How To Calculate Your Rich Ratio
We all know people overspend and frequently fall into debt. We also know people spend less than they make and invest/save their money to generate long-term, sustainable wealth.
And one way to accumulate wealth is through saving and investing in the global stock market.
This gives rise to the rich ratio.
The rich ratio helps individuals get a thorough grasp of their money. It simply refers to the amount of income you have vs. the amount of income you require.
For example, you are wealthy if you earn £10,000 per month and only spend half of that. By the same logic, if you make £1 million per month but spend double, you are not wealthy.
Calculating Your Rich Ratio
Divide the monthly income you anticipate getting from pensions or other sources, including what your investments should provide, by the amount you intend to spend each month to live the lifestyle in retirement you desire:
If you have more than you need, you are on track to a rich retirement. If you need more than you have, you are not. You want a score of 1 or above.
Let's look at a few examples to illustrate how someone with less money saved might have a greater Rich Ratio and live a happier life.
Neil enjoys luxury vacations and dining out frequently. He enjoys it so much that he'll require £8,333 per month (£100,000 per year) to maintain this lifestyle in retirement.
Neil has a Civil Service pension, a personal pension plan worth roughly £500,000 and a share portfolio of around £300,000 that he inherited a few years ago.
Neil's Haves: £3,000 (civil service pension) + £1,666 (4% of personal pension pot paid monthly) + £1,000 (4% of share portfolio paid monthly) = £5,666
Neil's Need: £8,333.
Neil's Wealth Ratio = £5,666/8,333 = 0.68
Neil's Rich Ratio is less than one.
Let's look at Laura and John. They are both retired and require £3,500 a month to enjoy their best life. They own their home, with no mortgage.
They will earn a monthly income of £2,377 from their ex-employer's defined benefit pensions and have £400,000 in personal pension plans.
Laura and John's Haves: £2,377 in defined benefit pensions + £1,333 (4% of personal pension pot paid monthly) = £3,710.
Laura and John's Need: £3,500.
Laura and John's Wealth Ratio = £3,710/£3,500 = 1.06.
While Laura and John's haves are far lower than Neil's, so is their need. As a result, they have a far higher Rich Ratio than Neil.
So, despite having a lower net worth (and less in retirement savings), Laura and John are on track for a richer retirement than Neil because they can satisfy their lifestyle goals with what they have.
Accordingly, it is likely that Laura and John will live happily throughout retirement, but Neil will not.
The most basic frameworks in life are frequently the most effective. And this is very much the case for the Rich Ratio.
Consider it a compass. If you consult your Rich Ratio regularly (and honestly), you will have a greater chance of keeping on track to a stress-free retirement.
Amyr Rocha Lima, CFP® is a financial planner who specialises in working with successful professionals age 50+ to help them reduce taxes, invest smarter and retire on their terms.
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