Are you on track? 8 Key Financial Ratios for high earners in the Bay Area
As a financial planner, I’ve had dozens of conversations with mid-career folks from the Bay Area and other expensive cities about their money. The people I talk to are typically high income earners – tech employees, self-employed business owners, and successful professionals.
If that’s you – then you earn a good living and your finances are stable, but you have a common question on your mind:
Am I doing everything I need to do to secure my financial future?
To help answer that, I’ve come up with a shortlist of 8 key financial ratios and their ideal targets to help you assess your financial health across three areas:
How well am I using my income?
Savings Rate
Ratio | Formula | Your Result | Target |
Savings Rate | Total Savings / Gross Income |
| 20%+ |
Why this matters: If you’re only going to focus on one ratio, focus on this one. Your savings ratio is the key to building wealth. I consider 20% the minimum target for securing your financial future. If you’re serious about earlier financial independence, you should be aiming for 30%+.
Exceptions: If you’ve already accrued a sizeable nest egg and you’ve hit your goal FI ratio (see below) or are well ahead of targets, you may not need to save much more. Also, your savings ratio does not have to be constant. You value money differently depending on the stage of your life – an extra $10K to spend in your 40s when you’re raising a family and caring for aging parents may be a lot more valuable than the same $10K in your 70s – so don’t sweat it if you can’t hit it every year.
Tax Rate
Ratio | Formula | Your Result | Target |
Tax Rate | Total Taxes / Gross Income |
| Minimize tax liability over your lifetime |
Why this matters: It’s not your house or your kid’s college education – as a high earner, taxes are your biggest lifetime expense. When you include Federal and State income tax, Social Security tax, and property tax – you may be looking at a tax rate of 30%-40%. This is why tax planning is critical to good financial planning. Your goal is to ensure that you fulfill your tax responsibilities while leveraging all available strategies to reduce your tax burden.
Exceptions: If your income is lower than usual – you’re self-employed and your income is variable, or you’re taking a career break – this could be an opportunity to increase your taxable income so that you’re taking advantage of being in a lower tax bracket. While you can’t escape taxes, good tax planning is all about paying your taxes at the lowest rates that you can.
Burn Rate
Ratio | Formula | Your Result | Target |
Burn Rate | Total Expenses / Gross Income |
| < 50% (total expenses) < 20% (housing cost) |
Why this matters: It’s not your house or your kid’s college education – as a high earner, taxes are your biggest lifetime expense. When you include Federal and State income tax, Social Security tax, and property tax – you may be looking at a tax rate of 30%-40%. This is why tax planning is critical to good financial planning. Your goal is to ensure that you fulfill your tax responsibilities while leveraging all available strategies to reduce your tax burden.
Exceptions: If your income is lower than usual – you’re self-employed and your income is variable, or you’re taking a career break – this could be an opportunity to increase your taxable income so that you’re taking advantage of being in a lower tax bracket. While you can’t escape taxes, good tax planning is all about paying your taxes at the lowest rates that you can.
Am I on track with my savings?
Financial Independence (FI) ratio
Ratio | Formula | Your Result | Target |
Financial Independence (FI) ratio | Net worth (excluding primary residence) / Annual expenses (estimated post-FI) |
| 25x for FI In your 30s: 3.0-7.0 In your 40s: 5.0-12.0 In your 50s: 10.0-18.0 |
Why this matters: Your FI ratio tells you how close you are to achieving financial independence, which is when your savings and investments grow large enough to support your lifestyle costs. Based on historical evidence, total savings of 25x of your annual expenses should allow you to withdraw enough money each year to cover your costs. Exclude your home from net worth if you will not be generating any income from it. Expenses should be your estimated annual costs at retirement – this may be significantly less than your current expenses.
Exceptions: If you have other sources of passive income not counted in your net worth (e.g. pension, rental real estate, royalties), you can use net annual expenses as the denominator (expenses – other sources of passive income). What about Social Security? For a high-earning household and taking a conservative approach, I believe it’s reasonable to assume that Social Security would provide for 10%-20% of your income. You can either include Social Security as another source of passive income or consider it as a safety cushion against unexpected investment returns.
Liquidity/Emergency Fund ratio
Ratio | Formula | Your Result | Target |
Liquidity/Emergency Fund ratio | Liquid assets (e.g. cash, money market) / Monthly expenses |
| 3-6x
|
Why this matters: As a rule of thumb, you should have 3-6 months of expenses worth of cash at hand. Not only is this to provide for emergencies, but this buffer also covers variability in your cash flow (e.g. you need $15K to cover a big vacation to Europe, and your bonus doesn’t hit until next month). Beyond a checking or savings account, you can also keep your emergency fund in an investment account where it’s invested in a low-risk asset like a money market fund.
Exceptions: If you are a single earner household, self-employed, or your income is at risk – you may consider keeping a larger emergency fund (e.g., 6-12 months). Money for large expenditures in the next 1-2 years (e.g., big tax bill, car purchase) should also be set aside. In today’s environment, treasuries, money market and CDs can be good places to stash cash. If you’re willing to take on more risk, hedged equity funds can provide you with some stock market exposure while protecting against some of the downside.
Concentration Ratio
Ratio | Formula | Your Result | Target |
Concentration Ratio | Value of single position / Net worth |
| Highly depends on your personal situation. >10% indicates a concentrated position
|
Why this matters: How you allocate your wealth should be tied to your personal goals. Concentrated positions are high risk/high reward. Whether your position is in your employer equity, a particular stock you love, or your own small business – it’s important to take an objective view, recognize the risk, and make a clear-eyed decision. Obviously – there are different degrees of risk. Shares in a public big tech company are considerably less risky than stock options in a private startup. But a bet in a single company is always going to be riskier than a diversified approach. In fact, over the long-term 42% of the stocks in the US stock market experienced negative returns – which means you would have been better off just holding cash!
Exceptions: If you’re in a position where you’re confident that your most important financial goals can be funded by your other assets, then it may be perfectly alright to swing for the fences with highly concentrated positions.
How well am I managing my risk?
Life insurance Ratio
Ratio | Formula | Your Result | Target |
Life insurance Ratio | (Life insurance coverage + Liquid net worth) / Gross Income |
| 12x
|
Why this matters: As a mid-career high earner, your biggest asset is most likely not your investment account – it’s your human capital, aka your earning capacity. If you have people who depend on your income, life insurance may be critical to provide for your loved ones in case you are gone. How much do you need? You should get enough coverage such that the life insurance payout + your liquid net worth (e.g. cash, investment and retirement accounts) is at least 12x your gross income. Along with Social Security (which, if nothing else, does a decent job of providing survivors benefits for families with kids), 12x should give your loved ones a large enough nest egg to replace 60%+ of your income. For most households, purchasing a 20-30 year term policy is a cheap and effective way to cover this risk.
Exceptions: While this is a general guideline, each family has unique needs. If you expect your partner to earn enough to support the household or you can count on other family members for support, you may not need life insurance. On the other hand, you may still decide to get some coverage to help your survivors through the grieving process.
Long-term care insurance Ratio
Ratio | Formula | Your Result | Target |
Long-term care insurance Ratio | Est. annual income in retirement / Est. annual long-term care cost ($90K/$180K individual/couple) |
| If <1, at least think about it
|
Why this matters: Here’s the truth: the cost of aging and illness is the biggest risk to your financial security once you are living off your savings. Considering that the cost of a home health aide in the SF Bay Area is around $90K/yr (source: Genworth) – if your income in retirement (Investments x 4% + Social Security + other sources of income) is greater than $90K (or $180K for a couple), you can be quite confident that you can cover your long-term care costs for as long as you need. Otherwise, it’s worth at least considering LTC insurance.
When to buy? Experts say the sweet spot is mid-50s to early 60s. After 65, you are at a much higher risk (~40%+) of getting declined by insurers due to pre-existing conditions.
Exceptions:
If your ratio is < 1, don’t panic – the average LTC claim is only ~3 years, and if you’re at this stage in your life you may be fine selling down assets to cover costs. That said, LTC insurance can be a way to alleviate the burden on family members and ensure that your assets remain intact for heirs.
Jennifer Dazols is a former Silicon Valley professional on a mission to transform the way we think about money and work. She is a CERTIFIED FINANCIAL PLANNER™, fee-only advisor and fiduciary who specializes in working with Women and LGBTQ professionals.