home Investing The Wealth Ratio

The Wealth Ratio

This was a very useful metric I found a couple years ago. It tells you how “wealthy” you are. This is a bit of a biased look. Wealth by the wealth ratio, means how easily you can provide for yourself using passive and portfolio income and not have to work. If you don’t know what passive income is, read my article Passive Income – What Is It. Portfolio income is money you make from your stocks and mutual fund investments.

In a nutshell, passive income is money you earn without having to actively work for it (like a job).

Formula

You take your total annual passive and portfolio income and divide it by your income needs (how much money you spend in a year). Then multiply it by 100. This will give you the percentage that comes from passive/portofolio income.

Where Are You?

For those of you who don’t have any passive/portfolio sources right now, this will 0%. So 0% of your income needs are covered by non-active income. All the money that goes to pay for those expenses comes from your job.

When you achieve 100%, you technically don’t need to work at a job anymore. Your other income will meet what you spend. The goal should be to exceed 100% by as much as possible. At this point, you are truly wealthy.

Below is an example of the calculation. Pretend this is a real example. This is a two income family with no kids. There income more than covers their expenses. However, if you were to take away one income (they have a baby and one parent will stay home or there are other circumstances) the one income would still cover it, but not by much. There is also zero passive/portfolio income in this situation. So the wealth ratio is 0%.

No Passive Income

Active Income Expenses
Wage 1 $3000 Mortgage $1100
Wage 2 $2800 Utilities $400
House Insurance $50
Passive Income Property Taxes $120
None $0 Car Insurance $120
Petrol $150
Portfolio Income Maintenance $100
None $0 Groceries $250
Other $200
Entertainment $200
Total $5800 Total $2690
Wealth Ratio: 0%

Here is the next example. The couple decides to rent out the basement of their house (assuming it had the right layout to do so). They charge $750/month, but do incur $100/month in new costs on average for maintaining their rental. As you can see they now have some passive income and it covers just under 27% of their monthly expenses. Thus their wealth ratio is 27%.

Some Passive Income

Active Income Expenses
Wage 1 $3000 Mortgage $1100
Wage 2 $2800 Utilities $400
House Insurance $50
Passive Income Property Taxes $120
Rental $750 Car Insurance $120
Petrol $150
Portfolio Income Maintenance $100
None $0 Groceries $250
Other $200
Entertainment $200
Extra Rental Costs $100
Total $6550 Total $2790
Wealth Ratio: 27%

Quality of Living

Notice that how much you spend enters into this equation? People who have high standards of living are going to need more money. Ever wonder why you can go to those rich acreage neighbourhoods and there isn’t anybody home during the day. No one is out walking their dog or anything. They have to work to pay the mortgage, taxes, and upkeep of their houses.

I’m not saying to live like a peasant, but a lot of people spend according to their income. It is our natural tendency to spend the extra money we make and live “on the edge”. If we kept the same spending habits we had today and then create enough passive income to match our current day salary, then we would be laughing. Most of us, however, would take the extra cash and have fun.

Is It Easy to Obtain 100%???

NO. I’m not going to beat around the bush. It takes work and time and more work. You need to take it one step at a time. These seminar guys are kind of annoying actually. The promise the moon, but don’t discuss reality very much.

My first recommendation would be to look for opportunities for passive income. I’ve sorted these on simplicity and initial investment from smallest to largest. The larger ones typically have better returns and more passive income is possible.

  • Put $500 into dividend paying stocks (or even bonds). This is probably the poorest performing passive income source, but at least it pays you something and the money is saved. It is the cheapest way to get out of the 0% passive situation.
  • Do you own anything that can be rented out? Garage, land, tools, furniture, computer equipment, photography equipment, etc.
  • Start a website where you can put some Google Ads. Just write reviews on products you have purchased. Try and find a free site that will let you put ads on it. You might need a geek buddy to help set it up.
  • Are you looking to buy your first house? Look for one with a basement suite or a garage that you are willing to rent out.
  • Sell a product. Develop a website, get a mailing list, advertise it, etc. What is a product? Anything someone wants to buy. Education material, software, or even a toy.

Note: A lot of these can be a job if you set them up that way. It is important that they are set up to require the least amount of work possible.

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