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Financial Planning Metrics

December 2011

Barbara O’Neill, Ph.D., CFP®
Extension Specialist in Financial Resource Management
Rutgers Cooperative Extension

Best wishes for a happy holiday season and New Year. December is a time when many people take stock of the past year’s accomplishments. The word “metric” has been used quite a lot lately. According to an online dictionary, “metric” can be defined as “a system of measurement that facilitates the quantification of some particular characteristic.” It seems like everyone is interested in measuring the progress or results of something and selecting tools with which to do it. Whether it is financial literacy or school test scores or someone’s health and lifestyle habits, people are looking for ways to determine how they “measure up.”

Following is a description of eight commonly used financial planning metrics:

Consumer Debt-To-Income Ratio - Monthly consumer debt expenses (excluding a mortgage) should not exceed 15% of take-home pay. This includes payments for credit cards, car loans, and student loans. A debt-to-income ratio of 20% or more is considered a “danger zone” and a red flag for financial distress.

Credit Score - The higher the number, the better. Credit scores range from the 300s to 850 with those in the 760+ range considered the best evidence of creditworthiness. People with high credit scores generally pay lower interest rates to borrow money than others.

Emergency Fund - Financial experts generally recommend having access to enough cash to cover household expenses for at least three to six months. This money can be a combination of liquid assets (e.g., money market fund) and lines of credit (e.g., home equity line).

Expense Ratios (Mutual Funds) - An expense ratio is the percentage of mutual fund assets deducted for management and operating expenses. The lower the number, the better; for example 0.20 (1/5 of 1%) versus 1.5%. High expense ratios are a drag on investment returns and should generally be avoided.

Inflation Rate - Some people use the annual inflation rate (i.e., as measured by the Consumer Price Index) as a benchmark and try to have their investments outpace it by a certain percentage.

Investment Returns on Specific Securities - Investment performance is generally tracked against market indices. Indices are portfolios of stocks or bonds that are tracked to monitor investment performance over time. Some common indices that are used to measure personal investment performance against include the Standard and Poor’s 500 (tracks 500 large U.S. company stocks), the Wilshire 5,000 (tracks all U.S. stocks), and the MSCI EAFE index (tracks the performance of stocks issued by overseas companies).

Net Worth - Net worth is calculated by subtracting household debts from household assets. A benchmark for net worth, described in the book The Millionaire Next Door, is calculated by multiplying your age by your pre-tax (gross) income, excluding inheritances, and dividing by ten. This number, or higher, is what your net worth should be. For example, if you are age 35 with a $40,000 gross income, 35 x 40 = $1.4 million, divided by 10 = $140,000 for an adequate net worth.

Retirement Savings - A general guideline is to save $300,000 for every $1,000 of monthly income (to supplement a pension and/or Social Security) needed in retirement. For example, $3,000 of supplemental monthly living expenses would require a $900,000 nest egg. This calculation is based upon the maximum 4% withdrawal rate recommended by many researchers. Four percent of $300,000 is $12,000 per year or $1,000 per month. Studies have found that a portfolio comprised of 50% stock and 50% fixed-income and cash assets will generally last 30 or more years with a 4% withdrawal rate.