As a financial writer, I try to do one thing above all else: Make intimidating financial topics easier to understand. Sometimes I succeed, often I fail, but my goal is always the same: Make managing your money simpler.
So I am excited to review a book that does just that: Your Money Ratios: 8 Simple Tools for Financial Security by Charles Farrell, JD, LLM.
(Farrell is a Denver, CO-investment adviser who writes the “Retirement Roadmap” column for CBS Moneywatch.)
Let me be clear: There are a lot of personal finance books out there. Probably too many. And not every book is for everybody. There are investing books, get-out-of-debt books, get-rich-in-real-estate books and “total money manual” books. Your Money Ratios is none of the above. I would call this book a “road map to retirement”. Essentially, Your Money Ratios helps you figure out how much you should save for retirement and how to manage your savings, debt, investments and insurance products at every age using simple “ratios”.
But at that, it does a great job.
Note: I also have a copy of this book to give away! Anybody who leaves a comment before Jan. 31st will be entered in a random drawing and notified by e-mail.
The Eight Tools
This is a book of eight “ratios” or “tools”. They are:
- The Capital to Income Ratio: The multiple of your annual income that you should have saved at every age if you want to retire at 65.
- The Savings Ratio: The percentage of income you should be saving every year to achieve your Capital to Income Ratio.
- The Mortgage to Income Ratio: The limit on how much of a mortgage payments you can comfortably make with your income.
- The Education Debt to Average Earnings Ratio: The amount of student loans you could take on, considering your expected post-grad earnings.
- The Investment Ratio: A basic asset allocation strategy between stocks and bonds for different ages.
- The Disability Insurance Ratio: An argument for disability insurance coverage and how much you need.
- The Life Insurance Ratio: How much life insurance you should have at different ages (if you have a spouse and/or children).
- The Long-Term Care Insurance Ratio: How to understand this often-overlooked kind of insurance, and how much you need.
As you can see, the book is about building financial security for the long-term. If you’re a typical Money Under 30 reader (in your twenties and just starting out on your own, perhaps repaying student debt and trying to save for a home), you may not think this kind of book is for you. And you wouldn’t be alone. Most Americans don’t start thinking about retirement issues until, at the earliest, they are well into their thirties. But as I’ve written before (e.g., in 23 Things Beginners Must Know About Saving for Retirement), the sooner you start the better. Whatever your age, giving Your Money Ratios a quick read paints a clear picture of how retirement works, and what you need to get there.
From Laborer to Capitalist
Your Money Ratios builds upon one simple concept: How do you go from being a laborer to being a capitalist? In other words, how can you stop working for your money and start making your money work for you? The answer, of course, is to save enough money to live on in retirement.
For better or worse (although I would argue mostly for the better), the “ratios” in this book makes it a book of simplifications. For example, take the book’s first tool: the Capital to Income Ratio.
Farrell suggests that average workers can retire at 65 on 80 percent of their pre-retirement income by saving 12 times their annual income. He goes onto provide benchmarks for one’s capital-to-income ratios at different ages. For example, Farrell suggests a 25-year old should have capital in retirement plans, savings accounts and real estate equity equal to at least 10 percent of his or her annual income and that a 30-year old should have 60 percent of his or her annual income in capital. (The recommended ratios climb more dramatically at 35, 40, 45, etc., as Farell assumes most twentysomethings are not earning much, paying down education debt, getting married, and buying homes).
Real-world retirements (and lives, in general) don’t always run so smoothly, but the 12/80/5 benchmark provides a helpful way to visualize how retirement works. (Save 12 times your annual paycheck to retire on 80 percent of your pre-retirement income by withdrawing five percent a year).
Dealing with Debt
As I mentioned before, Your Money Ratios is not a debt book. If you’re looking for down-and-dirty debt help, pick up Dave Ramsey’s The Total Money Makeover: A Proven Plan for Financial Fitness or Jean Chatzky’s Pay It Down!: Debt-Free on $10 a Day.
Your Money Ratios discusses debt in one chapter, but cursorily.The book breaks debt into two categories:
- Income-producing debt is debt that has the potential to make you money. This includes a mortgage, education debts and, in some cases, he argues, an auto loan (if the transportation helps in your business or commute to a higher-paying job).
- Income-reducing debt is everything else. I.e., credit card debt. This is the bad debt that does nothing but drain your budget and inhibit your ability to save. Farrell’s take on credit card debt is that it’s bad and if you’re in it, get out. A fair point, because saving usually doesn’t make sense if you’re paying 15, 18, or 20-plus percent on credit card debt.
Farrell looks at mortgage debt the closes and lays out what percentage of your income is “safe” to spend on your mortgage. He’s careful to point out that you should not use your home as your retirement fund and even that home ownership isn’t for everybody (usually those with modest income living in high-cost areas). Sound advice for a nation that has been bred to buy the biggest house we can as soon as we can and, recently, got into a lot of trouble for doing just that!
Who This Book Is Not For
Despite praises for Your Money Ratios thus far, I feel compelled to point out that this book is about how to retire by running the rat race. It’s about working nine-to-five until you’re 65.
That worked for many in our parents’ generation and it will inevitably work for some in our generation. I get the impression, however, that an increasing number of young people reject that notion of working for somebody else nonstop for forty years just for the chance to be old and comfortable. Many of us are interested in having multiple careers, finding ways to make a living part-time doing something we love so we never have to retire, or using savings to take several “mini-retirements” (like my friends who worked and saved for a few years out of school so they could spend a year of “mini-retirement” in Italy).
If that sounds like you, this book may not be all that helpful. If, however, you want a simple, straightforward guide to saving for retirement, Your Money Ratios is it.