A rich man is nothing but a poor man with money.
— W. C. Fields
Today I’m going to introduce a cousin of the Wealth Ratio. I call it the “Capital Wealth Ratio.”
If you recall, the original wealth ratio is:
The Capital Wealth Ratio is the similar, with one key difference — it excludes any interest you might have paid. In other words, it is:
So why is this ratio so important?
How Much Went to Making You Richer?
Put simply, the Capital Wealth Ratio tells you exactly how much of your income went toward actually making you richer. After all, as far as your net worth is concerned, a dollar less in debt is just as good as a dollar more in savings, and often better, depending on interest rates.
A dollar paid in interest, on the other hand, might as well have disappeared into a black hole, as far as you’re concerned. That dollar went toward making your creditor richer, not you.
There are a few points that are worth noting here:
- Use your after-tax income in the denominator. That’s what you actually brought home, after all.
- Retirement savings count, but adjust for taxes if you used a tax-defered IRA or 401(k). (If you used a Roth, go ahead and count your contribution at 100%.)
- Investments count as savings as well, but be careful about fudging what you call an “investment.” Factoring in things like money spent improving rental property can be iffy. You’ll have to use your judgment.
- Investment gains count as income, but if you reinvest them, you can add them to both the numerator and the denominator. Don’t forget dividends!
- If you took on any new debt, subtract the amount from your principal reduction. (Then punch yourself in the face.)
The original Wealth Ratio is somewhat aspirational — it shows you the savings potential you have locked up in the income you have now, so long as you’re able to fight off the temptations of lifestyle inflation once you get a little breathing room.
The Capital Wealth Ratio, by contrast, serves as a pretty good overall score card for how you actually did in a particular year. It represents what you paid yourself for all of your efforts.