How Much Should You Save? How Much Debt Should You Have?
Money Hacks reader Mia left a comment in how Much Should You Save for Retirement discussing other rules-of-thumb she’s learned. She pointed me to an article called “Rate yourself using debt-to-income ratio”.
The article suggests that “healthy families” should strive to:
- Save 12% of their income every year. A 30-year-old should have 10% of her income amassed in savings. A 35-year-old should have 90%. At 40, she should have 1.7x her income saved. At 50 this should be 3x income, and at 60 it should be 8.8x income.
- Add up all of your debt, including mortgage and student loans. At age 30, your debt should only be 1.7 times your income. This number should drop as you age. At 45, it should be equal to your income. By age 65, you should have no debt.
These ratios are fine, but they seem awfully ambitious, especially with regard to debt. I’m nearly 38. Should I be worried that our family’s debt is more than twice our income? What if it’s mostly mortgage debt?
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Jeremy Bettis said,
February 20, 2007 @ 4:25 pm
It seems like net worth is more important than the debt ratio. The book “The Millionaire Next Door” recommends a net worth ratio of Annual Income * Age / 10. So at 30 you should have 3x income as your net worth, at 40, 4x, etc. Now of course, that is the recommendation for being a wealthy person, not an average person.
DC said,
February 20, 2007 @ 5:21 pm
I think you take mortgage out of the equation personally since a home is an asset. Hopefully your home is worth more than what you owe but I realize that banks are allowing more and more people to mortgage 100-120% of the value of the home. Point is, you can liquidate an asset and have a positive net worth.
Student loans, credit card debt and even auto loans I think are different. Those should be accounted for.
Personal opinion.
vitr0x said,
February 20, 2007 @ 6:33 pm
I think I agree with DC. A mortgage will take up a lot of one’s debt, and I don’t think it’s fair to count that against a family’s debt–it’s just a part of cost of living in such cases. I would also agree that credit card debt and student loans are the debt that we should worry about more.
Mia said,
February 22, 2007 @ 9:05 am
It should be pointed out that the ratio’s above assumed that you’d earn, if I remember correctly, 5% on your investments (a pretty low assumption) and that you’d use 5% a year in retirement. But more to the point, no one should assume that a primary residence is an asset to be liquidated, or that it’s not ‘fair’ to count a mortgage as debt - people shouldn’t become stuck on these details, but should instead look at the big picture and use these ratio’s, formula’s, calculators, as guidelines to be individualized. Can you afford to continue mortgage payments after retirement? How much would you profit and how would you fund new living space if you liquidated your home? Do you owe more on your home at age 45 than you earn in a year, but still invest enough or more into retirement?
DC said,
February 22, 2007 @ 9:09 am
On top of that, the goal is to have money to live when you retire. Eventually you will sell your home and move into something smaller, condo, nursing home, etc. A house is not only a cost of living expense but just another investment.
Jeff H. said,
January 13, 2008 @ 12:26 pm
Debt, such as mortgage, is backed by an asset. That asset can have inherent value, just as many other big ticket items do, such as original works of art, antiques or classic cars. But if you have consumer debt on credit cards, there are likely no assets to back that debt.
Consider someone with $20K in consumer debt and a $60K in income. They would have a 1:3 ratio. Consider someone who owes $20K on their $250K house and makes $60K in income. They too would have a 1:3 ratio. Would you consider these two equal?
These ratios see to be flawed in that they don’t take into account your assets, savings or many other factors. So flawed that I don’t even know how useful they are for guides.
Planning for retirement is very complicated, and I think many of these quick calculators actually do a great dis-service to people trying to check out how they are doing.