Most (if not all) of you are familiar with the Savings Rate (check the link for more details). It is simply put the ratio between your savings (defined as income minus expenses) and income. It’s a great tool to give you an idea how efficient you are with your money.
After some conversations in Antwerp and comments on posts by another blogger (Mr FOB – Dutch Blog), we realized that we should also consider and review another Financial Independence (FI) metric: The Investment Index.
This is not a rocket science invention, but something useful for those of you that are interested how close you are towards FI. The Investment Index is nothing more than the ratio between your investment income and your household expenses.
Thus: Investment Income / Expenses * 100% = Investment Index
The result interpretation is pretty obvious, if it is higher than 100% you are technically FI. Well at least for that month or that year. Perhaps you would also continoiusly need well over 100% to stay FI in the long run (think inflation and market swings)!
The expenses are relatively easy to calculate. You just have to review your bank statements and add up all the costs you have on a monthly or yearly basis.
Small caveat, you can do this on cash-flow or cost basis principle. In the cash-flow case your entire expense of your mortgage is included (i.e. interest and principal payment). In the cost basis version, you only include your paid interest. Same applies to personal and business loans. For car loans (if you have any), I strongly recommend using the cash-flow principle!
The investment income should be easy to calculate, but depending on what type of asset(s) you have it could be quite the calculation.
Same as with the expenses, you can use the cash-flow principle of the cost basis principle. Albeit this primarily revolves around real estate (i.e. due to mortgage/loan payments). For most other assets (stocks, bonds, options, etc.), you simply take the increase in value (minus any investments and/or purchase costs) for the month or the year.
But fortunately you could also simplify life and just use your net worth increase for the month or the year (minus invested funds). This is obviously not as accurate, but in our case a lot easier to calculate (same as the financial freedom sloth, we can be very lazy!)
Yearly Historical Data
As noted above, we are lazy, so we used our net worth option to calculate our Investment Index. Note that we use cost basis for these calculations.
Considering we saw the FIRE light in 2014, it makes sense to see how we did since that time. As you can see below, 2014 and 2016 were pretty good. For 2014 is was primarily our real estate that helped out, as we had bought a wreck and transformed it into two nice rental units. As a result the value of the property rose more than the initial investment = good year from an investment income perspective.
As we emigrated back to the Netherlands 2015, this year was horrible. Very high expenses due to the international move, little to invest (and some major investments occurred into our real estate: new kitchen/bathroom) and thus a low (well negative actually) Investment Index.
In 2016 we turned things around, especially with the new real estate and the sky-rocketing market. We are actually getting really close to FI when looking at last year! In fact, if we were FI our expenses would be considerably lower as we would not have daycare. With daycare removed from the expenses, the Investment Index would actually have been 137%! We technically were FI last year, how good is that?!
Taxes and Cash-flow
But before we get too excited. Taxes have not been included in the above calculations, as the bill for our 2016 wealth will come later this year. As noted earlier, this is all evaluated on cost basis, from a cash-flow perspective we are definitely not there yet! Furthermore, this was yet another bull market year. So it’s a bit skewed upwards too.
We have come to the conclusion that we prefer to become FI on a cash-flow basis, and want to do this by having primarily dividend stocks and real estate. We therefore want to develop this Investment Index also from a cash-flow perspective, but realized that taxes are making this rather difficult. Keep in mind that we have Canadian pension accounts that have a withholding tax of 25%, which holds the majority of our dividend stocks. We will therefore pick this up in a later posts.
It is also interesting to see the difference between the Cheesy Index and the Investment Index with regards to the proximity to FI. The main reason for this is that the Cheesy Index assumes an average, a long term 4% Safe Withdrawal Rate (SWR). This actually is not entirely correct anymore as the 4% rule applies to a portfolio made of stocks and bonds. We simply don’t have such a portfolio. Secondly, the 4% is probably too high for the future for such a portolio. Check out the SWR post series by Earyretirementnow.com if you are interested.
That being said, we think that with our portfolio a long term 4% net return is considered somewhat conservative. It is therefore also unsurprising that the Investment Index show’s we are closer to FI than our Cheesy Index does. If we could only get our cash-flow up quickly, we could become FI very soon 🙂 Do miracles exist, or will it be old fashioned hard work? Nevermind, don’t answer that……
Have you calculated your equivalent of the “Investment Index” before? If so, where are you? How much does if differ from your equivalent of the “Cheesy Index”? We are curious to know!