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May 28, 2018


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If I had to pick a single number to serve as a progress marker towards financial independence, I'd combine three of your four numbers as follows: net worth divided by ( income multiplied by ( one minus savings rate ) ). IOW don't measure wealth in dollars, instead measure it in years.

This formula may seem crazy complicated but I believe it is the best metric. The denominator of annual income multplied by (one minus savings rate) is your annual spending rate. Dividing your net worth by your annual spending rate tells you how many years of expenses your net worth can support. You want this ratio to grow as quickly as you can. Once it reaches 33 years your net worth can support a safe withdrawal rate of 3% per year, and you are financially independent. You can afford to retire at that point.

One takeaway from this formula is that for reaching financial independence income is not as important as savings rate. Why? Because while net worth will grow over time proportionally to income, the denominator is also proportional to income, so the income factor effectively cancels out. But a higher savings rate will increase the numerator and also decrease the denominator, so you get a double whammy effect on this ratio.

This is why a higher income won't automatically get you closer to your nest egg target-- only if your savings rate increases as your income grows. As they say even if your income grows, spending everything you make doesn't bring you any closer to retirement.

Credit score is meaningless. You can have bad credit and be a millionaire. It's about 2 things, net worth and cash flow. Net worth is a long term metric and cash flow short term. Both of these have different meaning based on your stage in life. I've had points in my life where my net worth was great but cash flow low. There have also been points where net worth was low but cash flow high. Looking back net worth high/cash flow low was a tough time but I felt better knowing the long term.

It would be interesting to take this post to the next level and evaluate those factors at various stages in one's life. For example, when you're young Credit Score and Cash Flow are important. When you're in your at my stage (squeeze phase - taking care of parents and kids in college) cash flow is critical.

Actually, a full and effective guide to measure. I've read thoroughly and I believe it would be great if you add "Emergency fund" as another measurement tool. Anyway, it's one of the best post I've seen online. Thanks.

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