At first glance, I thought that “Your Money Ratios – 8 Simple Tools For Financial Security“ by Charles Farrell would be too simplistic. But, I learned a few things from the book and reaffirmed some financial planning wisdom and methods thanks to the book which focuses on beginners and relies heavily on rules of thumb to ensure that you are on track for financial security and prosperity.
For Beginners. “Your Money Ratios – 8 Simple Tools For Financial Security“ provides a baseline to help people learn to save, invest, and manage your financial life. The book also provides a way to get your life back in order. “Your Money Ratios” focuses on eight simple financial ratios based on your household income, debt, age, etc. I have listed them all below and what they will help you calculate.
Your Money Ratios:
- Capital To Income Ratio – How much should you have at certain ages in your nest egg to retire at age 65?
- Savings Ratio – Are you saving enough money every month?
- Mortgage To Income Ratio – Are you borrowing more money than you can afford?
- Education Debt Ratio – Are you borrowing too much money relative to the amount of money you are going to make in your new career?
- Investment Ratio – Do you have a safe enough split in your asset allocations between stocks and bonds?
- Disability Insurance Ratio – Do you have enough disability insurance relative to your income?
- Life Insurance Ratio – Do you have enough life insurance?
- Long Term Care Insurance Ratio – Do you have enough long term care insurance?
For More Experienced Investors. I liked how the book gave you a quick look or snapshot of how you are doing and whether or not you are on track. In the Army, Soldiers call it an azimuth check named after when Soldiers look down at their compass to ensure that they are still heading in the correct direction out in the woods. “Your Money Ratios – 8 Simple Tools For Financial Security“ provides an excellent azimuth check to your personal finances. I will not spoil all of the ratios’ calculations for you. You should definitely check out the book for details on all of them. But, I wanted to share with you how the Capital To Income Ratio reaffirmed that I was on track to save for retirement.
For example, Farrell uses the rule of thumb in the calculation of the Capital To Income Ratio that a 25 year-old income earner should have 10% of his or her annual income saved for retirement. A 30 year-old should have 60% of his annual income saved in retirement accounts, and a 35 year-old should have 140% of his annual income saved. So, for example, if you and your wife earned a combined income of $100,000 per year when you are 35 years-old, the rule of thumb and Capital To Income Ratio suggests that you should have $140,000 saved in your 401k, Roth IRAs, and other investments by that age.
One Thing I Did Not Like. One thing that I did not like was the Investment Ratio. I am going to go ahead and spoil this one because I do not agree with it at all. Farrell is very conservative….very! He recommends in his Investment Ratio for everyone 55 years-old and below to have 50% of their money invested in stocks and mutual funds and the other 50% invested in bonds and bond funds. When the author says that a 55 years-old and below, he means everyone below the age of 55. A 50/50 stock and bond split for a 25 year-old investor is too conservative. Farrell seems to have been traumatized by the market’s recent collapse in 2008. The old rule of thumb used to recommend having 100 minus your age allocated as a percentage in stocks and the rest in bonds. So, for example under that rule of thumb, a 25 year-old investor would have 75% invested in stocks and 25% in bonds, not the 50/50 split that Farrell recommends.
401-k vs. Roth IRA. I have discussed before the pros and cons of investing in a 401-k or a Roth IRA and which one is better. A lot of investors are in a low income tax bracket when they first graduate from college or high school and then usually move into a higher tax bracket towards the end of their careers and in retirement. Because 401k money is taxed when you withdraw it, you would then end up paying more in taxes using a 401k retirement plan rather than a Roth IRA in most scenarios. There is a distinct tax advantage to maxing out your contributions to a Roth IRA first, and then investing in a 401k plan with any additional savings after that. Farrell makes the argument in his book that it does not matter which type of account you use. He says that there is no difference or benefits to picking one plan or the other. His premise is based on the assumption that your tax rates will be the same in retirement as they are in your working lifetime. You are only shifting when you pay your taxes. With a Roth IRA, you pay your taxes now but earn less money in total towards retirement. With a 401-k or traditional IRA, you are spared the tax when you start investing, the money grows to a large sum over the course of your working life, and then it is taxed when you withdraw it. He likens it to shifting numbers around in an arithmetic problem.
“Your Money Ratios – 8 Simple Tools For Financial Security“ is a great resource to help you learn how much you should have for total savings at each age, what tax and investments vehicles can help you maximize your savings, how much you should be saving each year, how much mortgage debt you should have, how much insurance you need, and other key metrics in your financial life. I would definitely recommend this book for those just starting out or those investors who want to reaffirm that they are heading in the right direction towards retirement. But, I caution readers to take some of the author’s recommendations with a grain of salt.