Investment Index

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.

Investment Index
Investment Index

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)!

Expenses

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!

Investment income

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.

Investment Index
2014-2016 Investment Index

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.

Indexes

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!

Please follow and like us:

18 Comments

  1. Very interesting, including the comments! I checked at some points how our investing index would be (just didn’t have a name for it then), but it’s still so low I just don’t use it (yet) as a measurement we should use. Although because we aim to reach full FI, (living off passive income and not capital gains) it would be the perfect way to track it.

    We also take into account that the older we get, the more costs we will need for health care. We can always use withdrawals if the passive income won’t cover anymore by then.

    1. Fair points, you will likely also always get some AOW (how much is anybody’s guess). That for us is also a buffer. Same as the company pensions that we have build up over the years. All of those will be released around the time we will be between 65 and 70-ish. Which is the time health related issues also start to appear. But don’t underestimate your impact now by eating healthy and primarily plant based, this is your best risk mitigation for health costs!

  2. As you know, I combine income from work with passive income (e.g. dividends & capital gains) to calculate my savings rate. When we would sell our house and build a way cheaper one, our FIRE is pretty close. Hard to have a number, as a lot will depend on selling price of our current house and purchasing price of a lot of land & building cost. We will find out

    1. Hey Mr FOB,
      I know you use your entire income (paycheck and investment income). But you got to tell my why you do this? It will increase your saving rate (more income), but I struggle to see the added value.
      In any way, best of luck getting to FI and selling your house!

  3. I’d like to see the figure in numbers not percentage. As you claim up the corporate ladder, you’ll get increase in salaries, then you’d inflate your lifestyles, that means all of your previous 75% savings becomes somewhat irrelevant.

    Say you were making $30,000/year, your spending was $7,000/yr.
    But then you married, have kid. Your salary double including your wife’s salary. $60,000. spending $20,000

    Say, we’re basing our retirement on saving 70% of income, you’ll get to retire in 7 years
    saving of 50%, retire in 10 years. But that only account for people not inflating their lifestyles too too much.

    1. But that is the beauty of the index/percentage. It should slowly rise when you climb the coporate ladder and maintain your spending. This is clearly visible with us as the savings rates re high and cheesy index is growing rapidly.
      Point well made though, if you can maintain spending, your FIRE date closes in quickly when you earn more.

  4. Nice insight but I’m not going to calculate it. The percentage would be so low it’s demotivating. :p

    About the value gains. I also wouldn’t include them. I would also not withdraw anything. Just withdraw the dividends when I’m at the age where I don’t work anymore. I don’t want to use the value of the stocks itself.

    1. That would be the ultimate state, where you can just live off dividends or cash-flow from real estate. It should also index itself for the future.

  5. So if I extrapolate 2014 and 2016 (and forget 2015), I get a FI date in 2018 ;-).
    One tip to get a more meaningfull index, you could look at LTM (last twelve month) figures to calculate the index instead of monthly figures.

    1. And another ‘caveat’ I see in the investment index; basically you’re stating that the nominal investment return equates to the withdrawal rate. But then you don’t take into account the sequence of return risk; ie what if in the early years the investment return is (substantially) lower than the withdrawal rate. You could for example only look at the passive income part (dividends and/or net rental income), but then you completely ignore the investment returns.
      Don’t get me wrong, I like the idea of the index but I think it may overstate the FI number!

      1. Correct, that is also why I’m hinting on having a higher index (say 150% in good years, and 75% or so for the bad). Utltimately, your weath/”return on assets” will have to increase to accomodate inflation. It’s not meant to be perfect yet, was testing the waters a bit as the 4% rule certaily does not apply to us. Which makes the Cheesy Index also less accurate. We really have to find a cash-flow based measurement, which would also include a buffer for when issues arise with tenants or the property, and can accomodate taxes. Lots of ideas, just not sure yet what the best idea is.
        Thanks for the feedback!

  6. in all honesty? No idea! Since that side off the puzzle is unpredictable i will focus on the other side: I want to have finished renovating the house and have bought a ‘new’ car before pulling the plug on full time work. This way the big expenses are out of the way (and a lot of unpredictability on the spending side). i also will keep 2 years of expenses in cash to help with short time unpredictability. Once that is in place, I’ll just wing it for the rest and try to live with the strong fluctuations. or convert everything to dividend paying stocks and live of dividends if the fluctuations turn out to be to unpleasant.

    1. That is a very honest answer. But I like that you keep flexibility in the mix to be able to adapt to unfortunate events (or a series therefore 😉 ).
      But two years of cash, really? That is quite a bit of opportunity cost! Of do you keep this in the money market or savings account??

  7. I do not take investment gains into account. They are there to grow the stash. With a very concentrated portfolio (and the use of leverage) my investment gains are to unpredictable to count on to use as finance once post FIRE. In 2016 I had 68.000 euro in investment gains and at the moment I have 24.000 euro gains for 2017. Both more than cover my my expenses for a full year but next year I can have 0 or even negative …

    1. Fair enough, but how do you then propose to find the right (average) value? I.e. what stash do you want to have? If you have such types of variable gains due to leveraged assets, the 4% rule (or whatever value you prefer) also has no real meaning. How do you solve that conundrum?

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.