My wife and I registered online accounts with Social Security Administration so that thieves wouldn’t be able to register with our information stolen from Equifax. Social Security Administration recently sent us a reminder to review our Social Security statement. I took the opportunity to calculate our Wealth Conversion Efficiency ratio.
Wealth Conversion Efficiency ratio measures how efficient you are in converting your labor income to wealth. It’s based on the idea that you start out with nothing, or negative when you have student loans, then you earn income through your labor. After paying taxes and living expenses, you save some of your income. You grow your savings through investments. After some years you look back to see how much you have now relative to how much you earned through your labor all along. For instance if you have $1 million now and you earned total $2 million cumulatively, you converted 50% of what you earned to your wealth.
Just having a high income isn’t enough for a high Wealth Conversion Efficiency because taxes are high when you have a high income. Keeping your living expenses low relative to your income helps. Maxing out tax advantaged accounts helps. Investing well helps. Doing well in real estate or a business also helps. With good enough growth you can compensate for all the taxes you paid and all your living expenses in all these years since the very beginning.
Your Social Security statement is a good source for doing this calculation. Because there’s no earnings cap in Medicare tax since 1994 (see comment #4 from Paul below), the column “Your Taxed Medicare Earnings” gives you a complete history of your labor income since 1994. You can easily add those up and compare your current net worth against the total.
However, just adding up the raw numbers doesn’t take inflation into consideration. The $20,000 you earned years ago is worth a lot more today. We need to apply an inflation factor to each year’s earnings in the past. So I made a spreadsheet for it. You just enter the historical earnings from your Social Security statement and it will automatically adjust your earnings for inflation. If you worked before 1994 and you earned more than the taxed Medicare earnings back then, please replace the historical earnings before 1994 with your actual earnings.
Some types of income are still not reflected in the taxed Medicare earnings. Your 401k/403b employer match or employer contributions are not included. You can add them back in. If you are self-employed taxed as an S-Corp, you should add your S-Corp distributions. If you received gifts or inheritance, add them in the year you received them.
If you kept track of your net worth at the end of each year, you can enter them and see how your Wealth Conversion Efficiency progressed. It goes up over time because your investments typically grow faster than inflation. Given enough time, good savings rate, and good investment returns, someone can show a Wealth Conversion Efficiency of 100% or higher.
Spreadsheet: Wealth Conversion Efficiency, Adjusted for Inflation
For the two of us, our Wealth Conversion Efficiency ratio stands at 60% today. After paying taxes and living expenses and investing the rest, we kept 60% of what we earned so far after adjusting for inflation. A strong stock market in recent years helped. That number was a lot lower in 2008.
You can download a copy of the spreadsheet, enter your earnings and net worth numbers in private and see how well you did. I like this metric because it incorporates everything: savings rate, investment returns, luck, and time. Just based on a hunch, I think good benchmark numbers would look like these:
|Age||Wealth Conversion Efficiency|
I created an anonymous poll with just two questions: your age and your inflation-adjusted wealth conversion efficiency. If enough people answer the poll, I will publish a curve with the averages.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.