Your Money Ratios by Charles Farrell
One of the biggest challenges in personal finance is figuring out whether you’re on track to retire when you want to retire. There are so many variables, ranging from how much you’ll save, the returns you’ll earn, and how much you will actually need during retirement. And then there are countless unknowns, chief among them being how long you will live.
There are some retirement calculators that do a decent job guesstimating where you’ll stand at retirement age. Of course, these calculators are only as a good as the data and assumptions you enter to produce the results. So, what’s the solution?
While there is no foolproof way to predict the future, Your Money Ratios: 8 Simple Tools for Financial Security by Charles Farrell is a good start. I’ve been a fan of Farrell’s for some time, ever since reading his paper on financial ratios several years ago. So when the publisher contacted me asking if I wanted a free review copy of his new book, I jumped at the opportunity.
The core of the book is based on eight money ratios (two are under the debt ratio category). In the corporate world, management and investors routinely use ratios to assess the financial strength of companies. Just consider the P/E ratio (price to earnings) as a common example. Well, Mr. Farrell takes the concept of ratios and applies it to personal finance.
The book covers a lot more than just the ratios. Because they form the heart of the book, though, let’s take a look at them in some detail:
Capital-to-Income Ratio
Called the CIR, this ratio looks at how much savings you have compared to how much money you make. The ratio also factors in your age. This is based on the theory that the longer you’ve been in the workforce, the more money you should have saved.
The book contains charts to look up the ideal CIR based on your age. The goal? To have saved 12 times your income by retirement age of 65. At 35, for example, your CIR should be 1.4. This means that for every $10,000 in income, you should have $14,000 saved.
The Savings Ratio
In order to hit the CIR target, you need to save money. The Savings Ratio tells you how much you should be saving as a percentage of your income. Depending on your age, the percentage ranges from 12% to 15%.
The Debt Ratios
Money Ratios has several debt ratios, including charts relating to mortgages and education. As an example, the mortgage ratio should be no more than 2 times your income at age 30. Of course, this is just a rule of thumb and will vary based on a number of factors, including where you live. The goal is to be mortgage-free by age 65.
The Investment Ratio
The Investment Ratio is the ratio between stocks and bonds that you should keep in your investment portfolio. This is also where I disagree with the author. He recommends a 50-50 split between stocks and bonds for folks as young as 25. I think this asset allocation is way too conservative. In my opinion, the younger investors should have a much larger ratio of stocks, moving slowly into a bond-heavy portfolio as they reach retirement.
The Disability Insurance Ratio
The Disability Insurance ratio indicates what percentage of your income should be covered if you are ever unable to work because of a disability. For those 25 to 55, the ratio is 60%, which is generally about the most you can cover anyway.
The Life Insurance Ratio
How much life insurance you need has always been a bit of a controversial topic. Here, Farrell recommends 12 times your salary at age 25, with the amount decreasing until it reaches zero at age 65. This seems like a reasonable rule of thumb.
The Long-Term Care Insurance Ratio
As the name suggests, this covers how much long-term care insurance you should have. You can check out the book for details, but one thing here is clear–Farrell views insurance as extremely important. Notice that his ratios cover disability, life, and long-term insurance. In effect, he’s very interested in protecting your most important asset: you.
The book is definitely a good read, although the core information is also available from Farrell’s paper. The book adds a lot more detail and context, however, which many will likely find helpful.
The only downside that I could see in the book is that it reminded me just how far behind we are in saving!
I’m reading this right now and have made it about 1/4 of the way through. I generally find a lot of things to nitpick in these kinds of books but I’m very surprised to not be doing just that for this one. Farrell is taking everything into account and making very smart, reasonable assumptions behind his numbers. This is in stark contrast with someone like Dave Ramsey who assumes a 12% return on money.
Farrell does seem to have his feet on the ground when it comes to making assumptions. He’s a lawyer, and speaking from experience, lawyers tend to be a conservative lot.
Retirement…or as I like to call it….the pipe dream of plenty.