(5 minutes to read)
Maybe you’ve been working hard and saving money for your entire career. Maybe, in fact, you’ve been saving more each year as your income has increased, based on reading online articles that give general rules of thumb. Or maybe you’re a little behind. Either way, there are a lot of opinions out there, and it’s confusing. How do you know if you’re saving enough to reach financial freedom? How do you know if you have accumulated enough assets to support you in retirement?
There’s actually a simple calculation that can give you a rough idea very quickly. It’s called the Asset-Income Multiple, and it measures the amount of assets you’ve accumulated up to this point in relation to your current income. As you might guess, the bigger the number the better. Using some incredibly useful research by Marlena Lee and Massi De Santis at Dimensional Fund Advisors, you can look up your Asset-Income Multiple in the table below to see if you’re on track.
To calculate the Asset-Income Multiple, first add up the value of all your investment assets, including bank savings accounts, brokerage accounts, retirement accounts, and any other accounts that you will use to live on in retirement. Don’t include your home equity (the value of your home minus outstanding loan balance) unless you plan to sell your home and use the proceeds to live on in retirement. Once you’ve added up all your investment and retirement accounts, subtract any debt, such as car loans, credit card debt, and student loans. The total of your investment assets minus debt is your accumulated assets.
Now, divide your accumulated assets by your total household annual gross income. Gross annual income is the amount you earn in a full year before taxes, and before any retirement contributions or other deductions—it’s the top line on your paystub, the first and largest number from which all the other items are subtracted. After you divide this out, the resulting answer is your Asset-Income Multiple.
Compare your Asset-Income Multiple to those in the table below to see if you’re on track, using the column that is closest to your age (or do a little math to figure out the value in between two of the given ages). For example, if you are 45 years old, to be on track, your Asset-Income Multiple should be about 3.75 at this point, and about 5.25 if you want to be really confident that you’ll have enough savings in retirement. What might this look like from another angle? Well, if your annual household income at age 45 is $300,000 and your Asset-Income Multiple is 3.75, then you would have saved about $1,125,000 by this point.
These results reflect a particular savings strategy described by Lee and De Santis that recommends an increasing savings rate as your income increases throughout your career. For example, for income in the range of $100,000 to $130,000 per year, the research suggests a savings rate of about 18% per year would give you a good chance of meeting your retirement savings goal. However, once your income increases beyond $180,000 per year, their research suggests that a savings rate of about 26% is more appropriate.
There are plenty of other assumptions that go into the research behind the table, including:
You retire at age 65.
Your income follows a certain trajectory over your career, increasing in your early career and peaking around age 50.
You will be replacing 40% of your preretirement income with your savings (which works because you will no longer be saving for retirement; you will have some income from Social Security; and your spending, along with your tax burden, typically declines in retirement).
The allocation of stocks and bonds in your investment portfolio shifts from 100% stocks early in your career to a mix of stocks and bonds with a decreasing amount of stock over time.
You have no pension income except Social Security.
Of course, these assumptions don’t apply to everyone, and your situation may be (is likely to be) different. But the Asset-Income Multiple can give you a rough idea of where you stand. In short, if you’re 35 years old, you should have saved an amount about equal to your annual household income. If you’re 45, you should have saved about four times your household income. If you’re 55, you should have saved about eight times your household income. If your savings are below those amounts, it’s time to think about bumping up the amount you’re saving each year to catch up.
The Asset-Income Multiple is one quick, rough indicator of your financial health. For a complete understanding of whether you’re on the right path to retirement or financial freedom, you will want to have a full financial plan prepared for you using Monte Carlo analysis to explore the boundaries of your current situation and possible future outcomes. Monte Carlo analysis is the gold standard analytical technique for measuring whether you’re on track. You can read more about it in Are You on Track Financially? One Number Gives the Answer.
Parkworth Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you’d like to know whether you’re on the right path to retirement or financial freedom, schedule a complimentary consultation.
