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
- 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.