’ll talk about how much you should be saving in the “Savings Ratio” chapter), you should be hitting these ratios along the way. Since your goal is to accumulate capital worth at least 12 times your income, this ratio lays out your path from ages 25
to 65. All you need to do is keep driving your Capital to Income Ratio up so you are hitting each benchmark as you progress toward retirement. You do that by consistently saving each month, as well as properly managing your debt, investments, and insurance, which we will cover later.

Example: Let’s assume you are 40 and have a household income of $100,000. The Capital to Income Ratio at age 40 is 2.4. This means you should have 2.4 times your income in savings, or $240,000 saved. Now add up what is in your 401(k), IRAs, savings, and investment accounts and compare it to that fi gure. This will tell you if you are ahead or behind in your goals. By using the ratios, you can quickly benchmark your progress and stay on track for retirement. If you are not on track, you can make adjustments and get back on track in a few years.

CAPITAL TO INCOME RATIO

The first number is your age. The second number is your Capital to Income Ratio (the multiple of your annual income you should have accumulated)

• 25 years old -- CIR: 0.1
• 30 years old -- CIR: 0.6
• 35 years old -- CIR: 1.4
• 40 years old -- CIR: 2.4
• 45 years old -- CIR: 3.7
• 50 years old -- CIR: 5.2
• 55 years old -- CIR: 7.1
• 60 years old -- CIR: 9.4
• 65 years old -- CIR: 12.0

For most people, the income component of the CIR will be easy to calculate. If you are paid a stable salary each year, you simply use your total household income for purposes of the CIR. But some people have a more volatile income stream. It might rise and fall as the result of a year- end bonus; or it is volatile because they are in sales or run their own business. In these cases, you want to use your “core” annual income for purposes of the CIR calculation. To calculate your core annual income, take a simple average of your pay for the last four years. This average will help smooth out the ups and downs, and give you a better sense of the average income you are living on each year.

The Capital to Income Ratio begins at age 25, when a good number of people start to enter the workforce. But I recognize that because of education requirements, such as graduate school, many people do not start their careers until their mid- to late 20s. So, between 25 and 30, it may be diffi cult for many people to begin accumulating much savings. This is also the time when people are paying back student loans, getting married, having kids, and trying to buy a house. Consequently, I don’t expect that many people will be in a position to build much capital during their 20s. If you can accumulate capital equal to a little more than half of your salary, you will be doing pretty well. This is a modest amount, but a great start.

For the purposes of the CIR, capital means:

• The savings in your 401(k) plan, IRAs, annuities, and CDs
• The cash value of your life insurance
• The amount in your checking and savings accounts
• Equity in commercial real estate
• The fair market value of any business interests.

Capital does not include the equity in your home. Remember, being a capitalist is about being paid by others for the use of your money or assets. The house you live in does not generate income. If it were a rental or commercial property and you were allowing this asset to be used by others, you could expect some return. The real return you get from your own home is the rent- free use of the property once you pay off the mortgage. This will be very helpful to you in retirement, but the equity is generally unavailable as an income- producing asset because you are living there.

Comments

[The Biz of Life]

The goal of any investor is to compound capital at the highest rate possible for their given level of risk tolerance. The capital/income ratio seems to be one benchmark for measuring if enough assets are being accumulated for retirement. Everyone wants to know what their magic number is for retirement.

[Budgeting in the Fun Stuff]

I love benchmarks, but this one seems a little low, right?

My husband and I make about $78,000 a year jointly and have a CIR of 0.3...that means we should have $23,400 saved up, right?

That seems REALLY low to me...maybe our early retirement goal pushes us a little harder but we have more than $73,000 combined from cash, my 401k, our Roth IRA, and our stocks. I'm even ignoring what's in my husband's pension plan since I'm too lazy to look it up...it was a little more than $10k last year. That's more than 3 times as much as the benchmark states.

I'd love to say "whoo-hoo, we kick butt", but I think it's a benchmark error more than a personal success. If we only had $23,400 saved up, I'd be very worried about our future.

[Stephan]

This post just reinforces the idea that saving any amount when your young will be very helpful towards achieving your retirement goals by the time you are 65. Its never to early to start, and that is the motto i live by.
Preferred Financial Services

[Eugene Krabs]

Hmm. It's interesting to learn and play with ratios like this one, but what does it mean in real life terms? Isn't it possible for someone who make $20k a year and someone else who makes $200k a year to both have the same CIR in the same age group, and yet, end up with very different results in real life?

Perhaps that's not the point the author is trying to make, but just the same, I think it's worth noting.

[Traciatim]

Isn't it much easier to just say "Save 15% of your gross income every year?" I mean, if you are earning 5% on your money, and you get a 2% raise each year the math of the CRI chart above works pretty well to end up at near a 12 CRI in the end anyway if you put 15% of your gross income each year. The key here is starting at 25 or earlier. Starting early is hammered in by almost every financial advisor and pretty much all material you read about saving for the future.

[jim]

I'm curious why they think that 12 CRI is good enough to and replace 80% of your income. They don't really go into how they plan to stretch the capital into retirement years. I expect thats in a different chapter.

Budgeting Fun Stuff: The ratio is pretty low in the earlier years likely because it assumes that people are going to have relatively lower income in their 20's, they are saving for homes, paying off college debts, having babies, etc. So I think its fairly normal for people in their mid 20's to have very little in the way of cash savings accumulated. I was in debt at age 25. If you're doing considerably better then that then you're ahead of the curve. And no I wouldn't be considerably worried if I "only" had the amount this benchmark cites. But of course everyones different. An Electrician may have good cash savings by age 25 and an Electrical Engineer may be in debt in student loans still. The engineer will likely pull ahead in later years.

Triciatim : Save 15% is a goal (a good one). This measure is more like a benchmark. The idea here is to take a snapshot of your current state and compare it to where you 'ought to be' at that age.

[brooklyn money]

I really like this guide and way of thinking about the "number." One thing that I always find challenging with formulas that take into account your current income is that my income today has only been by income for the last few months. My income in previous years was a lot lower, so obviously my savings are a lot lower and I've been living on less for years, but I'm still supposed to use my current income as a benchmark.

[Bad_Brad]

I'm glad I came across this today. :)

I'm 35 years old and almost exactly on target in terms of CRI.

[BD]

I'm definitely above my capital to income ratio, due to getting on board with the 401K programs at whatever job I was with at the time. Then again, my C to I ratio is 2.4, and I average about 10,000 a year now, LOL. So whatever amount I had saved was when I made around 20,000 a year. Now, I just manage to stay out of debt, but can't save much, so by the time i get to the next ratio bracket, I'll probably be behind.

[[email protected]]

Per the formulas outlined I am way behind. However, if I were allowed to include my secondary home and investment real estate it would be ahead. So, why is real estate considered to be a non-capital asset ? While I cannot argue it has taken a tumble, select RE is still a good investment if you invest wisely. I consider it to be part of my overall balance in portfolio management.

[Bad_Brad]

[email protected] - I think the formula excludes your primary residence but does include any equity you have in investment properties.

[Georgia]

At 69, I had $78k in my 503b. I did not start saving until I was 49 and a good deal of the time I was putting in 25%. Shocked me, as I had never been able to save much. In fact, we had been up to $34k in cc debt.

Luckily, I still am ok. I have SS & 2 small retirements. I need to only take out the minimum each year to use on my home or on visiting family. But the best news is, since I only take it out annually, I have taken out around $15k since 2006 (none in 2009)and yet, by the end of this year, I will have approximately $76.5k in my account.
This is only a savings account type of retirement, so I did not lose anything in the downturn except a now much lower interest rate.

They had informed me that if I took a monthly payment of $468, with an interest rate of 4% my money would last for 20 years. See what monthly compounding can do for you?