If you’ve followed FIRE bloggers long enough (about 10 minutes will do), you’ll probably hear them talk about their savings rate. Many are saving 50% or more of their income.
In 13 years of being a FIRE blogger, I’ve never calculated my savings rate. For many people calculating a savings rate is may be easy. With our finances, calculating a savings rate presented a number of problems.
Before I get to those problems, let’s approach how an average person could calculate their savings rate. Let’s say you earn $50,000 a year. You try your best to max out your Roth IRA and 401K, but you also have a powerful need to eat food and have shelter. You’re able to save $10,000. That gives you a 20% savings rate ($50,000 / 10,000). You might want to calculate your income after taxes by looking at a recent pay stub and doing some multiplying. There are no savings rate calculation police checking your work.
It’s a little more complicated for us. Here are the main two complications:
- I have a lot of irregular income
I don’t know if who much my dog sitting or blogging is going to make on any given month, much less for a full year. I don’t know what freelance income I might make.
- Our real estate properties are problematic
We have three rental properties and a primary residence with 15 year mortgages. Some people may choose 30-year mortgages with lower payments and invest those savings. I could probably figure out what the savings would be with the rental properties by calculating the amount of the principle debt being paid off. I don’t know how to apply to our primary residence. I know I said there are no savings rate calculation police above, but I don’t know what would be close to accurate.
If forced to guess, I’d say that we have about a 50% savings rate. That would be based on the mortgage debt being paid off on the real estate properties and the retirement account savings. That’s the most we can afford with another $30,000 a year in education costs for my wife and kids.
Since I am envious of everyone else’s ability to calculate their savings rate, I decided to come up with my own metric.
Introducing Net Worth Growth to Income Ratio
I track our net worth with personalCapital and an office spreadsheet. I’ve been doing it for years. For this reason, it’s very easy for me to look up how much our net worth grew in any given year. As I explained above, I don’t know how much money we’re going to make this year, but thanks to our tax filings, it’s easy enough for me to look up last year’s numbers. If necessity is the mother of invention, laziness is the father of invention.
Plugging those two numbers into my calculator shows me that in 2018 we had a net worth growth to income ratio of 65.86%.* For example, if we made $100,000 last year, we’d have $65,860 of net worth growth with that ratio.
Where did I come up with this? Well one easily argue that growing your net worth is the most important thing in personal finance. Translating as much of your income into that net worth growth is important.
I was a little hesitant to move forward with this idea, but I reached out to Twitter and got some good encouragement. Here’s a sampling of the responses:
The winning ratio? ?
— Retire by 40 (@retirebyforty) June 20, 2019
“Winning ratio?” I like that.
It really is pretty elegant (not that was your goal lol). It takes things like principal payment into account whereas a savings rate wouldn't. It also rewards investing in non-mark to market investing (i.e. business)
— Evan (@MJTM) June 21, 2019
“Pretty elegant” I love that.
“The Millionaire Nextdoor” uses prodigious accumulators of wealth, which is age x income / 10. Your proposal is more meaningful.
But what if your are retired? How about net worth over lifetime income? A healthy growth rate will result in a number greater than one.
— PerpetualMoneyMachine (@MoneyPerpetual) June 21, 2019
“More meaningful” than a metric in The Millionaire Nextdoor? That’s amazing praise.
Is the Net Worth Growth to Income Ratio Valid?
In some ways, it’s easy to criticize net worth growth. If the stock market does well (as it has) or the real estate market does well (as it has) our net worth is going to grow despite what we choose to save. It can be a reflection of past savings and investments in combination with our current savings and spending. I don’t know if this is good or bad. It can be seen as bad if great markets are masking a poor savings rate.
On the other hand, if you are able to get this ratio at 100% (the net worth growth and income the same number), you are essentially living as if you spent nothing, right? That’s a very good thing, right? This gives you more of a “bottom-line” view, which some could argue is all that really matters.
I know of a family where both spouses earn a very high income, but they spend a lot of it and are often wondering why they aren’t in a better money situation. This could be a quick tool to show them that making $300,000 may not be helping their financial situation because their their net worth isn’t going up and they have a very, very low ratio.
That last Twitter quote made a good point asking what happens if you are retired. In that scenario, you might not be earning much income, but you’d presumably have a nest egg that might be growing. I’d argue that savings rate doesn’t mean much if you are retired since you likely aren’t saving much of what I presume is an insignificant or tiny retirement income.
Someday soon, I hope to pull some of our old tax forms and calculate some past numbers to see what I can learn from them. Can you calculate your net worth growth to income ratio for last year?
* I’m mixing up ratio and percent a lot in this article. For our purposes, the nomenclature is no big deal.
I like it. But it is a mouthful.
I’m pretty sure we had good numbers over the last few years. Probably pretty close to 100%. The stock market was doing well.
Actually, I do have the numbers.
2018: negative net worth growth due to bad December!
2017: 1.62. Good stock market year…
Lazy Man says
Yep, it is a mouthful. I was thinking of shorter like NWG/I, but that’s not too much better.
Abigail @ipickuppennies says
Interesting concept. I think it definitely has its merits over the savings rate, though the two are obviously inextricably tied together, even if stock market gains have something to do with net worth gains. But I agree that net worth is more important than a savings rate in the end, so a net worth growth to income ratio is pretty handy.
Define income? Define Net Worth? Those questions get posed a lot on FI sites, and the problem overall is moot if you use the same information year over year so that is good. The other issue is what is a good number? If the stock market goes up 20%, and you made 15% that means you were less than the stock market. However if the stock market goes up 20% and you were at 20%, you only put in 30%, is that a good thing or a bad thing?
I have said this before, if a number makes sense for you to track, you will find a way to track it and you use it as you see fit. I track accounts performance vs SP500 and DJIA. Others just look at the basic returns and go from there.
Since my mother said never say something bad without offering a solution, I think I might have something which might be a little more informational. ((Income – Savings Amount)/Income)*((Net Worth Growth % – Index Growth %)/Net Worth Growth %) = % Yearly Net Worth Contribution. Example, You made 100k, Saved 50K, Net Worth % up 50%, Index Growth % up 20% (SP 500 or DJIA, what ever you pick). ((100k-50k)/100k)*((50-20)/50)=30%. You contributed 30% to your net worth growth this year, the rest was outside forces. What this does is take away scale (by using percentages), and shows you the actual affect your contributions have on your net worth. This does the same thing as your ratio – but cancels out market influences and income:savings ratios.
As I have said already, if some numbers work for you, but not others, more power to you. I would rather see how much I contributed to my Net Worth vs. how much it is versus my income (as a high income earner, ratios do more to motivate me vs. absolute dollars).
PS – I wrote this in about 5 minutes – feel free to pick it apart – I have no feelings invested in this :)
Lazy Man says
I’m not invested in the metric either. I thought it might make some sense for me to track because it was super easy.
The problem I have with your proposal is that I still have to figure out a savings amount, which is a little complicated with the real estate properties – or maybe it’s not complicated, but I just don’t know what that calculation should be.
The savings metric I use .. because I am lazy as hell .. is how much money did I save into investment portfolios. So for me, what contributions did I add to 401k, Roth, Investment and HSA. I don’t mess with retail banking accounts as at that point you are getting into the amounts of money which don’t make that much difference due to ebbs and flows of monthly life.
Lazy Man says
I think that works for most people, but our savings in those things are greatly limited by the savings we are making in the equity of our rental properties. We could, in theory, refinance the properties to fresh 30-year fixed mortgages that would give us money to put in more pure investment accounts. I don’t think that’s a wise financial move to make, so I’m looking at counting some of the investment properties as “savings.”
Maybe call it the lazy winning ratio.
My most persistent financial goal has been to keep my ratio above 1. That is, I try to grow my net worth by at least as much as my salary. I started tracking 6 years ago, and have been successful every year. You are right in pointing out that this is mostly a function of the success of the market. I’ll count it a nice problem to have if my savings rate has little impact on my net worth compared to market appreciation.