Your Lifetime Balance Sheet

The book Risk Less and Prosper: Your Guide to Safer Investing features an interesting look into what it calls your "lifetime balance sheet." It lists both assets and liabilities that every person has at the start of their working careers. The summary is as follows:

Assets

• Financial Assets -- presumably given to them if they have it before they have even started working
• Human Capital -- the ability to work and earn income

Liabilities

• Pre-Retirement Consumption Spending -- food, clothing, shelter, vacations, etc.
• Other Goals -- college for the kids is one, not sure what others are (savings for cars and the like maybe?)
• Retirement Spending -- what you'll need to spend to live in retirement

Given these, here's how the process goes over a lifetime:

• You have little, if any, financial assets when you start your working life.


• You then begin to work (using your human capital) and earn an income.


• Much of this income goes to pre-retirement consumption spending and other goals. The rest is saved as financial assets.


• As time goes on, you (hopefully) grow your income (human capital) while keeping your pre-retirement consumption spending as low as possible. This allows you to put more and more into your financial assets. (BTW, as you work you're also building up your Social Security "financial asset.")


• When you retire (assuming you no longer work at all), you simply have one asset (financial assets) and one liability (retirement spending) remaining. The hope is that the former is larger than the latter. ;-)

It's an interesting/different way to look at net worth IMO. Instead of simply looking at accumulating assets from a strictly financial point-of-view, it looks at the value of time and how you turn that time into money. I have a friend that says every dollar you have represents some time that someone has given of their life in order to earn it, which is so true. And the book's take above really highlights this fact.

The information also reinforces basic financial principles that need to be applied to be sure that final relationship (financial assets to retirement spending) turns out in your favor. These are:

• Maximize your lifetime earnings by doing a great job throughout your career. Doing so can help you generate millions of dollars more than you might have otherwise earned.


• Keep spending under control. If you don't it doesn't matter how much you make because you'll simply spend it all.


• Save as much as you can for as long as you can. This will help the financial assets you do generate to grow as large as possible on their own.


• Avoid the worst money mistakes anyone can make. If you don't, all your hard work and savings could easily be down the drain.

It's pretty simple stuff really (so simple that it can be boiled down to one formula or two sentences. Almost anyone can do it (assuming that they have at least a minimum amount of income), but many do not have the discipline to. Yes, the principles are simple, but they aren't easy.

Comments

[Emily Hunter]

Thanks for highlighting this book! :) I love books which aren't the same old rehashed advice, or they find a different tack to reshash the old stuff. Guess it's time for me to actually.. umm.. read something other than blogs this year.

[Kris @ Everyday Tips]

It will be strange in a few years when the house is paid off. Shortly after that, all three of my kids will be done with college, and we will have basically no expenses outside of the usual fixed ones like taxes and utilities. (Although I think travel will become a 'fixed expense' :) )

We kind of did things in reverse in that we had kids pretty quick after college and a lot of our savings will come when we hit 50 or so. We have still saved quite a bit over the years, but definitely not as much as those who started their families later.

[Rick Francis]

I think the lifetime balance sheet is an interesting idea, however it is dangerous to count on Human Capital. It will always be an estimate, and one that is tricky to get right. A career change or poor health would radically change the value.

I wouldn’t trust any calculations based on Human Capital- especially something like consumption smoothing where you borrow (or save less) when you are young on the assumption that your Human Capital will allow you to make up the savings in the future.
-Rick Francis