Wednesday, May 26, 2010

Our Three Financial Measures

"You get what you measure." ~ old adage

In our household, we measure three values to determine our financial health: investment income, total savings, and total debt. I believe these values will show whether we can maintain our early retirement status or not. To make the values relevant to our pre-retirement income, I divide each value by my salary prior to retirement for a ratio. Here is why these values are important to us:

  • Investment income. This value is important since we would like to live entirely on the income from our savings. Our target is to generate 80% of my pre-retirement salary through investments. This gives us an investment income ratio target of 0.8. If the ratio is significantly less that 0.8, we need to consider other options for generating income, such as doing part time work or returning to full time employment.

    Since we have paid off our mortgage and reduced other expenses, our income needs are about 0.5 of our pre-retirement salary. Thus a target of 0.8 gives us a comfortable margin of safety.

  • Total savings. We have estimated that a savings total equal to 20 times our pre-retirement salary is needed to maintain sufficient inflation adjusted retirement income through our nineties. This calculation was done when our target income was 0.8 of our pre-retirement salary. At this point, we are not doing a recalculation, even though our monthly expense needs are at 0.50 of our pre-retirement income.

  • Total debt. Our target debt is zero. Debt creates additional expenses, which we want to avoid in retirement. For example, paying off our mortgage reduced our monthly expense by 24%.
  • For reference, we do not include the value of home, cars or other personal items in any of our financial measures, since these items do not generate income.

    I track these measure on a quarterly basis to determine if we are on track and to take action when we are not meeting targets. For the latest quarterly review, see Wealth Builder Ratios - Q1 2010 Update , or check the right sidebar.

    For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

    This is not financial advice. Please consult a professional advisor.

    Copyright © 2010 Achievement Catalyst, LLC

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