Financial Wellness Metrics for Pre-Retirees

As one approaches retirement, monitoring your financial situation by understanding your net worth and assessing the assets and resources needed to maintain a comfortable lifestyle throughout retirement is vital. This article explores eight key financial wellness metrics that pre-retirees must monitor as they approach retirement.

1. Income Replacement Ratio

One of the primary financial wellness metrics is the Income Replacement Ratio (IRR), which calculates the percentage of your pre-retirement income that your retirement income will replace. Many individuals work toward a target ratio between 70-80%. Therefore, if you currently make $100,000 annually, your retirement income should ideally be between $70,000 to $80,000.

2. Net Worth

Net worth is one of the most fundamental financial wellness metrics, measuring the total assets, including savings, personal properties, and investments, minus any liabilities or debts. This metric gives an essential broad picture of your financial health and indicates financial stability that may help you to support yourself comfortably in retirement.

3. Liquidity Ratio

The liquidity ratio is another critical metric that measures your ability to cover short-term expenses without selling long-term assets or taking on additional debt. This ratio is calculated by dividing your liquid assets, such as cash, savings, and short-term investments, by your current liabilities. A ratio of 1 or greater indicates a healthy level of liquidity. A ratio of 0 or -1, and so on, may indicate concern.

4. Savings Rate

Your savings rate, the percentage of income you put aside for savings, is a critical component of retirement planning since it directly impacts the savings you’ll have available to support yourself. Financial professionals often recommend a savings rate of 10% to 15% of gross income. However, the savings rate may change depending on one’s situation, market conditions, risk tolerance, and timeline until retirement.

5. Debt-to-Income Ratio

Recognizing your level of debt is equally important when preparing for retirement. The Debt-to-Income Ratio (DTI) compares your total monthly debt payment to your gross monthly income, providing a deeper look at how you manage your debts. Lenders often use this metric to determine your ability to manage monthly payments and repay borrowed money. A lower DTI ratio indicates a good balance between debt and income.

6. Medical Expense Forecast

Health care can be a significant expense in retirement. Understanding your likely medical costs can help you plan for this considerable expenditure. Consider your current health status, anticipated medical needs, family medical history, and potential long-term care costs.

7. Retirement Savings Lifespan

Another crucial metric involves determining how long your retirement savings may last. By evaluating your expected annual withdrawal rate alongside your total savings and expected longevity, you can estimate the lifespan of your retirement savings.

8. Investment Diversification

A diversified investment portfolio ensures that your wealth is not dependent on the success of just one type of investment. By including a variety of investments that respond differently to market changes—some rising while others fall—you can help reduce the impact of market volatility. A helpful tool for investment advisors in determining the necessary level of diversification for a portfolio is Modern Portfolio Theory (MPT). MPT states that for any given portfolio of assets, there is an optimized combination of stocks and other investments that provides the greatest return for a specific level of risk.

Since everyone’s retirement journey is different, these metrics provide a starting point to determine what is appropriate and realistic for your circumstances. It’s always advisable to seek assistance from a financial professional since calculating these metrics on your own may be complex.

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