A Wealth Ratio Example

Image by Barry Moser

They did not know it was impossible, so they did it!
— Mark Twain

Just to drive the point home from the last post, Let’s see how the wealth ratio works out for the average American family.

Let’s say our hypothetical family makes $40,000 after taxes. That amounts to $3333 per month. Let’s also assume they’re already managing to squirrel away 10% every month. They might feel justified in being proud of this, by the way — it’sway above average. (By the way, the description in that article of “wary” Americans raising their savings rate to a stratospheric 5% is alarming, to say the least.) Suggesting they save 50% probably sounds like a fantasy to them, and 75% downright absurd.

If you have a look at their monthly debt payments, it’s easy to see why:

Credit Card $450
Car $400
Student Loan $287
Mortgage ($160k at 4% ) $1076

That’s a total debt service of $2213 per month. I honestly shook my head in disbelief when I looked these up, but sure enough, these figures are quite typical. Doesn’t leave much room to maneuver, does it?

So what does this family’s wealth ratio come to?

$2213 in debt + $333 in savings / $3333 in income = 76%

76% – that means this family could be financially independent in less than 7 years once those debts are paid. Even if you factor out the mortgage, their wealth ratio comes to over 44%. That adds up to a little under 19 years to retirement. That might sound intolerably long to readers of this blog, but if you start out at that rate, it amounts to retiring in your 40s. Not bad considering so many Americans think they’ll never be able to retire at all.

All this family has to do is 1) pay down the debt, 2) not rack up any more debt, and 3) maintain their current lifestyle (perhaps dialed down ever-so-slightly so as to comply with #2).

I won’t suggest that this is easy, but it absolutely is possible. Now just imagine how much easier it would be if this family hadn’t dug themselves into such a giant hole to begin with.

3 Comments

  1. Wow.
    Every time I read things about average American mortgages I just drool with jealously. $160,000 @ 4%? An average FIRST HOME OWNER mortgage here in Australia would really be more like $350,000 @ 6.5%. Often it’s above $450,000…

    You’re right about the average savings rate though, too bad your average Joe will just spend all that debt payment money on crap the moment those debts are paid off though.

    • Sean Owen

      Well to be fair, that $160k mortgage assumes 20% down on a $200k house. But I feel the same way as you living in the Bay Area. You can’t buy a closet in the basement of a crackhouse in San Francisco for $350k.

      That mortgage rate is a double-edged sword, though. Sure, we can get inexpensive mortgages right now, but savings accounts earn a negative real return. At least in Australia you guys can get decent interest on your savings. I’ve been thinking of opening up an Australian savings account myself.

      • Oh I wasn’t really referring to the interest rates so much, more the ridiculous house prices. Although our savings interest rates aren’t that super either. I think they’re around the 4% ish mark and that’s basically what our inflation amount is here on average. So not negative… But still crummy.

        I’d probably not recommend getting a savings account here to be honest. I can see the Australian dollar going down soon as our economy is really grinding to a halt. No ones buying anything anymore as they’re all leveraged up to their eyeballs from high house process. Exports are crap as our dollar is too high to compete and our government is cutting jobs and projects left and right. Not to mention our mining boom is on its last legs.

        I’d probably recommend ING though if you really still want to do it. They usually have the best rate from my research 🙂

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