The Eight Money Ratios, Part 1

The book Your Money Ratios: 8 Simple Tools for Financial Security lists eight money ratios that are designed to help us all determine where we stand financially. They're so good that the Wall Street Journal called them "some of the best tools we have seen for gauging where you stand." So I thought I'd list each of them as well as tell you where I stand on each measure.

The Capital to Income Ratio

The first ratio is the capital to income ratio, which I've already detailed previously in an excerpt. It basically measures the amount of wealth you should have accumulated based on your income. In essence, the formula for it is:

Net worth (not including home equity) / annual income

And here's how to tell where you should stand. 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

So, if you're 35 years old and make $30,000 a year, you should have at least $42,000 in net worth ($30,000 *1.4).

I'm closest to 45 years old, so I should have 3.7 times my annual income in net worth. I actually have 5.4 times my income in assets despite the fact that 1) I make a decent income, 2) they don't allow me to count the value of my (totally debt-free) home in the calculation, and 3) I give away a decent amount of my salary every year. So IMO the numbers are rather low. But then again, I'm more of a saver/investor so it figures I'd think as much.

The Savings Ratio

The second ratio is the savings ratio, the amount of your pay you should be saving every year at different ages. Here's a list of the ages  and the minimum percentage of your salary/income you should be saving at each age:

• 25 years old -- 12%
• 30 years old -- 12%
• 35 years old -- 12%
• 40 years old -- 12%
• 45 years old -- 15%
• 50 years old -- 15%
• 55 years old -- 15%
• 60 years old -- 15%
• 65 years old -- 15%

As I've discussed, we're way above saving 15% of our income -- and we have been for years. Our average savings per year for the past five years is roughly 1/3 of our income -- over twice what it needs to be to be "good."

So these percentages seem low to me. The author uses them because they will get you to the correct Capital to Income Ratio for your age. But since I think those are low as well, it goes without saying that I think the savings numbers are low.

A few more bits of information to round out this ratio:

• The author does suggest that you should save more than these percentages because returns can not be guaranteed. So by saving more, you're being conservative and guarding against poor investment returns. He recommends an extra 3% to the numbers above.

• The savings rates are pre-tax numbers, so they are on your gross income.

• The savings rate does include both your savings as well as any employer match you might get in a 401k.

So what do you think of these ratios -- good or not so good? And where do you stand compared to them?

Comments

[Ken]

Wife and are are 27 and 26. Income combined $150k. Net worth $250k.

CIR = 250/150 = 1.66

If you remove sayings for house, net worth would be $190k.

CIR then = 190/150 = 1.26

Savings rate just for retirement accounts are maxed out. So $43k

This equals 28%.

Plus we continue to save for a house and other things, like cars and vacations to pay cash.

[Todd]

So what does it mean if I am way below on the CIR ratio, but way above on the Savings Ratio. Should there be any correlation between the two ratios? My CIR is almost a full point below my age group, yet my savings rate ratio is above 25%. I wonder if receiving very healthy wage increases in the last few years skews the CIR ratio. Any thoughts?

[FMF]

Todd --

I think there should be a correlation between the two. Of course if you have had some very big salary increases recently and haven't had time to really accumulate savings, then your CIR will be lagging a bit. But it should catch up quickly if you're saving over 25% of your salary.

[MC]

I think this only makes sense if you are in a career where you have a consistently improving salary and the improvement is even and constant over your entire life. Since this doesn't really describe anyone I know, I'm not sure how useful the ratio thing is in general.

For people who have to do professional training (lawyer, doctor) while being paid almost nothing, and later in life work their way into very high salaries, it's totally not applicable. Similar for people who start their own businesses--they may not make money for quite a while at first (they may lose money), but if successful they really clean up later. What about people who switch careers? No one stays in one career anymore...

[Todd]

FMF - I think you are correct in that the CIR should catch up given a high savings rate, but I think MC may also be on to something. I was curious if the CIR ratio wouldn't work for those scenarios where there are large salary increases during a certain point in a career. Mathematically, I am not sure the CIR milestone is attainable if one is consistently seeing significant raises. It appears that only once the salary plateaus, then the CIR will catch up.

[Holly]

Wow. This really sheds light on a negative net worth at age 39!!! :*(

It's difficult for us to actually know where we stand because husband will be getting a gov't. pension.

Quick two-part question (and I'll bet you have answered this somewhere in another post, FMF): When calculating net worth, would your house be considered in the calculation? If so, would you use the current market value or the purchase price in the assets column? Just wondering...

[FMF]

Holly --

Personally, I use my house when calculating my net worth. Many others do not though, so it's personal preference.

I use an estimated current value, less the costs it would take me to sell the home.

[Nate]

Saw the link to your article '5 Steps to 6 Figures in 7 Years'. I remember reading that post several months ago when I was making 45k @ 24 years of age. At that point I set a goal to make 6 figures by 30 years old. Just wanted to let you know, that post really inspired me in many ways to begin outperforming at work. It stirred up some serious goals from within. 5 months later and I am making over 6 figures this year... I really attribute that post to driving my goals and direction in the short term.

Thanks

[FMF]

Nate --

That's a really great story! Thanks for sharing!!!

BTW, if you ever want to share what you did to go from $45k to six figures in a year and a half (if I read your comment correctly), I'm sure my readers would LOVE to hear it. Drop me an email and we can set up a guest post.

[Monevator]

Wow, my ratio is way ahead of where I need to be on that measure.

On the other hand, it doesn't really make up for being closer to the 40 band than the 30 band. :(

@Nate - congratulations!

[Holly]

Thanks, FMF. I will calculate net worth without the house (for now) since that's the only way I have a positive net worth...YIKES!

Yes, CONGRATS, Nate! The way I read it, he states that he went from $45,000 to making six figures in just about 6 months. No?

And to all of you overachievers -- Very inspiring ;*)

[FMF]

Holly --

Just to be clear, the numbers in the post above do NOT include the value of your home -- so if you're comparing to them, don't use yours either.

If you're just keeping track for your own sake (which is what I was referring to in my response), calculate it however you like.

[Budgeting in the Fun Stuff]

I feel like I'm cheating when I participate in things like this since I'm married. A DINK family usually comes out ahead on these things, but here we go.

We're 27, make about $80k jointly a year, and have a net worth (without the house or cars, which are both in the positive by quite a bit) of about $75k.

That would make our CIR = .9 (instead of the target .3) and our long-term savings rate is about 25% (instead of 12%) in pension contributions, 401k, Roth IRA, individual stocks, and the emergency fund.

We also save an additional 25%-30% for short-term goals like taxes, home and car maintenance, vacations, fun money, and pet expenses.

Even if we had kids, I'd think these targets are a little low...

[Nate]

FMF, Monevator, Holly -- Thank you guys so much for the congrats (very nice surprise)!

I would love to do a guest post - I will email you FMF.

Holly you are correct - I went from making $45k to 6 figures in about 6 months after reading the post (I was 24 then and I am 24 now – until June 6th). Seriously can't thank you enough FMF! I can actually remember exactly where I was and what I was doing when I read the post and made the decision to make 6 figures before I turned 30.

I make more money now than my entire family (parents and 3 siblings) combined. I would love to share how I did this. Honestly I am surprised myself that it happened so fast. The best part is GIVING!!! Wow that feels good.

I just bought a computer at a garage sale 2 weeks ago for $5 and sold it on Craigslist (after a minor repair) for $225. I want to put this money with some other cash I have and buy a used car at the local car auction (I hope to spend less than $800). Make sure it runs GREAT with my car buddy. Then I want to toss the keys (and title) to a random person who needs it. I hope to do this on or near my birthday June 6th of this year. OH MY GOSH - I can't wait to do this. It will be AWESOME!

[Holly]

Just a thought, Nate...would you be more inclined to give the car to a person who has proven 'worthy', such as a single mother trying to hold a job, a student who found a way to get into college and finally graduate, or a military vet who has been injured in Afghanistan or Iraq? That would be a great thing! Either way, it sounds fantastic!

[LotharBot]

ages under 30, one income, one kid. CIR 2.5 not counting life insurance. Savings rate over 50%.

I think the CIR numbers given above should be much higher; you should have at least 20x when you reach retirement age. And you should always have life insurance coverage of at least a couple years of income, which doesn't appear to be reflected there.

I also think people would do well to begin with a higher savings rate -- say, 25% or even more -- for the first few years. It creates a lot of flexibility down the road if you've accumulated a solid emergency fund and have a nice start on long-term savings. It also helps establish a habit of keeping an eye on spending and living below your means.

[Nate]

Holly - yes! I plan on having the car soon enough so I can ask around and generally pay attention to find someone who needs a leg up. I would like to give it to someone who is trying their hardest and could use a break (I have been there - and some people have done similar things for me in the past at just the right time!). That being said - I don't want the person to even know me - I just want to strike up a conversation with them and when we are done talking - give them a car and be gone. SWEET!

Live like no one else so later you can GIVE like no one else ;-)

[Param]

At 35, I have CIR of ~25 & SR of ~20%. What am I missing? Does this indicate I save badly, but hit a jackpot somewhere???

[Mike Hunt]

Age is just under 37, CIR is 6.1 and SR is 50%.

Key metric isn't CIR but CYER (Capital to yearly Expenses ratio)- maybe you will get to that in a later post.

Get the CYER ratio to 50+ and then you are well ready to retire with no worries.

-Mike

[mysticaltyger]

FMF--I agree with you that the ratios and savings rates required are a little low. But you know what? If most Americans were at these levels, we would not have the problems we have today. We would not have had a mortgage crisis, huge levels of government debt, and all the other garbage we have to deal with.

There's absolutely nothing wrong with being a saver, but I think we savers of the world are going to have to admit that most of the rest of the world is never going to be like us, and, to a certain extent, that's ok.

[AZnOUT]

My savings rate is currently high, but my CIR is extremely low but improving with each month. A few factors to consider in my ratios (aside from certain financial decisions made while "I worked hard and played harder" throughout my 20's and early 30's; currently 37)...1) my healthy income tripled over the last four years requiring me to play catch up and negatively impacts my improving ratios and 2) I've eliminated $175K of lifetime debt over this period limiting my savings in this time period.

Note: I always expected to eliminate the debt by the age of 40 (just not this quickly as I've been very fortunate) and while I've ramped up my savings each month, I wouldn't have sacrificed the life experiences to hope for an earlier retirement?? (50-55 will work for me). Nevertheless it feels good to have the interest/dividend income flowing in my direction for a change:)

[Param]

Totally agree with Mike. CYER is a better measure of your resilience during unexpected happenings to economy or yourself.

[Concojones]

Age 28, CIR = 2, SR = 30%
I agree with Mike on "CYER" (I guess 25 would be adequate).

[Concojones]

FMF,

I'm all for Mike's suggestion for a future post on CYER (CER). It is brilliant in its simplicity: save 25 times your yearly expenses - that's 300 times monthy expenses.

On track with your retirement savings? Look at your CER.

[Mike Hunt]

Concojones,

I think it depends on your age. I am turning 37 next month and because I live in SE Asia and own the place my wife (who is 30) and I live in outright, our expenses (including going out to eat 10+ times a week and taking a monthly vacation) are conservatively estimated to be about $3k a month or $36k a year. Taxes are the biggest expense as we pay about 33% of our gross in local taxes. Based on liquid capital we have a CYER of about 50 right now but I, as the sole earner in the family at present, am hesitant to retire.

Why? Because we may decide to have a kid and that will change our expenses, potentially dramatically. Also I would expect to live around 45 or so more years based on average life expectancy, and my wife would live about 55 years so it's too risky to retire right now. Am aiming for a higher CER number just to be safe- and will factor this in and recalculate based on expenses again once we decide on whether or not we want to or can have children.

Also I don't know if I will stay here or return back to the US, if we go back we will likely buy a house in cash and for sure that will draw down our capital and the CER will plummet. So it seems much easier to stay working in a high paying job and saving some more here.

The younger you are the more contingencies you have to plan for if you want to retire really early. That said, I'm on track for hopefully being able to retire comfortably at age 50.

-Mike

[Concojones]

Mike,

Right, the future is uncertain when you're young. But won't it always be? I don't think we can plan ahead for everything. I do plan ahead for what's likely though (house, kids, even though they're big question marks too).

The best we can do is run some likely scenarios and see how much they cost. And then I'd expect you to be not that far from the number you need to retire. In my country, Belgium, only few people work past their mid-fifties, it's crazy. I don't know if it's a good idea for you to retire at 37 (what would you do all day?), but you probably could...

[Mike Hunt]

Hi Concojones,

Thanks for the comment. In Belguim, I trust most people have a pension for when they retire in their mid-fifties, would you agree with this?

I'm going to keep working for now.

-Mike

[Concojones]

Mike,
yes they have a pension or something similar.