Finance 260: Retirement Savings and Ratios
Finance 260: Retirement Savings and Ratios
Retirement Savings Ratio
Purpose of Ratio: Assesses the amount of savings dedicated to retirement as a percentage of gross pay.
Savings Rates by Age
25-35 years old: Save 10-13% of gross pay.
35-45 years old: Save 13-20% of gross pay.
45-55 years old: Save 20-40% of gross pay.
Definitions and Clarifications
Savings Defined:
"Savings" refers explicitly to stock market investments and/or bonds. Cash is not included in this category.
Employer Contributions:
Contributions made by an employer to retirement savings plans (such as matching contributions) are included in the savings ratio.
Focus on Retirement:
The calculations and percentages provided are specifically for retirement savings, with investments intended for retirement.
Savings Ratio Calculation Example 1: Cornelius
Gross Pay: $100,000
Contribution to 401(k): 5% of salary
Employer Match: Up to 4% of salary
Total Savings: Cornelius's savings ratio calculation includes his contributions and employer match:
ext{Savings Ratio} = rac{(5 ext{ ext{% of } } 100,000) + (4 ext{ ext{% of } } 100,000)}{100,000}
Savings Ratio Calculation Example 2: Cornelius
Gross Pay: $125,000
Contribution to 401(k): 4%
Employer Match: Up to 3%
Other Savings: Cornelius also saves an additional $350 per month to a brokerage account (flex investment account).
Calculation:
ext{Savings Ratio} = rac{(4 ext{ ext{% of } } 125,000) + (3 ext{ ext{% of } } 125,000) + (350 imes 12)}{125,000}
Investment Assets to Gross Pay Ratio
Purpose of Ratio: Evaluates the proportion of investment assets relative to gross pay at different ages.
Investment Assets Ratio by Age
25 years old: Ratio is 0.2:1.
30 years old: Ratio ranges from 0.6 to 0.8:1.
35 years old: Ratio ranges from 1.6 to 1.8:1.
45 years old: Ratio is between 3 to 4:1.
55 years old: Ratio is between 8 to 10:1.
65 years old: Ratio ranges from 16 to 20:1.
Example: Cornelius Investment Assets Ratio
Gross Pay: $200,000
Investment Assets: $135,000
Calculation:
ext{Investment Assets to Gross Pay Ratio} = rac{135,000}{200,000}
Debt Ratios
Housing Ratio 1:
Calculation: ext{Housing Ratio 1} = rac{ ext{Housing Costs}}{ ext{Gross Pay}}
Should be less than or equal to 28%.
Housing Ratio 2:
Calculation: ext{Housing Ratio 2} = rac{ ext{Housing Costs} + ext{Other Debt Payments}}{ ext{Gross Pay}}
Should be less than or equal to 36%.
Definitions
Housing Costs (PITI): Includes Principal (P), Interest (I), Taxes (T), and Insurance (I).
Other Debts: Includes payments such as:
Car Loan Payments
Boat Loan Payments
Student Loan Payments
Credit Card Payments
Any monthly debt payment
Debt Ratio Example 1: Cornelius
Annual Principal and Interest: $25,000
Annual Property Taxes: $3,000
Annual Insurance: $1,500
Monthly Student Loan Payments: $1,000
Salary: $150,000
**Calculations:
Calculate Housing Ratio 1 and Housing Ratio 2 using total housing costs and debt payments.**
Debt Ratio Example 2: Cornelius
Annual Principal and Interest: $30,000
Annual Property Taxes: $5,000
Annual Insurance: $1,800
Monthly Student Loan Payments: $1,000
Monthly Auto Loan Payment: $600
Salary: $175,000
Calculations:
Calculate Housing Ratio 1 and Housing Ratio 2 using the provided figures.
Emergency Funds
Purpose of an Emergency Fund: Covers 3-6 months of non-discretionary spending.
Definition of Non-Discretionary Spending:
Expenses that must be paid regardless of employment status, such as:
Debt payments (mortgage, car, etc.)
Utilities
Insurance premiums
Property taxes
Food expenses
Personal Recommendations:
General Advice: Establish 3-6 months' worth of expenses.
For Individuals Seeking More Security: Timeframe may extend to 12 months.
Emergency Fund Calculation Example 1: Cornelius
Cash on Hand: $10,000
Mortgage Payment (including insurance and property taxes): $1,000/month
Groceries: $400/month
Starbucks: $150/month
Car Payment: $300/month
Calculation of Emergency Fund Ratio:
ext{Emergency Fund Ratio} = rac{ ext{Cash}}{ ext{Monthly Non-Discretionary Expenses}}
Emergency Fund Calculation Example 2: Cornelius
Cash on Hand: $5,000
Mortgage Payment: $1,500/month
Groceries: $600/month
Starbucks: $150/month
Car Payment: $300/month
Other Expenses:
Bar expenses totaling $500/month
Medical costs totaling $100/month
Protein shakes totaling $200/month
Calculation of Emergency Fund Ratio:
ext{Emergency Fund Ratio} = rac{ ext{Cash}}{ ext{Monthly Non-Discretionary Expenses}}
Budget and Expense Tracking
Step 1: Identify how much needs to be saved.
Step 2: Find a method to save that amount.
How to Save (Step 2 Breakdown):
a. Track expenses comprehensively.
b. Adjust spending habits accordingly.
c. Upon reaching savings goals, enjoy greater financial freedom.
Recommendations for Financial Prioritization
Prioritize filling financial "buckets" in the following order:
Emergency Fund
Retirement Account (up to company match)
Reevaluation of personal situation for decisions on:
Paying off credit card debt
Student loans
ROTH IRA contributions
Taxable brokerage accounts
Variations of the options above.
Semester Takeaways
Expected Stock Market Return: Approximately 10% over time.
Stock Market Volatility: Emphasizes the year-to-year inconsistency of returns.
Retirement Savings Target: Aim to save 10% of gross income for retirement to retire comfortably (if started early).
ROTH Contributions: Recommended to utilize a ROTH retirement account while young due to potential growth.
Expense Tracking Frequency: Conducting occasional expense audits is more sustainable than continuous tracking and can help identify spending patterns.
Credit Card Management: Essential to manage credit card use responsibly to avoid high interest charges; ensure timely payments.
Philosophical Perspective on Money: Money itself does not guarantee satisfaction; it is the management and purpose of money that contribute to personal fulfillment.