Regular readers of this blog may have noticed that over time, I (Mr AVI) have evolved in my  thinking on better measures to track performance of AVI family financial journey.   The three measures that I have been tracking for some time now are,

• Net Worth as fraction of AVI Family FI number
• Liquid Net worth to Debt Ratio
• Liquid Cash to Two year living expense ratio

Tracking net worth has its pros and cons and I wrote an article on the topic, check it out here. That said, a solution to my reservation towards sharing net worth in absolute dollars is to present net worth as a fraction of  FI number (undisclosed to non-enterprising reader). This solution allows me to be honest and public about the evolution of AVI family Net Worth over time without the fears of soliciting unwarranted attention.

Liquid net worth to debt ratio is a metric that I decided to track following my post on paying off AVI family home mortgage. I am tracking this number to form a quantitative judgement on when I would feel 100 % comfortable for pulling the trigger on pre-payment of home mortgage without the burden of being house rich and cash poor!

Finally, the last metric, liquid cash to two year living expense ratio, that I have been tracking offers me yet another quantitative measure to enjoy a peaceful night’s sleep. And bouy, was this metric a savior! As pandemic hammered the markets, and with that AVI family net worth collapsed, at point dropping by >20 % , I was assured in the knowledge that AVI family has a healthy cash buffer to sustain a similar life style for atleast two years into the future!

Continuing to track this measure has also given me the courage to double down on markets when equities were on sale and at the same time allowing me to have the mental reserve to live through the downturn without ever selling into it! As I am writing this, have these decisions paid off! As noted in my last post, AVI family net worth is now the highest its ever been. Further evidence is in the chart below. AVI portfolio handily beat S&P 500 over the most recent 3 month period!

While all these metrics serve their purpose, I always felt there was something missing. None of these metrics really measure the efficacy of AVI family saving rate. A sure fire way to build wealth at a fast pace is to continue to increase income without a corresponding rise in life-style inflation. On this front how was AVI family doing? I don’t know!

Well, until I came across the following post from Nick Maggiulli from of Dollars and Data blog. In there he talks about the Lifetime Wealth Ratio (LWR), a metric coined by J. Money, who run the personal finance blog, Budgets are Sexy. J. Money defined LWR as:

[math] \text{LWR} = \frac{\text{Net Worth}}{\text{Total Lifetime Income}} [/math]

The numerator, Net worth is a familiar metric, given as

[math] \text{Net Worth} = \text{Total Asset} – \text{Liability} [/math]

The denominator in this equation, Total Lifetime Income. Assuming, we measure LWR at an annual time scale, the goal would be to measure net worth annually and total lifetime income annually to compute the annual LWR number. A reliable and easy method to get the annual numbers for total life time income would be from the social security website, which provides each tax payer his/her annual taxed medicare earnings. For Mr AVI the records goes all the way back to 2006.

In order to compute the LWR for year 2019, therefore I would compute the sum total of all annual taxed medicare income (from 2006 through end of 2019), which would give me the denominator for LWR. The numerator would be the net worth recorded as of 12/31/2019.

For year, 2019, doing this calculation produces, an LWR of 71.7 % for AVI family. To put this number in context, J. Money offers the following breakdown:

• 0%-10% – Meh
• 10%-25% – Now we’re cooking!
• 25-50% – You’re on fire, baby! Give me your number!
• 50-100% – Marry me.
• 100%-1,000% – How do I get into your will?

A number greater than 50 % would be indicative of some one who is able to turn more than half of his/her earned income into wealth.

While knowing this is certainly better than just knowing the net worth number, the historical LWR offers much better insights into life style of a given individual and his/her evolution to financial prudence (or imprudence). Mr AVI began seriously traking his net worth from year 2014, and the table below shows the evolution of LWR for Mr AVI

 

Back in 2014, the LWR was merely “now we’r cooking” and as time progressed it has evolved to “Marry me”! So, whats going on?

Note, Net Worth is Asset – Liability. If assets, grow, as it should happen with growing income, and if liabilities remain constant, which can happen if there is no corresponding life-style inflation, LWR will gradually grow. And that is exactly what is going on! AVI family has managed to sustain 2014 life-style (adjusted for an increase by one for count of total AVI family members) with 2020 income and what a difference that makes!

As Nick Maguilli notes in his blog post, LWR is a measure of how good one is in converting income into wealth! The motto for this website is, sustainable wealth creation, and LWR represents an excellent quantitative metric to track AVI family progress towards that goal.

Nick Maguilli goes on to point out some of the weaknesses of the measure, in particular, (1) LWR is skewed against young people (2) LWR is biased against high earners who have to pay higher taxes and (c) LWR is least useful to track wealth creation for low income individuals. He goes on to offer a refined definition of LWR, which he calls Wealth Discipline Ration (WDR), which he defines as:

[math] \text{WDR} = \frac{\text{Net Worth}}{\text{Total Lifetime Income- Basic Lifetime Spending}} [/math]

WDR corrects for the problem that low income earners face, namely, majority of their income goes towards living expense. The correction that Nick applies is qualitative and based on assumptions, a big negative in my opinion for a robust quantitative metric for wealth creation. It also does not offer any remedy to the problem (2), the high tax problem of high income earners. To me a simple correction to fix the later problem is to discount “taxable medicare earnings”, which is akin to gross income to net income, i.e. income in the pocket or after tax income.

I am not particularly bothered by problem 1 because I perceive LWR as a measure of wealth creation and a critical step in the path towards wealth creation is compounding that comes only with time.

In conclusion despite some of the weaknesses, I prefer LWR over WDR or any other corrective measure for three simple reasons, (a) it is simple and (b) it is precise and (c) It can be updated annually, a reasonable time frame to evaluate the incremental change in individual (family) savings efficiency, discount for vagaries in daily fluctuations in net worth.

From here on, in my annual summary report, I will include LWR as an important metric to track the efficiency of AVI family towards FI and sustainable wealth creation!

Video/Book/Article/Audio for the Week

• Article: Fascinating article with charts on short-term market prediction. The article came out on Aug 9th and observing the rally in markets over the past two days, I am convinced the charts are speaking of a very interesting short-term market rally is building up in beaten down value stocks
• Article: In one of my blog posts on geoarbitrage, I noted that Warren Buffett should be considered the father of Geoarbitrage. I came across yet another accolade article for Warren Buffett, America’s youngest early retiree, how apropos for a fan of Warren Buffett and a fan of the FIRE movement!
• Article: David Einhorn Q2 investor letter
• Article (Jeremy Siegel) and podcast (Wealthtrack interview with Joel Greenblatt) on why to remain bullish on stocks