Today I’m highlighting the capital to income ratio, which I’d heard about before, but hat tip to White Coat Investor (good new finance blog I found which you should check out) for making me rethink it and share again here. Basically, this is one of the many ratios that Charles Farrell focuses on in his book Your Money Ratios. The capital to income ratio is a basic measure of your retirement savings divided by your current income. Why does this ratio matter? Because it gives a good measure as you progress through your life where you should be. Too many Americans coast through life enjoying life in the moment without regard for “saving for a rainy day” (retirement). Some of the drawbacks of the measure, as I see it, include the following:
- One-size-fits-all approaches are usually flawed. This is the case when when to refinance a mortgage, what % of your salary you should spend on a car, an engagement ring (that one money salary thing the industry thought up and puts in their ads is annoying), and many other measures that “experts” tout. Much depends on your personal situation.
- Incomes and Expenses Change. As you progress through life, your current income could jump all over the place (like my wife is home with the kids now but will be back to work in 5 years, so does that mean in 5 years, my income savings are suddenly deficient?). Additionally, when my kids hit college years, unless I have all 3 kids’ 529 plans fully funded (which is my goal), I’ll be paying for part of their tuition from my current earnings. That means less to put toward retirement in those years, hence, I need to accelerate my retirement savings before the dreaded college bills start coming in.
However, you’ve gotta start somewhere! And using the table below as a barometer to measure yourself against as you age beats blissful ignorance of what your future needs will be in retirement.
Capital to Income Ratio Recommendations
Here’s where you should be at according to the recommendations:
|Age||Capital to Income Ratio|
What is My Capital to Income Ratio?
Ironically, when I calculated mine, I’m roughly right in line with where we should be. I hadn’t previously looked at the measure in detail and hence, I’d never planned my retirement savings to the goals in the table, but I’m 36 and my ratio is about 1.5. So, while I often think I should have more saved by now, or that swimming pool we put in last year could have gone a long way toward college and retirement, I’m encouraged that all the extra money I’ve been putting toward the kids’ college and our retirement has me on-track for a responsible financial future. We all make the same financial miscalculations because we’re wildly optimistic, you switch to joint finances, or basically, things change. But rather than flying blind, this is a nice measure to take with you as you age, and it becomes increasingly important as you reach your retirement age (albeit, much tougher to influence with so little time remaining).
What Is Your Capital to Income Ratio?
Are You Pleased, Concerned, or Ambivalent About Your Ratio?