Calculate your lifetime savings ratio
Many people regularly calculate their savings ratio based on the amount they save vs their income. This article is for those people. It's all well and good trying to calculate your savings ratio on a year to year basis, but that calculation kind of ignores the big picture. The big picture is your ultimate goal of retirement, which is undoubtedly tied to your net worth.
The problem inherent with doing the year-to-year comparison is that one year can have a ton of expenses (medical, moving, investing, etc) while the next year may have near nothing because you already bought the house or car or whatever you wanted in the prior year. This will make your year over year savings rate a bogus calculation that will make you feel good or bad depending on random life occurrences. I think the best way to get rid of fluctuation in a data set is to average it. The best way to do that with finances would be the following formula:
Well this is great finally a way to calculate a metric that nobody else has thought of. I think everybody should already know their net worth (at least at the resolution of around +/-10k) especially after 5+ years in the workforce. A few sites that will do it are Bank of America or Personal Capitol. Or just with a plain old pen and paper. Financial Samurai has a great article on net worth if you want to compare it to something.
The more difficult thing to accurately calculate is your lifetime earnings. Luckily, old Dave has a trick for you. There is actually a site that tracks your yearly earnings every year without you even knowing about it! You know what it is? The social security site. That's right the government actually did something right and yes it has to do with spying on you to make sure they get money. But hey at least they did it well I guess. Just make an account, log in, and see for yourself what you have made every year since you started working! I had done an article on it in the past because I thought it was cool, but not super useful. Now it has become apparent to me how to use this history to see how well we are doing on our way to retirement and what to expect with out net worth building.
Here is an example of somebody who maybe joined a union as an electrical worker in 2001 with no debt to his name:
Here are some of the huge financial things this above chart would not take into account when you try to figure out how many dollars actually got to your pocket:
- TAX! federal, state, property, you name it
- 401k/IRA investments
Next step is net worth. For this example let's say this guy bought a 200k house after the market crashed (and not before LOL.) This will add about $200k to his net worth as a whole when the value of his house doubled. Assuming a savings rate of 30% on the rest of his income, this will ballpark our guy with a net worth of $560k. Not bad for 14 years in the workforce and no college degree/loan to hold him back! In the above example we are shown the following:
Let me point out the obvious here: If this union electrician saved just 30% of his income in cash, his lifetime savings ratio would be .3 or 30% and it would never change. Interestingly enough in my above example the equity growth of his house of $200k equated to a 16% boost in lifetime savings after only a few years. Yes this is because he "lucked out" and bought a house after the 2008 crash and it doubled it's value since then. If he had bought a house before the crash and it lost half it's value and he sold it, he may be looking at a 30% - 8% = 22% Lifetime Savings Ratio. Which still isn't that bad. This goes to illustrate that the Lifetime Savings Ratio also is dependant on the performance of your investments, and as such you would excpect the ratio to increase as time goes on.
The cool thing about this lifetime ratio is it will let you know if you are investing well and properly, independent of your income. Think about it: a part time person may have accumulated only half the wealth, but if their Lifetime Savings Ratio is the same as the guy in the above example, it means that their investments are performing well. They may have only bought a $100k house and made $100k off the deal, but their ratio would still be 46% which could be construed as "good" or "on par" with our friend the electrician.
The lifetime savings ratio will also place a buffer on the rich. You may even be able to compete with them on some level that makes sense using ratios instead of brute numbers. If a rich man makes $100,000 in the stock market off of 1 million, you only have to make 10% on your investment to be just as smart as they are! Even if you have inherited a bunch of money, this metric can still be useful if you - Just add the inheritance amount to the earnings field to see how that income performed and whether you have under-utilized the cash you got.
Since no article like this can be complete without an arbitrary metric being ascribed to as good or bad or great, I leave you with the following chart:
In the above chart I am being pretty realistic on the bad calls. If you can't get to a Lifetime Savings Ratio of 40% by the time you have been working for 15 years, you might never get there, and you will be relying on the government social security program to pick up your tab at 60+ years of age. Likely social security will be cut at some point in our lives, so I don't recommend relying on this income at all. I won't sugar coat it - a rate less than 40% after 15 years is not a good deal and you should be doing better than that. Remember this site is for the financially savvy, and generally the markets average 7% a year, so even just saving at a reasonable rate and dropping it in the market with a 401k should get you almost to the 40% point with ease. Provided you don't spend the rest on cheeseburgers.
On the other hand, within the first 5 years of working, it is expected that you will have few investments if any, and you will just be getting started in the game of life. You may even be saddled with student debt or some other malady which won't really affect your lifetime goals, but will skew this data set for a few years in the beginning. With that in mind, I would say to most people in the workplace for less than 5 years that as long as you are reading financial sites regularly, you can rebound from almost any hiccup big or small - it just takes time.