Section 2: Math Time

Step 3.  Doing some calculations

OK – everyone hates math (but ostriches love math – they try to multiply often, or so I am told). So… I’ll put the math into an Appendix 1 and focus on what the numbers mean.

The numbers are explained below, but in broad terms:

1. Solve for the amounts that you need to support your lifestyle.
2. Solve for the earnings you need on your investments to cover those needs.
3. Consider how much “room” you have for losses in investments, overspending, and as a Nest Egg for the future.

The formulas are provided as a “Fixed Income” and “Total Income” basis. These are used to decide what “Case” you are in.  I break the information into 3 groups:

Also, I provide equivalent “Rates” and “Amounts”. Why? I saw this a lot in my professional career:  Someone would show a really high rate of return (say 20%), and everyone would go “wow, how profitable!” But…  20% of $0 is still (follow me here…..)  $0.

Group 1:  Income Ratio Formulas: 

• Income Ratio:  What % of your expenses is covered by your income. Tells you how much you’re spending to live on and whether it’s on fixed expenses (house) or total expenses (ostriches).
• Income Needed:  Your Expenses less your Income, or “how much do I need to make in interest/earnings?”. Note that this is the amount before taxes are considered.

Group 2:  What do I need to earn from my Invested Assets?

If you know what you need, you have to then relate it back to what you actually have saved. The formulas provided give these as “minimum” numbers. They are “minimum” because they only consider what you would need in this year, and not what you might need in the future.

So, following the same “rate and amount” idea. 

• Minimum Interest Rate Needed:  This is the rate earned on Invested Assets that exactly equals the Income Needed. I do this before taxes, so that you can compare this rate to the earnings rates that are being shown to you by banks, mutual funds, and so forth.
• Minimum Invested Assets:  This is the amount of savings that you need so that IF you were to earn an assumed target return it would pay your expenses.

Group 3:  How do I know if I’m ok?

This group is the amount of “cushion” you have in your lifestyle to help you get comfortable with the ostrich farm purchase.

• Risk Tolerance Rate = Target Return – Minimum Interest Rate.  This is the amount of money you can lose in a down market and still pay for your expenses out of earnings.
• Nest Egg = Total Savings you have (ignoring house, etc.) less your Minimum Invested Assets. 

The shortcoming of what I have above is that all of these measurements are as of today, and don’t consider what might happen tomorrow. I am NOT suggesting that you spend all of this money. You need to keep investing your Nest Egg – the earnings on that provide for future increases in costs (i.e., inflation!).

OK, so let’s take stock (or bonds or ostrich farms – you pick)

• We figured out what we need to spend to live the way we want.
• We took this information and put together a bunch of numbers – Income needs, Minimum Interest and Risk measures.

The hard work is now done.  It is time for a little self-analysis.…..

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