This is a useful book.
It helps you to answer the five universal questions in personal finance:
- How much should I have saved at my age?
- How much should I be saving each year?
- How much debt I can carry?
- How do I invest my savings?
- How do I buy the necessary insurance to protect my income and assets?
The unifying theory of personal finance that the book proposes is:
All decisions you make should help move you from being a labourer to being a capitalist. As a labourer, you are paid a wage for your services. You work for someone and you are paid money for doing the work. As a capitalist, you are paid not for the value of your labour, but for the use of your money. This payment can come in the form of dividends, interest or price appreciation. You generate income from your capital.
The 8 money ratios:
You can see the exact ratios in the excel sheet here-Your money ratios
1. CAPITAL TO INCOME RATIO
Identifies how much capital (savings) you should have at your age to help you stay on track for retirement.
Capital here includes:
- Your savings and market value of investments
- Cash value of life insurance
- Amount in checking and savings accounts
- Equity in commercial or rental real estate
- Fair market value of any business interests
It does not include the equity in your home.
It assumes you can live on 80% of your pre-retirement income and withdraw 5% from your capital each year.
- 5%-70% chance of not running out of money in 30 years
- 4%-95% chance of not running out of money in 30 years
- 6%-50% chance of not running out of money in 30 years
2. SAVINGS RATIO
Identifies how much you should be saving each year so that you can reach your desired Capital to Income Ratio each year.
- If the savings ratio is 0.12 and you earn $100,000 in gross income( income before tax), then savings per year=12,000
3. MORTGAGE TO INCOME RATIO
Identifies how much mortgage debt you could consider incurring and still leave enough room in the monthly budget to meet your Savings Ratio.
- Buy a house only if you do not plan to move for 10 years.
- Renting is also a good option
- Go for fixed rate mortgages for a long period and pay off the house by the time you are 65 years.
- Keep car debt to a minimum and do not allow it to encroach your other ratios
- Avoid credit card debt altogether
4. EDUCATION TO AVERAGE EARNINGS RATIO
Identifies how much debt you could reasonably incur to get a college or advanced degree. Also applies to parents who are thinking of taking on debt to educate their children.
- Average earnings are the earnings for 10 years after the college
- Save for your retirement first, then the kid’s education
5. INVESTMENT RATIO
Helps you understand how to grow and protect the capital you have accumulated.
- Save in tax-deferred accounts and tax free accounts and not taxable accounts.
- 50% in stocks( US and EAFE and possibly emerging) and 50% in bonds( US intermediate term bonds, TIPS, corporate bonds and municipal bonds can also be considered)
- This approach will help avoid large losses and help steady gains.
- Rebalance to 50/50 only if stocks go up. You can add new money to stocks but do not sell bonds to get to 50/50 allocation( a bit of a weird recommendation, I think)
6. DISABILITY INSURANCE RATIO
Helps you understand how much disability insurance you need at each age.
7. LIFE INSURANCE RATIO
Helps you understand how much life insurance you need at each age.
- Term insurance is enough for most of us. Do not buy permanent insurance.
8. LONG TERM CARE RATIO
Helps you understand whether you need long-term care insurance, and if so, how much.
Investments x 5%+ social security+pension income- long-term care cost per year( x 2 if married)=estimated LTC insurance need.
LTC insurance needed/2= amount per spouse.
Health insurance: Take good care of your health. High deductible+ co-insure(if you can afford) will decrease your premium
The whole book in one sentence: To go from labourer to capitalist, get a good paying job, save at least 12-15% of pay each year, keep your debt in proportion to your income, invest your money prudently, and get insurance to protect your income and assets.