Personal Finance Ratios: Savings-to-Income, Debt-to-Income, and Savings Rate-to-Income

There was a recent post on how much savings one should have at age 30 over at the Bogleheads forum. Being 30 myself, I was intrigued, but I am in the camp that believes that there is no right answer at 30. You’re still so young that you could just be out of school for a few years, and at that time it’s mostly up to how much student loan debt you racked up. Most important might be your ability to live under your means, and that you’re learning a valuable skill of some sort.

However, there was mention of a paper the the FPA Journal called Personal Financial Ratios: An Elegant Road Map to Financial Health and Retirement, where the author presents a variety of ratios as a rough benchmark to help clients determine whether they are on track to retire by age 65. These include Savings-to-Income, Debt-to-Income, and Savings Rate-to-Income.

The actual numbers depend on how you believe your investments will perform annually after inflation. (5% on the left table, 4% on the right.) Definitions below.

Savings include the current value of one’s investments, such as a 401(k), IRAs, brokerage accounts, investment real estate, and the value of any private business interests. The home is excluded as an investment. Debt comprises all debt, including mortgage, student loans, car, and consumer debt. Savings rate refers to the percentage of pre-tax income an investor is saving each year out of their total income.

A Hypothetical Example
Let’s take a look at a hypothetical 45-year-old individual to see how he might use the ratios to assess his financial circumstances. This person has the following financial statistics:

Salary \$110,000
Mortgage \$125,000
Auto Loan \$25,000
Investments \$260,000
Annual Savings \$10,000
Employer 401(k) Match \$3,000

Based on these statistics, the hypothetical individual ratios are as follows:

Savings to Earnings: \$260,000 / \$110,000 = 2.36
Debt to Earnings: (\$125,000 + \$25,000) / \$110,000 = 1.36
Savings Rate to Earnings: (\$10,000 + \$3,000) / \$110,000 = 11.8 %

As for us, we’re doing okay according to the table for age 30 regarding the savings-to-income ratios (0.5) and savings rate-to-income ratios (50%+). Our debt-to-income ratio is a bit high though, at around 2. Of course, this is highly dependent on our income number, which might change if we downshift with kids. I guess that’s another reason to wait until we’re a bit older to really start benchmarking like this.

One thing I don’t like about the ratios is that home equity is never included, because the author says that it’s hard to extract home equity. Okay, I agree on that point, but there is no mention of compensating for renters in the analysis. If I have no debt at age 65 + a paid-off house, that’s a lot different than no debt at 65 + still paying rent forever. My largest expense by far is housing (greater than all other expenses combined), and having that taken care of changes my retirement outlook drastically.

So… should we be using these ratios as a benchmark?

1. jbo says:

I agree
A lot of people throughout the years buy large and large houses and after retirement some end up downsizing. Well if you start out and have a 250,000 dollar home and by the time you have kids and they are in college you purchased a large home for twice the 500,000. Then when your kids leave you feel you don’t need that size of a house, you could sell it and move back into something smaller, maybe half the price. So you’ve made money off your equity at retirement.

Plus the example you wrote about a person having to pay for rent at retirement.
But many authors take your primary home as a liability and not an asset.

2. I don’t have the dataset to see what the std deviation should be, but this may be the ratio we should really care about:

Savings rate to earnings / debt to earnings

For the example that would be 0.118 / 1.36 = 0.087. Multiply that times 100 to create a “score” for this person of 8.7. It’s not a % but simply a score that only bears meaning in comparison to other “scores”. Again I don’t have a dataset to get a bell curve going, but for the sake of argument perhaps a score of 10 would be considered “fair”. I’m too tired to think about it, but you might removed the “earnings” in each and get the same results.

I love playing with numbers, there’s 10 minutes I’ll never get back.

3. PK says:

I’m a bit disappointed that the tables only go down to age 30. What about me at age 25?

4. The Dean says:

Very interesting… I agree, housing like rent or rental income should account for something.

According to this though I am doing okay. Maybe even retire a little early (not likely, but one can dream)

@the weakonomist, I like your idea! Going by your calculations I am just over “fair” with an 11.45. See 10 your ten minutes weren’t spent in vain

5. Victor says:

“If I have no debt at age 65 + a paid-off house, that’s a lot different than no debt at 65 + still paying rent forever”

I beg to disagree….

Depends on what state you live in…. California may have cheap property taxes, but in other states like Illinois or Wisconsin property taxes are sky-high, which you are also ‘paying forever’.

For example property taxes for a house I recently looked at in Geneva, IL (A nice, but not prestigious Chicago suburb) are about \$8,000 dollars. It was not a mansion but your typical 3 bed, 2 bad, 2000sq ft suburban home.

6. Vern says:

My debt-to-income at age 33 is 1.96, but my wife currently stays home with our kids, so this will definitely drop when she returns to work.

Don’t wait to have kids to late in life. You have more energy to handle them when you’re younger, and you’ll never be financially prepared anyway.

7. Homer S. says:

Victor Says:
May 22nd, 2009 at 6:44 am

“If I have no debt at age 65 + a paid-off house, that’s a lot different than no debt at 65 + still paying rent forever”

I beg to disagree….

==========================================================

I beg to disagree with your disagreement…

The \$667 you describe as monthly taxes is a much smaller number than what a renter would be paying for that 2000 sq ft 3/2 in a nice, but not prestigious Chicago suburb. 🙂

I’m not trying to tell anyone to buy this house. However, the original statement is correct. “If I have no debt at age 65 + a paid-off house, that’s a lot different than no debt at 65 + still paying rent forever”

8. Health Insurance Guru says:

It should be hard to extract home equity. Everyone using their homes as a kind of personal ATM contributed mightily to the current housing crisis.

Savings needs to be in the bank, c.d, annuity, bond, or other instrument, but not a personal residence.

9. Brian says:

Even if you have high prop tax, a paid off house would still be a benefit. If it is the case that prop tax alone is more than your rent, then whoever is paying that property tax paid waaaaay too much for their house, and 100% of the time either 1- the rent will increase, or 2- the house prices will decrease.

Still, wouldn’t the paid off house be covered in “debt to earnings”? If you were 65 and your house was paid off, your debt to earnings would be 0, as shown in their tables. Otherwise, if your house isn’t paid off, you will still have a positive value, so you wouldn’t be “ready” according to the tables.

10. I’m sure we can find other variables that should be incorporated in these ratios all day long. But one missing variable that jumped out at me was tax rates. Technically, tax rates may be different for each stream of income. For instance your income maybe taxed at an ordinary income rate but your investments could be taxed a a lower rate depending on the nature of the investment etc. If you factored in the appropriate tax rates, then there would be more of an apples to apples comparison with the numerator and denominator in some of the ratios.

11. mimi says:

I agree that you always pay rent regardless, in terms of taxes and maintenance. Owning a house outright is an illusion. But it definitely comes with benefits, to be sure. If you put away a certain amount that could generate the interest needed to pay your taxes, more or less, then you could kind of pretend to pull it off. My taxes are around 9K/yr, so \$225K @ 4% would cover it, I guess. Maybe \$250K – \$300K to leave room for inflation. That’s more than I owe on my mortgage.

12. James says:

@ Jonathan – I completely agree with you that Home Equity is probably the biggest variable missed by this analysis.

@ Victor – I disagree with you that property taxes along are worth throwing out home equity. I live in Wisconsin, and I pay about 2% property taxes every year. So, for a 200K house, we would pay about \$350/month. To rent that house would be at least \$1000 per month, so that is still a big difference in expenses from owning to renting.
If you can actually rent a house for the amount of Property Taxes per year, then more power to you, but I have to agree with Brian that your rent is necessarily going to go up in order to cover all expenses and make a profit for the landlord.

13. Dean says:

Very interesting… I agree, housing like rent or rental income should account for something.

According to this though I am doing okay. Maybe even retire a little early (not likely, but one can dream)

@the weakonomist, I like your idea! Going by your calculations I am just over “fair” with an 11.45. See your ten minutes weren’t spent in vain

14. Modder says:

I saw this one a while back and used it to revamp my planning.

I however determined that looking a these ratios on an income base is not helpful. If you are saving a majority of your income (and/or your income is growing/fluctuating yet your lifestyle is constant), you should be more worried about how many years of expenses you have socked away then how many years of income you have in the piggy bank.

I think the number I am shooting for is to have 20x my annual expenses plus healthcare costs saved prior to retirement.

15. I agree with Modder. If you save a lot and spend much less than you earn then this kind of figuring will skew things.

16. TStrump says:

Not all debt is created equally.
I think the debt ratio could be misleading.
But, as an accountant I love these measures as they provide tons of useful information.

17. Tony says:

Weakonomist, isn’t

Savings rate to earnings / debt to earnings

the same thing as

Savings / debt ?

18. Tony says:

Oops, that should be (Savings rate) / debt above.

I.e. [(Savings Rate)/(Earnings)]/[(Debt)/(Earnings)] = (Savings Rate)/(Debt)

19. Tom says:

Home equity should be considered to some extent. If Savings include retirement money, then why not add in home equity. A renter looks great with Debt to Income while the home owner could look to be extremely in debt.

I would propose that you have 2 Savings to Income ratios (with and w/o home equity) and 2 Debt to Income ratios (with and w/o mortgages.) Obviously the calc of home equity is a whole other issue, but in my mind, it should be what you reasonably believe you could sell the home in a few months.

good info. I think I may start tracking these ratios for myself on a monthly basis.

20. I think home equity should come into play. Sure we don’t know the exact value, but a ballpark figure should work. I owe \$140K on my home, but it’s worth about \$550K. So I shouldn’t count any of that \$400K as savings? Ridiculous!

Also, while debt to income might be valuable, I think we should look at savings minus debt, too. My savings to income ratio is more than fine. But if you looked at my debt to income ratio, I barely make their cutoff. However, I could pay off my debt tomorrow and have zero debt and still meet the savings to income ratio.

I know this is just a benchmark, and I’m sure it’s good for people starting out, but it can be improved.

21. Stewart says:

@Ryan
You raise a good point about tax rates (and also income). In both these cases, they are assuming that retirement savings would make up 60% of retirement income. Social Security or Home Equity burnoff making up the rest to get you to 80% of pre-retirement, pre-paying off debt income that is a rule of thumb.

But as income increases, you would probably need to be responsible for even more of that. I don’t know any handy formula that helps adjust for this (aka, how much does SS make up your retirement income at various levels of income). Aka, if you make 50K/Y, does it make up 50% and at 100K/Y it is 20% and at 200K is it 15%

22. Kim says:

I see both sides. Find the analysis a bit off since I don’t know any people that make 110k a year and only have 125k mortgage. Even putting the recommended down payment of 20% down won’t get you down to 125k in a safe neighborhood in most cities. You can buy houses that inexpensively in rural areas, but the jobs aren’t there. Even in places like Boulder County where you might find a 110k a year job, you won’t find houses or even units for 125k.
In these times, I keep feeling like a cheap mortgage at 4 percent is your best long term friend. The dollar is falling in value fast fast fast. We are not going to be able to continue to buy cheap. Fix your expenses where you can because taxes, health care costs, gas absolutely everything is going to double and triple.

23. Money Reviews says:

I’d rate terribly with these ratios. My wife and I earn a decent income, but school loans of \$160,000 two new cars, our home, and an investment property put us roughly half a million in debt.