I read a great personal finance book this weekend. The book is called Your Money Ratios. There are 8 ratios in the book. The first ratio is the Capital to Income ratio. The others deal with how much stocks or bonds you should have in your investments, based on your age, how much home mortgage debt you should take on, and various other ratios. I highly recommend this book. It’s very easy to understand.
I am going to focus in on the Capital to Income Ratio. This ratio takes into your age and your current level of income to calculate the amount of capital it takes for you to live on about 80% of your pre-retirement income. Take a look at this table.
Let’s say that you’re 40 years old, your capital to income ratio is 2.4. You then multiply this 2.4 ratio to your annual household income. If your annual household income is $70,000, your capital should be $168,000. If your amount is some where around this number, you are on track to retire at 80% of your pre-retirement income. Capital includes 401(k) plan, IRAs, annuities, and CDs, the cash value of life insurance, checking and savings amounts, and equity in commercial real estate. It does not include the equity in your home because that equity is not an income-generating source of capital.
The problem for me when I tried to use this approach to calculate my target savings is that as a public employee, I receive a pre-defined benefit amount when I retired based on my years of service and salaries. To help me sort out this problem, I had created a tool that combines both the Capital to Income Ratio and the annuities I will receive from my employer for retirement.
Here is the tool. Let me know if it works. Update at 3 pm: A reader told me she can’t use this calculator. Please come back tomorrow to download it. I will fix it tonight. Thanks