James C. Molet's Blog, page 28
March 20, 2017
Forget About Your Net Worth When Retirement Planning
Back in October 2015 I posited that net worth is a useless metric, particularly with respect to retirement planning. I argued that at the end of the day, the only thing that really matters is how much income you can generate from your passive and portfolio sources. Measuring net worth often distracts people from this reality.
Primary Residences and Vehicles
Two ‘assets’ that people love to include in their calculation of net worth are their homes (I’m referring to primary residences and not rental or investment properties) and automobiles. For too many people the value they assign to their home and vehicles form a significant amount of their net worth.
As an example, let’s assume a couple has paid off both of their vehicles, has some equity in their home, and is 15 years away from retirement. Let’s further assume they have no credit card debt, no student loans, Kelley Blue Book informs them their vehicles are worth a combined $15,000, and based on the loan balance on their home and a projected value provided by Zillow, they estimate they have $65,000 in equity.
Family Vehicles – Paid in Full
Considering they aren’t retiring for 15 years, what good does it do to assign a value to their home and vehicles right now? Unless they plan on selling those cars and the home – and not replacing them – those ‘assets’ won’t be generating any monthly income … now or in retirement.
Passive and Portfolio Income
Continuing with this couple, let’s take a look at what will be their passive and portfolio sources in retirement. Let’s assume they aren’t positioned to receive any passive income outside of Social Security (let’s say their combined annual benefit will be $30,000) and their savings (e.g. checking account) and investments (e.g. Roth IRA) total $5,000.
Combining the projected values of their home and vehicles, and their savings/investments, their net worth would be $85,000. That looks pretty good, but only $5,000 of that will have any relevance as they slide into retirement.
Perhaps there is a second couple – also 15 years away from retirement – out there who only have $2,500 equity in their home and vehicles, are projecting a combined $30,000 in Social Security benefits; and have $25,000 between a checking account, an IRA, and a 401(k) for a net worth of $27,500.
Who’s in a better position with respect to drawing retirement income? The answer is obvious.
With all that said, and although I have long railed against focusing on net worth, I recently decided to add a Net Worth table to the workbook I use to track and manage my finances. I did so because I thought it might be interesting to track it and watch it increase over time. However, when I look throughout my workbook I understand the relevancy of the various bit of information. I know that the only relevant entry, with respect to generating portfolio income in retirement, is the first entry in the table below.
Net Worth Table
Some notes on this table: The wife and I don’t have any credit card debt and both of our vehicles are paid for. Additionally, I anticipate the rental property will eventually be a source of retirement income as I will either continue to collect rent on the property or sell it at some point in the future and move the proceeds into an investment account. However, at this time the rental property does not figure into my active retirement planning and the only place it shows up in my workbook – comprised of seven worksheets – is the table above.
Final Thoughts
Do yourself a favor and stop focusing on net worth as a measure of how prepared you are for retirement. I’ll keep tracking my net worth and perhaps I’ll pat myself on the back when my table indicates the wife and I are millionaires. (At our current contribution rate, projected appreciation of our homes, and projected investment returns, I anticipate we’ll cross that threshold sometime during July of next year.) But of course I’ll be much more interested, and in a celebratory mood, when our investment portfolio crosses $1,000.000.00.
Instead of focusing too intensely on net worth, spend your time and energy minimizing your expenses and developing multiple streams of passive and portfolio income; those are the numbers that are truly relevant for retirement planning.
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