Taken from this forum thread.
Calculation for ERE Indicator
Okay, here's a parsimonious suggestion that should be both easy to calculate, hard to game, and more useful than SWR.
To compute, take each independent source(*) of dollar income and divide it by total expenses. If the number is >1, reduce to 1. Add them together.
In my case, my sources are
- Portfolio * 0.03 (you can pick whatever here as long as it's consistent) / spending > 1
- ERE book sales / spending > 1.
- Blog ads / spending ~ 0.75
- Misc sales of old books, etc. on amazon / spending ~ 0.1
Resulting in an indicator value of 1+1+0.75+0.1 = 2.85
This indicator rewards diversification over concentration because attempts to "go over 1" are not rewarded. By only measuring the demonstrated ability to generate dollar income, it also avoids potential gaming and endless debates/self-delusion about the imputed value of cooking your own dinner as well as the "well if I really would, I bet I could sell my services for $X", etc. Thus the indicator also encourages demonstrated and ongoing ability to produce market value relative to one's [market] expenses.
(*) Obviously a source of debate. For example, should a RE portfolio of two houses be counted as one source or two sources? Similarly, if you split your portfolio, do you get to count it as several independent sources. I'd say that's a discretionary choice. In the spirit of trying to become what we measure, I'd suggest not doing that.
For the consumer side of the equation, I propose the following:
Divide the expenses into three buckets according to whether they close the loop (2), kill the loop (1), or contribute very little to the web-of-goals (3), yet are priced very differently depending on where one lives (compare rent in NYC to rent in Podunk, or RE taxes west of the Mississippi to rents east thereof); and also don't really affect any loops over a period of decades.
- Consumer stuff you buy new / total expenses. This is food, event tickets, tools, gadgets, magazine subscriptions, club membership, airplane tickets, gasoline, utilities, ...
- Consumer stuff you buy used / total expenses. E.g. craigslist, eBay, flea markets, yard sales, ... (You don't get to subtract what you sell, instead any such effort goes on the income side. This term also prevents anyone from gaming the index by buying used only to turn around and sell it w/o profit (i.e. "churning") for a higher score.)
- Services you're practically forced to pay for just because you're alive / expenses, e.g. "head tax", or own stuff that must be insured to operate. This includes all insurances, which are here considered part of being a responsible citizen i.e. health and driving (in some countries this is covered by taxes or culture). It also includes RE taxes and rent.
- 0.39 (all food and utilities)
- 0.02 (the few things I buy used, usually tools)
- 0.59 (RE taxes and insurance)
Now, comes the tricky part. Calculate (2)-(1) and add it to the income score. Ignore (3). Yes, adding signs implies that I'm now weighing, but there's no constant parameters to remember.
Result: 0.02-0.39+0 = -0.37 which I add to my 2.85 of the income side and arrive at +2.48
To drive this towards +1, I would need to grow more of my own food, shop less, and reduce my utilities bill with either consumption reduction or renewables. All good/ERE-compatible stuff. More self-reliance. More anti-fragile. Close the loops.
What's the idea here? Basically, your home isn't counted except for heat+water+electricity which is definitely lost value since it's literally burned into the air. If you're an owner, then you get punished because you're benefiting less on the income side due to less investment income. If you're a renter, then you get punished because your expenses are higher. This also works if NAV values are such that renting beats owning because in that case, your investment returns would be higher than your rent=expense penalty. IOW, the index rewards deliberate financial choices whether to own or rent.
You also get punished directly for not being self-reliant in the food department or for adding more pollution due to direct consumerism. OTOH, you get rewarded for taking things out of people's garages or preventing them from getting into landfills. Yet you can't go overboard [trying to game] because buying is still reflected in your expenses; and insofar you get stuff for free, it's not reflected unless you sell it on (thus preventing hoarding).
IOW, I think this arrangement is hard to game and I also think it results in more ERE like behavior although like with any tool, you can obviously abuse it in stupid/self-destructive ways.