The Money Mustache Community
Learning, Sharing, and Teaching => Ask a Mustachian => Topic started by: StiffUpperLip on July 06, 2017, 07:30:20 AM
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Do you consider all money as equivalent when calculating your net worth?
For example, I have money in a ISA (easy access), a SIPP (not accessible til 55 and rising) and a final salary pension (accessible from 60) - would you just add these together as equivalent to determine an overall net worth number even though that would tell only half the story?
Or would you only count 'accessible' funds?
I also have a house which is borderline underwater (financially speaking, not literally) by +/- £10k depending on which site I use to estimate value which as I'm just starting out could become quite demotivating if I include it's fluctuating value, which won't be realised until/unless we sell regardless...
I'm in a quandary I suppose as to what metric to use to track progress and savings etc, with these a parent contradictions/complications... any advice would be gratefully received and hopefully pull me out of analysis paralysis...
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I really don't think about net worth as it can be so deceptive. It's not a terribly useful measure of anything either IMO.
Looks like you can currently only count on your ISA and any cash savings minus any debts - nothing else is accessible?
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"Net worth" technically should include all your assets including the illiquid ones, but I agree that it's not a helpful metric in an immediate practical sense.
I have a detailed plan of how I'm going to finance retirement at 55 using my various "pots" and I see them all as having a specific purpose. If you've got an aspiration for retirement or for a specific total asset value, it's worth taking the time to decide how you want to use each pot, count up what you've got in each pot now, assess how much you need to have in each pot to achieve what you want to achieve, decide whether it's realistic on your current or future income and savings rate, and allocate your savings and investments accordingly.
Everything else is small print, but there's a lot of small print!
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I think you would do it differently depending on why you are doing the calculation. E.g., net worth = assets - liabilities, so that includes the equity in my house. OTOH, since I don't plan to ever move, when I am planning my retirement, I ignore that equity. Of course, it's still there as a backstop in case everything goes into the shitter when I'm 80, but since that's not my desired plan, I exclude it.
For me, the most useful approach has been something I read elsewhere here (and I wish I could recall who to give credit to): I plan by "buckets," with each bucket covering a specific time frame.
E.g., our current plans are to quit at 58, when the kids are out of the house. So from say 58-66, I will need $X (normal expenses) + Y (college not covered by savings) + Z (we plan to travel a lot in the first few years). For that period, I will need to rely on my investments, since we will not have pension or SS. So to figure out how much I will need to have to cover that period, I will need (X+Y+Z) x 8 years. So assume that normal expenses are $40K and college cash flow and extra travel are $10K each, that means I will need $60K x 8 = $480K. Discount that to present value (because I don't need $480K *now*, I need enough $ now to become $480K when I hit 58), so maybe I need $400K invested now to cover that 8 years.
Then from 66-70, college will be over, so my expenses go down to X + Z (because we are still traveling). So now my annual costs are $40K + $10K travel, so I need $50K x 4 years = $200K, let's say present value is $120K [side note: since this period starts 8 years into the future, I need *less* now to get to my $200K target, because my little 'stache will have 8 more years to grow into that $200K figure].
Now from 70-80, I am going to assume that the travel will cut back some, so say $5K/yr. But I am going to plan for more medical costs as things start going wrong, so say $10K/yr. So now my annual need is $55K. But now I have Social Security to cover part of those costs! So assuming that is $30K, that means I need to cover only $25K/yr from my investments. So $25K x 10 years = $250K. Discount to present value [again, even greater discount because this is even farther into the future], and I need maybe $100K now.
Etc. etc. etc. Basically, start from your planned RE date, and go all the way out until 95 or 100 or whatever makes sense to you, dividing the time up into different pots depending on what you foresee for your expenses and when you are eligible for different sources of income. And then you start filling those pots from the oldest to the youngest -- take car of "old" you first (e.g., 80-100), and then move backwards for the younger and younger periods. And when the math tells you that your "pots" are filled all the way back to the current date, then poof! you are FIRE'd!
I found that this approach gave me a much better sense of where I am on my path to RE (FWIW, when I did this, it told me I needed significantly less money saved than I had calculated using the standard 4% rule) -- for me, my old age is completely covered, as is my "standard" RE age with SS, and now I am filling that first bucket, when the kids are in college and I want to travel a lot.
It also can help guide which vehicle(s) you save in - for example, if you have a pension and protected retirement accounts, and you can't access any of that until 65, then you might already have a full "pot" from 65-95 -- but maybe you don't have enough in accessible funds to cover the period from (say) 45-65. [I don't know UK rules about early withdrawal and such, sorry] And when I get closer to the target RE date, it will also guide my asset allocation -- e.g., my first "bucket" will be more conservative, because I will need ready cash in case of a market crash, so I will likely do something like a 7-year bond ladder with a chunk of that. OTOH, my "old age" bucket I still won't need for another 25 years, so that can stay in the market.
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Net worth is: assets - liabilities
That's all assets & all liabilities.
Anything else, for what ever whim or reason, isn't net worth.
But, net worth doesn't tell the whole financial status, and therefor is not the prime metric.
We do have different 'pots' of money (and debt). The right tools for the different jobs.
The metrics to use to track progress of the different jobs are each different;
Debt; amounts, interest rates, time to pay off, pre-payment options or penalties
Savings; amounts, accessibility, interest and fees, percentage of income saved
Investments; amounts, fees (including taxes), gain/loss, accessability
Living expenses - needed to determine how long your assets will support you without other income (RE).
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Stiff, I agree with other responding to your query that net worth may not be very helpful, but it may be a fun number to play around with.
You can convert a pension into a roughly equivalent asset by multiplying what it will pay per year times 25 (inverse of the 4% rule), ignoring default and other risks. As the pension isn't accessible until age 60, then your financial assets can be characterized by time periods. For example, from current age till the SIPP starts paying out, your financial asset value is your ISA balance, plus whatever net worth you have in your house, net of transaction costs, and any conventional savings or other personal property. Then your financial asset value steps up to include the SIPP's capital value at age 55, and again to include the capital asset value of the pension at age 60. If you plot this it is a step function with time on the "x" and financial assets on the "y".
But I suggest that it may be more helpful to plot annual income by age, and relate that to your annual requirements, and see when you hit FI. Then see about ways to reduce your requirements through simple living.