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How am I doing compared to others: 3 ways to measure your financial security

Posted: Jonathan Chapman

We are often asked, “How am I doing compared to others?” I get the sense that people do not ask this question hoping to be better off than others or in “Keeping up with the Joneses.” I genuinely think it comes from a true lack of understanding or confirmation as to where they are financially, which is why they have hired us in the first place. It is like a ship at sea that does not have a navigator, compass or GPS. They may end up on the other shore but not necessarily at the desired port. Once we have worked with them to develop a comprehensive financial plan, they should have a clear understanding as to where they are with regards to meeting their goals and objectives. More importantly, they will then know what adjustments they need to make in order to get them on the right course. At the end of the day, it is not really about where they stand compared to others. Instead, it is about having that confirmation whether or not they are financially secure and doing the right things to become (or stay) financially independent.

That being said, there are a few “back of the envelope” ways to gauge your financial security through some financial planning rules of thumb. Keep in mind, these are very rudimentary ways to calculate where you stand, especially since every client situation is different. However, they serve as good benchmarks to gauge financial security, or lack thereof.

4% rule

The 4% rule states that an investor can withdraw 4% of their diversified investment portfolio on an annual basis for the rest of their life without depleting their assets. As an example, if you have a $3,000,000 diversified portfolio, this rule would imply that you could withdraw $120,000 out of it annually without depleting it. Therefore, if your expenses are less than or equal to 4% of your investment portfolio, then you have achieved financial independence.

What’s my number?

Another question people often ask that’s associated with the rule above is “What’s my number?” In other words, how much do I need to become financially independent? A good rule of thumb for that is to multiply your expenses by 25. Therefore, if your expenses are $100,000 annually, you would need $2,500,000 to support those expenses for the rest of your life.

Where should I be now?

People often ask this question to get a sense as to where they stand based on their age. One way to gauge that is based on investment assets compared to current income. This assumes that a person is living within their means. A good ratio for that is the “Investment Assets to Gross Pay Ratio” which implies that your ratio of investment assets plus cash compared to your gross pay should go up over time. The formula for that is pretty simple. Take your current investment assets plus any cash and divide it by your gross pay. Therefore, if you are 55 years old with $1,000,000 in investment assets plus cash and your Gross Pay is $200,000 annually, then your ratio would be 5. Using the table below, your ratio should be 8-10 to 1 by that age, meaning that your investment assets plus cash should be 8 to 10 times your income by that point. Therefore, in this scenario, an investor would be “behind the curve.”

There are several other rules and benchmarks applicable to understanding your financial stability but these three can give someone a good sense as to where they stand financially. Keep in mind though that there are many other factors that should go into determining where someone stands compared to their goals and objectives. A comprehensive financial plan will help determine where your ship is, where it is currently headed, and most importantly, how to get it on or maintain its course to get you to the desired port.

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