That’s the premise of a new book by Charles Farrell, “Your Money Ratios: 8 Simple Tools for Financial Security at Every Stage of Life.” The book lives up to its title—people at any stage of life can pick this up and figure out exactly how they relate to where they should be, according to Farrell.
At the heart of this book lies a tried but true idea, but it’s presented in a way that I have never seen before:
“All decisions you make should help move you from being a laborer to being a capitalist…You must start out as a laborer to generate income. You then save a portion of that income every year. Those savings become your investment capital. Once your capital is large enough, the payment for the use of your money will replace your wages, and you can retire.”
This is retirement planning explained in the simplest terms—saving up enough capital so that we can live from the income it produces during our golden years.
“Retirement,” as an idea, is getting a bad rap lately, particularly from the “lifestyle design” group. But in the same vein, moving from laborer to capitalist doesn’t have to mean retirement. It doesn’t even have to mean being 65. In fact, it’s the core idea behind many of the “start working for yourself” books I’ve read in the past, including one of my favorites—Your Money or Your Life.
In order to stop working and maintain our ability to pay expenses, we need to have a means of producing passive income, either from assets we’ve created or from capital we’ve collected. There’s no way around it.
Anyway, this is where the ratios come into play:
“To make that journey from laborer to capitalist, you must effectively manage the core issues of personal finance: deciding how much to save each year, how much capital you should have accumulated at each age, how much debt to carry, how to prudently invest your capital, and how to purchase insurance to protect your capital.”
The CIR Ratio
The main ratio that governs the idea of moving from laborer to capitalist is the Capital-to-Income ratio presented on Page 17. The remaining 200 pages are simple auxiliary ratios that help you to get to the main goal—capital accumulation.
The Capital-to-Income ratio uses your income and an age-based multiplier to quickly show you how much money you should have saved up at every stage of your life, and ranges from 0.1 at age 25 to 12.0 at age 65, the target retirement date.
The 12.0 amount is based on a wide variety of factors, but basically takes into account everything that could realistically affect your money from now to, and through, retirement. It’s a good start.
The Other Ratios
The rest of the book presents other ratios that help you guard your capital as you grow it. Here are the highlights:
- The Savings Ratio, which is nothing more than your target savings rate. Can you guess the average required rate to get to a CIR of 12.0? 12-15% per year. With an average savings rate in the U.S. in the low single digits, it’s no surprise people are finding it hard to retire on time!
- Mortgage to Income ratio—because way too many people are over-borrowing for their home. Interestingly, I like Farrell’s reasoning for why a home is an income-producing asset—because if you pay it off, you don’t have to pay to live there during retirement!
- Education Debt Ratio
- Investment Ratio (percentage of stocks-to-bonds based on age). Surprisingly, Farrell suggests a fairly static approach through most of our lives that balances bonds and stocks evenly for better downside protection.
- Several insurance ratios: the Disability Insurance Ratio, the Life Insurance Ratio, and the Long-Term Care Insurance Ratio.
Farrell covers a number of other topics, including why you should expect Social Security to be a part of your retirement, the types of investment accounts you should use, how to pick and buy health insurance, and how to get professional help.
What’s the Best Thing About This Book?
The biggest benefit of this book is that you can get an idea of where you are in life financially by simply plugging in your income and age and evaluating the results. While this sounds overly simplistic, that’s exactly the idea. Sometimes removing the complexity and emotion that comes with personal finance isn’t such a bad thing.
If you’re interested in picking up a copy, it’s available on Amazon. Cheers!
Photo by lrargerich