Power percentage: A more effective metric of financial performance than savings rate?

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Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

I've been recently listening to some of the podcasts by Pete the Planner and have found them interesting, funny, and a bit enlightening. Generally, the show consists of him going through various callers financial situation and helping them stabilize their financial lives and get on the path to financial independence.

Something he mentions quite often is a metric he devised: power percentage. I've not been able to find this metric discussed anywhere yet on this forum. It is similar to savings rate though more inclusive of activities that are likely to improve one's net worth. Basically, it's your savings rate plus the percentage of your gross pay being used to pay off non-recurrent debt (i.e. mortgage, student loans, medical debt). Rather than go through all of the specifics in its calculation, I will simply copy what he says about it below.
"Begin by adding up the following monthly activities: retirement plan deposit, employer match, college fund deposits, savings deposits (which won’t be immediately spent on vacations, holidays, etc.), other investment deposits, HSA contributions (which you don’t have immediate plans to use), mortgage principal payment (not interest, property taxes, or insurance), medical debt payments, credit card payments (from cards which you’re currently not using), student loan payments (above and beyond interest-only payments), and any other debt in which you are making consistent money payments (except car payments).

Once you add all of those healthy financial activities up, divide by your gross (pre-tax) monthly income. For example, if you add up all your monthly activity and arrive at $1,500, and your gross monthly income is $5,000, then your Power Percentage™ is 30 percent ($1,500 / $5,000 = .30)."
http://petetheplanner.com/power-percentage/

I like the fact that, unlike a savings rate, it takes into account activities that reduce one's debt. Two people could have the same savings rate, for instance, but one could be paying off a lot more debt than the other; the power percentage would reflect that. And debt reduction and eventual elimination can go a long way toward helping people achieve financial independence.

He elaborates on how to interpret one's power percentage as discussed below.
"The Power Percentage™ scale is as follows. Less than 10 percent, and you’re in big trouble. You’re way too dependent on your income. Relief is not on the horizon because you’re not doing anything about it. You are consuming your entire income while not saving money and not paying on debts. If your Power Percentage™ is between 11 and 20 percent, you’re doing okay, but your Power Percentage™ has a long way to go prior to retirement. A Power Percentage™ of 21 percent to 34 percent indicates you’re living a healthy financial lifestyle. And finally, a Power Percentage™ of 35 percent or higher proves to you that you’re well on your way to mastering your financial life."
http://petetheplanner.com/power-percentage/

I generally agree with his assessment, although I think that it's possible that someone could have a high power percentage and still have a long way to go before reaching retirement. For instance, someone might be saving a lot of their income but just leaving it in cash (i.e. savings account). Without being properly invested, it's possible that such a person might not ever be financially independent. Pete usually asks callers about their investments in very general terms, but the power percentage certainly doesn't capture AA, a vital element of financial independence for most of us.

Even with that caveat, I still think that power percentage (PP) may be a more appropriate metric of gauging one's financial performance than savings rate alone.

Thoughts about this metric?
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by qwertyjazz »

I like it because it makes me feel better about paying off debt I did for years. Assuming reasonable debt taken on based on future income, it can work.
OTOH now that I know about SRR, savings is different than paying down debt
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Re: Power percentage: A more effective metric of financial performance than savings rate?

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qwertyjazz wrote:I like it because it makes me feel better about paying off debt I did for years. Assuming reasonable debt taken on based on future income, it can work.
OTOH now that I know about SRR, savings is different than paying down debt
Yes, savings is different from investing, but I would argue that, apart from liquidity issues, paying down a mortgage is generally equivalent from a long-term perspective to buying bonds (at current rates at least). Paying down old credit card debt is a slam dunk benefit to your net worth.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by bayview »

As a metric that rewards those of us with 5-figure incomes (and thus smaller denominators), I like it. :D 36% here for the two of us (too complicated to split it out to individual levels.)
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Re: Power percentage: A more effective metric of financial performance than savings rate?

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bayview wrote:As a metric that rewards those of us with 5-figure incomes (and thus smaller denominators), I like it. :D 36% here for the two of us (too complicated to split it out to individual levels.)
I'm not sure how it "rewards" those with incomes under $100k. Perhaps you could explain.

It seems to me that it's easier to throw a high percentage of one's income at debt and savings when your income is high rather than low.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by bayview »

willthrill81 wrote:
bayview wrote:As a metric that rewards those of us with 5-figure incomes (and thus smaller denominators), I like it. :D 36% here for the two of us (too complicated to split it out to individual levels.)
I'm not sure how it "rewards" those with incomes under $100k. Perhaps you could explain.

It seems to me that it's easier to throw a high percentage of one's income at debt and savings when your income is high rather than low.
I was being tongue in cheek. It certainly seems kinder than the one that floated around a few days ago regarding net worth.

And no, maxing out TSP and catch-up plus taxable savings isn't particularly easy. Good practice for the retirement budget though.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by Dottie57 »

"Power Percentage" seems more like a gimmick to me. Net worth is a good metric. You can certainly see how it changes and it has a clear , concise definition.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by AlohaJoe »

willthrill81 wrote:I've not been able to find this metric discussed anywhere yet on this forum.
I haven't seen it discussed on Bogleheads either but I've seen other books with similar suggestions (though none of them gave it a cute name). In The Value of Debt (which is not a book that would go over well with the average Boglehead) the author makes the same suggestion: money you're using to pay off a mortgage isn't really an "expense".

I think it is a fair point. No doubt some would argue that "you always need some place to live" or that home equity isn't as liquid as a 401(k).
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by AlohaJoe »

Dottie57 wrote:"Power Percentage" seems more like a gimmick to me. Net worth is a good metric. You can certainly see how it changes and it has a clear , concise definition.
It does?

Does your net worth include the value of your Social Security? What discount rate did you use for valuing that?

Does your net worth include the value of your human capital? How did you decide that?

Is your net worth defined in terms of after-tax or pre-tax? Does it discount assets that are less liquid? By how much are they discounted?
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by TD2626 »

It seems as though this metric would be devised to console those with debt. If one has a net worth of minus $1,000,000 (i.e. enormous student loan debt, mortgage debt, car/credit card debt, etc), and one saves $1,000,000 (over many years), one would have $0. You can't retire on a $0 portfolio. If you have a net worth of $0 and save $1,000,000 - there is a difference. 4% of $1,000,000 is $40,000 - and with, say, social security added in, you could retire. Although paying down debt is a very healthy financial activity, having the debt in the first place generally isn't! Any financial health score should tend to penalize those with high debt and reward those with little debt.

One could use other metrics - for example, 4% of net worth divided by annual expenses (converted to a percentage).

(Note - I use 4% as that is often cited as a "safe withdrawal rate" - of course this is a rule of thumb that has many limitations)
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

AlohaJoe wrote:
Dottie57 wrote:"Power Percentage" seems more like a gimmick to me. Net worth is a good metric. You can certainly see how it changes and it has a clear , concise definition.
It does?

Does your net worth include the value of your Social Security? What discount rate did you use for valuing that?

Does your net worth include the value of your human capital? How did you decide that?

Is your net worth defined in terms of after-tax or pre-tax? Does it discount assets that are less liquid? By how much are they discounted?
There are many issues with using net worth as a metric for financial performance. One of the biggest is that it tends to be strongly correlated with income. This makes it look like people making average or below average income are doing a poor job with their finances, which can be just plain wrong.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by Dottie57 »

AlohaJoe wrote:
Dottie57 wrote:"Power Percentage" seems more like a gimmick to me. Net worth is a good metric. You can certainly see how it changes and it has a clear , concise definition.
It does?

Does your net worth include the value of your Social Security? What discount rate did you use for valuing that?
NO, I don't include SS. I only include inhertable assets.

Does your net worth include the value of your human capital? NO, I only include inheritable assets. How did you decide that?

Is your net worth defined in terms of after-tax or pre-tax? Does it discount assets that are less liquid? By how much are they discounted? I include my account balances in networth except for checking. Also include my home which at this point is somewhat liquid since the condos in my complex are selling well. Home value is 12% of my networth.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by KlangFool »

willthrill81 wrote:
AlohaJoe wrote:
Dottie57 wrote:"Power Percentage" seems more like a gimmick to me. Net worth is a good metric. You can certainly see how it changes and it has a clear , concise definition.
It does?

Does your net worth include the value of your Social Security? What discount rate did you use for valuing that?

Does your net worth include the value of your human capital? How did you decide that?

Is your net worth defined in terms of after-tax or pre-tax? Does it discount assets that are less liquid? By how much are they discounted?
There are many issues with using net worth as a metric for financial performance. One of the biggest is that it tends to be strongly correlated with income. This makes it look like people making average or below average income are doing a poor job with their finances, which can be just plain wrong.
willthrill81,

Take the net worth and divide by current annual expense to solve that problem. If a person is around 25, he/she is doing very well.

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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

KlangFool wrote:
willthrill81 wrote:
AlohaJoe wrote:
Dottie57 wrote:"Power Percentage" seems more like a gimmick to me. Net worth is a good metric. You can certainly see how it changes and it has a clear , concise definition.
It does?

Does your net worth include the value of your Social Security? What discount rate did you use for valuing that?

Does your net worth include the value of your human capital? How did you decide that?

Is your net worth defined in terms of after-tax or pre-tax? Does it discount assets that are less liquid? By how much are they discounted?
There are many issues with using net worth as a metric for financial performance. One of the biggest is that it tends to be strongly correlated with income. This makes it look like people making average or below average income are doing a poor job with their finances, which can be just plain wrong.
willthrill81,

Take the net worth and divide by current annual expense to solve that problem. If a person is around 25, he/she is doing very well.

KlangFool
The problem with that measure is that it, practically, is only measuring how close to being FI someone is. At factor of 25, they are probably already FI or very close to it. Someone may be saving or reducing their debt with 50% of their income (being very efficient by anyone's standards) yet only have a number like 1-3 early in their career.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

TD2626 wrote:It seems as though this metric would be devised to console those with debt. If one has a net worth of minus $1,000,000 (i.e. enormous student loan debt, mortgage debt, car/credit card debt, etc), and one saves $1,000,000 (over many years), one would have $0. You can't retire on a $0 portfolio. If you have a net worth of $0 and save $1,000,000 - there is a difference. 4% of $1,000,000 is $40,000 - and with, say, social security added in, you could retire. Although paying down debt is a very healthy financial activity, having the debt in the first place generally isn't! Any financial health score should tend to penalize those with high debt and reward those with little debt.

One could use other metrics - for example, 4% of net worth divided by annual expenses (converted to a percentage).

(Note - I use 4% as that is often cited as a "safe withdrawal rate" - of course this is a rule of thumb that has many limitations)
The power percentage metric doesn't encourage one to take out debt in the first place, but it does imply that paying off that debt is a benefit to your financial health, which virtually everyone agrees with. Once that debt is paid off, in order to keep one's PP at the same level, that money would then need to be routed toward saving/investing.

As I said to Klangfool, metrics that gauge how close you are to FI have the problem of being low for most of your career, even when you're doing everything well. It says almost nothing about how efficiently you're managing your income, which both PP and savings rate do. It's far more of a moving target than something like PP or savings rate.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by AlohaJoe »

willthrill81 wrote:As I said to Klangfool, metrics that gauge how close you are to FI have the problem of being low for most of your career, even when you're doing everything well. It says almost nothing about how efficiently you're managing your income, which both PP and savings rate do. It's far more of a moving target than something like PP or savings rate.
For an example of what willthrill81 is talking about here, Kitces' blog post[1] on the "empty nest transition" and its effect on retirement saving has a nice discussion. The usual metrics (just looking at how much you contribute to a 401(k) or what the balance of your 401(k) is), while not wrong exactly, also don't necessarily tell the full picture.

Image

[1]: https://www.kitces.com/blog/empty-nest- ... etirement/
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by spammagnet »

willthrill81 wrote:... Something he mentions quite often is a metric he devised: power percentage. I've not been able to find this metric discussed anywhere yet on this forum.
"Begin by adding up the following monthly activities: ...."
Simplified, it's the change in your net worth divided by your gross income. It seems to be a fair indicator of how you're using your financial resources. To be more accurate than my simplified description, I'd say the numerator should not include unrealized gains and the denominator should include employer contributions to retirement savings. It does standardize the metric a bit for higher income vs lower income, but higher income people do have more disposable income available to direct towards their net worth.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by TD2626 »

How about this further idea for a more effective metric? (new proposed ratio)

#1. Take 4% of your net worth divided by annual expenses. This represents how far down the path to retirement you have gotten.
#2. Take the number of years you have worked in your life and divide by the number of years total you plan to work in your life, including years already worked. This is the percentage of your career you have gone through.

Divide #1 by #2 to get the new proposed ratio.

This ratio would be such that you would want it at or above 1.0 - below 1 is bad, and far above 1 is good. Obviously is is an oversimplification and doesn't take into account many, many things - but it takes into account debt repayment and burden (as the power percentage does) while also being able to account for more circumstances. For example, this ratio works for those who are working and those who are retired. Maybe a ratio such as this could be used as a rule of thumb?

Examples:

---Someone in good shape:
Net worth (which takes into account debt as the power percentage suggests): $500k
Expenses: $50k
Years worked so far: 10
Years you intend to work before retiring: 35
4% of 500k: 20K
20K/50K=0.4=Net Worth SWR/Expenses
10/35=0.2857=Years of savings done
0.4/0.2857=1.4

---Someone in worse shape (much later in their career with the same net worth)
Net worth: $500k
Expenses: $50k
Years worked so far: 20
Years you intend to work before retiring: 35
4% of 500k: 20K
20K/50K=0.4=Net Worth SWR/Expenses
20/35=0.57142=Years of savings done
0.4/0.57142=0.7

---Someone just about to retire:
Net worth: $1,250K
Expenses: $50K
Years worked so far: 35 years of 35 year career completed (already retired)
Years you intend to work before retiring: 35
4% of 500k: 20K
50K/50K=1.0=Net Worth SWR/Expenses
35/35=1=Years of savings done
1.0/1.0=1.0

Note - if I messed up the math or made some major mistake in my thinking let me know (I could have overlooked something huge) Also, if this discussion of more effective methods of measuring one's financial performance is best done in its own thread or if the thread should be re-titled maybe that should be done.

Any thoughts on this proposed idea for a ratio?

(Fixed calculation typo mentioned below).
Last edited by TD2626 on Mon Jun 05, 2017 6:57 am, edited 1 time in total.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by thehappycampers »

---Someone just about to retire:
Net worth: $1,250K
Expenses: $50K
Years worked so far: 35 years of 35 year career completed (already retired)
Years you intend to work before retiring: 35
4% of 500k: 20K
50K/50K=1.0=Net Worth SWR/Expenses
35/35=0.57142=Years of savings done
1.0/1.0=1.0

I think you mean -- "35/35 = 1.0 = Years of savings done" -- instead of "35/35=0.57142=Years of savings done" in the second to last line (copy paste from your previous example?). You correct it in the next line though.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by KlangFool »

OP,

This power percentage creates an illusion to all those "House Poor" people that they are doing very well. But, most of their "savings" is in the house. Hence, it does not take much to blow this "House of Cards" down.

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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by spammagnet »

KlangFool wrote:This power percentage creates an illusion to all those "House Poor" people that they are doing very well. But, most of their "savings" is in the house. Hence, it does not take much to blow this "House of Cards" down.
Good point
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by Carson »

TD2626 wrote:Although paying down debt is a very healthy financial activity, having the debt in the first place generally isn't! Any financial health score should tend to penalize those with high debt and reward those with little debt.
I strongly agree with this point. Also, I have seen from peers that the first thing they often do when they pay off debt is to take on another debt payment for some other thing. At the end of the day, this isn't doing anything to get themselves ahead financially with liquid assets.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

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spammagnet wrote:
KlangFool wrote:This power percentage creates an illusion to all those "House Poor" people that they are doing very well. But, most of their "savings" is in the house. Hence, it does not take much to blow this "House of Cards" down.
Good point
The vast majority of house poor people are in the first few years of a 30 year mortgage. As such, the principal portion of their mortgage payment is low, so it wouldn't contribute much to their power percentage. Less than a third of the principal and interest portion of a 30 year mortgage is principal in the first year of the mortgage, for instance.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by KlangFool »

willthrill81 wrote:
spammagnet wrote:
KlangFool wrote:This power percentage creates an illusion to all those "House Poor" people that they are doing very well. But, most of their "savings" is in the house. Hence, it does not take much to blow this "House of Cards" down.
Good point
The vast majority of house poor people are in the first few years of a 30 year mortgage. As such, the principal portion of their mortgage payment is low, so it wouldn't contribute much to their power percentage. Less than a third of the principal and interest portion of a 30 year mortgage is principal in the first year of the mortgage, for instance.
willthrill81,

Let's assume that you are correct. It does not change anything. For example, a "House Poor" person in the last 10 years of the 30 years loan might have a good power percentage. But, if the person saves very little outside the house, it is still a "House of Cards". They have to be lucky in order to survive.

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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

Carson wrote:
TD2626 wrote:Although paying down debt is a very healthy financial activity, having the debt in the first place generally isn't! Any financial health score should tend to penalize those with high debt and reward those with little debt.
I strongly agree with this point. Also, I have seen from peers that the first thing they often do when they pay off debt is to take on another debt payment for some other thing. At the end of the day, this isn't doing anything to get themselves ahead financially with liquid assets.
I agree that someone who is paying off their prior dumb mistakes is in a worse position than someone who didn't make those dumb mistakes and is now investing those dollars wisely.

That being said, if most people looked at their net worth, for instance, and realized how long it would take to really improve it, they would likely give up in despair.

Also, the person who is actually interested in their power percentage may well be the person who has seen 'the error of their ways' and is now trying to get on the path to FI.

There are no perfect metrics, but I do think that power percentage may be one of the better ones to include on one's financial dashboard, along with net worth (in relation to expenses and possibly age).
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

KlangFool wrote:
willthrill81 wrote:
spammagnet wrote:
KlangFool wrote:This power percentage creates an illusion to all those "House Poor" people that they are doing very well. But, most of their "savings" is in the house. Hence, it does not take much to blow this "House of Cards" down.
Good point
The vast majority of house poor people are in the first few years of a 30 year mortgage. As such, the principal portion of their mortgage payment is low, so it wouldn't contribute much to their power percentage. Less than a third of the principal and interest portion of a 30 year mortgage is principal in the first year of the mortgage, for instance.
willthrill81,

Let's assume that you are correct. It does not change anything. For example, a "House Poor" person in the last 10 years of the 30 years loan might have a good power percentage. But, if the person saves very little outside the house, it is still a "House of Cards". They have to be lucky in order to survive.

KlangFool
Very few people who were truly house poor when they took out a 30 year mortgage will still be house poor 20 years later due to inflation. Over the last 20 years, for instance, a period with historically low inflation, a $50,000 income in 1997 would now be approximately $77,000, a 54% increase, assuming their pay kept pace with inflation. So their power percentage would look a little better since they would be paying a healthy amount in principal, but their income would have increased as well. Unless they are saving more, their PP will still be low.

And at any rate, very few people are going to have even a modest power percentage by only making regular mortgage payments.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by bigred77 »

"Power Percentage" seems like a decent metric to me. Savings rate plus debt reduction is fairly imperative to ones financial health. Probably don't want to tip too decisively to debt reduction for any extended periods of time but it does a good job of showing the percentage of one's income that one is using to improve their personal balance sheet.

I personally focus on keeping my savings rate between 25% and 33% if at all possible. I then focus more on absolute numbers when deciding between accelerating debt reduction and spending with my remaining funds. My PP score is a touch over 40% and my savings rate currently is right at 25%. Those numbers tell me I'm doing a decent job of having some balance in my life.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by KlangFool »

willthrill81 wrote:
Very few people who were truly house poor when they took out a 30 year mortgage will still be house poor 20 years later due to inflation. Over the last 20 years, for instance, a period with historically low inflation, a $50,000 income in 1997 would now be approximately $77,000, a 54% increase, assuming their pay kept pace with inflation. So their power percentage would look a little better since they would be paying a healthy amount in principal, but their income would have increased as well. Unless they are saving more, their PP will still be low.

And at any rate, very few people are going to have even a modest power percentage by only making regular mortgage payments.
willthrill81,

<< Over the last 20 years, for instance, a period with historically low inflation, a $50,000 income in 1997 would now be approximately $77,000, a 54% increase, assuming their pay kept pace with inflation. >>

Most folks' pay has not kept up with inflation over the last 20 years. So, this assumption is flawed.

http://www.pewresearch.org/fact-tank/20 ... r-decades/

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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

KlangFool wrote:
willthrill81 wrote:
Very few people who were truly house poor when they took out a 30 year mortgage will still be house poor 20 years later due to inflation. Over the last 20 years, for instance, a period with historically low inflation, a $50,000 income in 1997 would now be approximately $77,000, a 54% increase, assuming their pay kept pace with inflation. So their power percentage would look a little better since they would be paying a healthy amount in principal, but their income would have increased as well. Unless they are saving more, their PP will still be low.

And at any rate, very few people are going to have even a modest power percentage by only making regular mortgage payments.
willthrill81,

<< Over the last 20 years, for instance, a period with historically low inflation, a $50,000 income in 1997 would now be approximately $77,000, a 54% increase, assuming their pay kept pace with inflation. >>

Most folks' pay has not kept up with inflation over the last 20 years. So, this assumption is flawed.

http://www.pewresearch.org/fact-tank/20 ... r-decades/

KlangFool
According to that article, real wages (adjusted for inflation) have been relatively flat for decades, so the assumption is generally correct.

"But after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then."
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by marcopolo »

willthrill81 wrote: According to that article, real wages (adjusted for inflation) have been relatively flat for decades, so the assumption is generally correct.

"But after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then."

Also keep in mind that those studies of wage growth look at averages. I would think for most people, the growth would be better than that because people don't typically have the same entry level job all their lives. Early in their careers they are likely below the average, then throughout their careers move to positions requiring more skills and experience, and hopefully better than average compensations. So, while the average wages may have barely kept up with inflation, an individual's wages likely have a positive real growth. Of course, that will not apply to everyone.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

marcopolo wrote:
willthrill81 wrote: According to that article, real wages (adjusted for inflation) have been relatively flat for decades, so the assumption is generally correct.

"But after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then."

Also keep in mind that those studies of wage growth look at averages. I would think for most people, the growth would be better than that because people don't typically have the same entry level job all their lives. Early in their careers they are likely below the average, then throughout their careers move to positions requiring more skills and experience, and hopefully better than average compensations. So, while the average wages may have barely kept up with inflation, an individual's wages likely have a positive real growth. Of course, that will not apply to everyone.
That's a very good point, and the evidence is clear that individuals' wages tend to increase with age up to around age 55, at which point the averages start to go down, probably due to early retirements and age discrimination. That's part of the reason why I'm shooting for FI by age 55.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by Hoosier CPA »

I listen to Pete the Planner while commuting sometimes also.

My understanding is the power percentage is best viewed as a metric for how effectively someone is using their earned income over a given, shorter term period of time - I think of it as a one year time frame. For example, I can see how I did over the past 12 months in terms of taking the income I earned and translating that into purposes that improve my financial well-being. The denominator is gross income, and the numerator includes all items where I've invested money that improve my situation. Improving this percentage helps in two ways - the first is the obvious, that it helps contribute a larger amount of my income towards long-term objectives. The 2nd is that it reduces my dependence on my income, as the more I'm using towards improving my financial well-being, the less I'm using it to maintain lifestyle. The lower lifestyle expenses I have, the less income I'll need to "replace" in retirement.

Looking just at changes in net worth is obviously important but the power percentage separates spending activity from investing performance.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by marcopolo »

I am not sure I am getting the utility of this metric. I could increase it (make my situation seem better) by running up big credit card bills, buying way more house than I need (or can afford), etc., and then making payments towards those?

It just seems like an excuse to live beyond your means.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by Meg77 »

I like this metric, and I use something similar to track my own "savings rate" but didn't have a term for it. It takes into account the decision to make extra payments on debt which is often more rational than saving money. I think it is most effective though if only debt used to purchase assets like real estate is considered as part of the ratio, not necessarily principal payments on consumer debt (which is more like delayed spending than saving).

For example, when we decided to refinance our mortgage from a 30 year to a 15 year, we viewed that as a positive financial decision by minimizing interest expense and getting rid of a large fixed cost sooner. However that change resulted in a drop to our savings rate, which is what prompted me to reconsider the utility of monitoring my savings rate in a traditional way. I redid my cash flow statement to show only mortgage interest as an annual expense, rather than "mortgage payment." Principal repayment is tracked as "financial progress" along with 401k contributions, etc. I also count employer matching as a type of compensation on the top line, and then add it again as a savings line item below.

Our target is to be contributing 50% of our gross income (including matching, credit card rewards and gifts all as "income") toward financial progress. It's a much more accurate picture than a simple savings rate calculation in my view because a simple savings rate encourages taking out long amortizations on homes and cars, not to mention using debt to begin with for everything. Theoretically you could have a huge savings rate but be racking up credit card debt each month too. I do agree that if we had a lot of consumer debt I'm not sure I'd count payments on that toward this figure. Repaying consumer debt is really more like delayed spending than saving. For example when we paid off my husband's student loan I counted that as "educational expense," and auto payments were listed as "auto expense" not debt repayment.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by avalpert »

I don't think either is a particular good measure of financial performance without considerably more context about the components around them and that trying to focus on a single number like this is as likely to lead to bad decisions as good ones.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by MrNewEngland »

marcopolo wrote:I am not sure I am getting the utility of this metric. I could increase it (make my situation seem better) by running up big credit card bills, buying way more house than I need (or can afford), etc., and then making payments towards those?

It just seems like an excuse to live beyond your means.
No, he does not include revolving debt or car loans.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by gilgamesh »

I really like this concept. Never totally liked only including the amount invested and not certain debt payment. For instance my business loan payments are hefty ($100k/yr), and I know I could sell my business for around inflation adjusted amount when I retire. I think the principal portion of that should be partly considered as investing...only partly included, because it's mostly savings and not investing.

Same for the house, if there will be a downgrade after retirement. Say, in retirement it will be downgraded by half, then half of my principal portion should be considered into the savings rate. Certainly all the extra payments towards the mortgage. (Target retirement nest egg is not expected to include primary residence mortgage, as in its assumed retirement home is paid for and thus not including that portion as savings towards retirement nest egg)

Like a more nuanced approach to include these types of payments that will help in retirement.

However, I'm reluctant to include these as my bond part of AA. They are ignored in the AA.

I agree car payments should not be there...I'm not sure I'll include past CC debt, but once incurred, and to encourage someone from climbing out of the pits, this measure is very valid.

Thanks for sharing.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

gilgamesh wrote:I really like this concept. Never totally liked only including the amount invested and not certain debt payment. For instance my business loan payments are hefty ($100k/yr), and I know I could sell my business for around inflation adjusted amount when I retire. I think the principal portion of that should be partly considered as investing...only partly included, because it's mostly savings and not investing.

Same for the house, if there will be a downgrade after retirement. Say, in retirement it will be downgraded by half, then half of my principal portion should be considered into the savings rate. Certainly all the extra payments towards the mortgage. (Target retirement nest egg is not expected to include primary residence mortgage, as in its assumed retirement home is paid for and thus not including that portion as savings towards retirement nest egg)

Like a more nuanced approach to include these types of payments that will help in retirement.

However, I'm reluctant to include these as my bond part of AA. They are ignored in the AA.

I agree car payments should not be there...I'm not sure I'll include past CC debt, but once incurred, and to encourage someone from climbing out of the pits, this measure is very valid.

Thanks for sharing.
I agree that not including the reduction of long-term debt (a negative bond) in a measure of one's current financial performance doesn't make sense. Mortgages, for instance, are very relevant for retirement planning purposes, particularly if the mortgage will be paid off by retirement. If someone has a 30 year mortgage instead of a 15 year mortgage, the difference between the two, in most situations, should be invested somewhere.

How to incorporate 'old' credit card debt is a challenge, I'll grant. If someone has 'seen the error of their ways' and is trying to permanently get out from under credit card debt, then it makes sense to include such payments in one's PP, particularly if the money being allocated to them will be routed toward investing once the debt is repaid. But going into CC debt merely to repay it later just to try to improve one's PP would be just...dumb. I can't believe that a significant number of people would actually try to consciously fool themselves this way, but who knows.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by gilgamesh »

Yeah! I was thinking of the 15 yr vs 30 yr mortgage too....the conventional way just ignores this. One who chose 15 years and invest less compared to someone who chose 30 years and invest more is a clear example of why this nuanced approach is necessary.

However being house poor can be masked by this approach and thus my idea to include only the difference between today's house value and retirement house into it. Not a full correction as its savings vs investing. This area is a bit tricky. But, I like your though process where you included the fact early payments are mostly interest and the constant mortgage payment effectively loses buying power through the years. It's pretty neat.

As this radio show advices listeners on how to get out of their rut, existing CC balances should be included as 'investing'.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by Tabulator »

How much of a hypothetical credit card payment counts toward this metric if it is only a minimum payment, ie, one that mostly covers interest, not principal?

I think we can imagine that only the principal portion really counts because of what he said about student loans. But I did not find that he stated this explicitly with regard to credit cards. Did I miss something?
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

Tabulator wrote:How much of a hypothetical credit card payment counts toward this metric if it is only a minimum payment, ie, one that mostly covers interest, not principal?

I think we can imagine that only the principal portion really counts because of what he said about student loans. But I did not find that he stated this explicitly with regard to credit cards. Did I miss something?
I would say that, like a mortgage, only the principal portions of credit card payments (assuming one is no reducing one's total credit card debt) should count toward a power percentage.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by TD2626 »

You shouldn't count your spending as savings. This precludes credit card payments as being included as "savings" in my opinion.

I feel that real estate shouldn't be included in anyone's portfolio unless held for investment purposes only -- which excludes most mortgages. One is spending on housing. Similarly, most kinds of debt are ultimately, when examined closely, spending instead of savings. I guess one could argue that principal payments on mortgages of investment real estate properties can be considered savings as it increases investments.... but I don't agree with this either as an investment or as a metric.

One needs to have a net worth focus, not an income/expenses focus.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by TD2626 »

You shouldn't count your spending as savings. This precludes credit card payments as being included as "savings" in my opinion.

I feel that real estate shouldn't be included in anyone's portfolio unless held for investment purposes only -- which excludes most mortgages. One is spending on housing. Similarly, most kinds of debt are ultimately, when examined closely, spending instead of savings. I guess one could argue that principal payments on mortgages of investment real estate properties can be considered savings as it increases investments.... but I don't agree with this either as an investment or as a metric.

One needs to have a net worth focus, not an income/expenses focus.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

TD2626 wrote:You shouldn't count your spending as savings. This precludes credit card payments as being included as "savings" in my opinion.
Credit card payments are only included in the PP if they are no longer being used (i.e. someone did prior 'stupid' spending but has now 'seen the light' and is permanently getting out of credit card debt.
TD2626 wrote:I feel that real estate shouldn't be included in anyone's portfolio unless held for investment purposes only -- which excludes most mortgages. One is spending on housing. Similarly, most kinds of debt are ultimately, when examined closely, spending instead of savings. I guess one could argue that principal payments on mortgages of investment real estate properties can be considered savings as it increases investments.... but I don't agree with this either as an investment or as a metric.

One needs to have a net worth focus, not an income/expenses focus.
Paying off a debt like a mortgage does increase your net worth. And unless you have the option of living somewhere for free, having a paid off home will permanently reduce your living expenses (though obviously not eliminate them entirely since you still have property taxes, insurance, maintenance, etc.) and your needed retirement portfolio.

You state that expenses should not be part of one's focus, but this is simply false. If you could eliminate all of your expenses, then you would need no retirement income, and net worth would be rather meaningless. Similarly, one's net worth means nothing apart from the income it produces in relation to your expenses.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by avalpert »

willthrill81 wrote: Paying off a debt like a mortgage does increase your net worth.
No it doesn't - it is neutral as to your net worth (you decrease assets and liabilities by the amount of the payment).
having a paid off home will permanently reduce your living expenses
By the same amount it permanently reduces the income being generated by your assets (because you aren't renting out the home).
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

avalpert wrote:
willthrill81 wrote: Paying off a debt like a mortgage does increase your net worth.
No it doesn't - it is neutral as to your net worth (you decrease assets and liabilities by the amount of the payment).
It is only neutral if the assets used to pay off the debt are not otherwise spent. For most people, I'm not so sure that that's actually the case.
having a paid off home will permanently reduce your living expenses
By the same amount it permanently reduces the income being generated by your assets (because you aren't renting out the home).[/quote]

Are you insinuating that mortgages should never be paid off?
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by avalpert »

willthrill81 wrote:
avalpert wrote:
willthrill81 wrote: Paying off a debt like a mortgage does increase your net worth.
No it doesn't - it is neutral as to your net worth (you decrease assets and liabilities by the amount of the payment).
It is only neutral if the assets used to pay off the debt are not otherwise spent. For most people, I'm not so sure that that's actually the case.
It is neutral period - really this is elementary accounting. If we are going to play games of alternatives that can be done with the money why not say it decreases net worth because they would otherwise invest it in higher returning investments...
having a paid off home will permanently reduce your living expenses
By the same amount it permanently reduces the income being generated by your assets (because you aren't renting out the home).
Are you insinuating that mortgages should never be paid off?[/quote]
Well, not here though I could see an argument for that depending on available rates. Here all I am saying is that by owning the house you are paying yourself rent.
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Re: Power percentage: A more effective metric of financial performance than savings rate?

Post by willthrill81 »

avalpert wrote:
willthrill81 wrote:Paying off a debt like a mortgage does increase your net worth.
No it doesn't - it is neutral as to your net worth (you decrease assets and liabilities by the amount of the payment).
It is only neutral if the assets used to pay off the debt are not otherwise spent. For most people, I'm not so sure that that's actually the case.
It is neutral period - really this is elementary accounting. If we are going to play games of alternatives that can be done with the money why not say it decreases net worth because they would otherwise invest it in higher returning investments...
I completely get that using assets from a checking account, for instance, to reduce a mortgage is net worth neutral. But most folks aren't simply going to leave the money in their checking account; they will do something with it. And for most people (probably not most Bogleheads though), that means spending it on things that will reduce their net worth over time. I'm addressing the behavioral side of the issue, not the accounting side of it.
avalpert wrote:
willthrill81 wrote:having a paid off home will permanently reduce your living expenses
By the same amount it permanently reduces the income being generated by your assets (because you aren't renting out the home).
willthrill81 wrote:Are you insinuating that mortgages should never be paid off?
Well, not here though I could see an argument for that depending on available rates. Here all I am saying is that by owning the house you are paying yourself rent.
I agree and don't see the point of the comment.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings
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