Here's a piece on net worth courtesy of Marotta Asset Management. It details how to calculate your net worth as well as looks at several benchmarks for you to determine how well you're doing financially:
Are you on track to meet your [financial] goals? Have you measured? What gets measured is more likely to be accomplished. Computing your net worth once a year is the first and most important step toward financial security.
Net worth is a snapshot of how much money would be left if everything you owned were converted into cash and all your debts were paid off. Your net worth is computed by creating four smaller lists.
Liquid assets: An asset is something that you own that is worth significant value. A liquid asset is something that can be sold in a matter of days. Include all of the following types of investments: personal bank accounts (checking, savings, money market), certificates of deposit, bonds, mutual funds, stocks, and exchange traded funds. Use values as of 12/31 of the previous year so that all of your amounts will be on the same day.
Non-liquid assets: Non-liquid assets are those things that you own that cannot be quickly and easily sold without penalty. In this category include the value of your retirement accounts (IRAs, 401ks, 403bs, Keoghs, Profit Sharing Plans, and Pension Plans). Also include any real estate investments including the market value of your home. In the Charlottesville area using the assessed value is an easy indicator of the market value of your home.
Other non-liquid assets can include business interests such as proprietorships, partnerships, or company stock in a company that is not publicly traded. Include the cash value of any life insurance that is not term insurance. Some people include personal property such as jewelry, collectibles, cars, and boats in this category. While these often have a high retail value, their true worth is often a small fraction of their initial cost. I recommend not including personal property.
Immediate Liabilities: Now list what you owe to creditors. These are called liabilities and are also divided into immediate liabilities and long-term debt. Immediate liabilities include credit card debt, car loans, student loans, and any other loan, bill or debt that must be paid within two years.
Long Term Debt: The last category lists long-term debts. For most people this is primarily their home mortgage, but may include other real estate or business loans.
The first time you gather all of this information will be the most challenging, but in subsequent years it becomes much easier. By keeping a record of your net worth each year, you have a valuable tool for financial planning.
Now compute three additional values: Your Total Assets by adding your Liquid Assets and Non-Liquid Assets. Your Total Liabilities by adding your Immediate Liabilities and Long Term Debt. And finally, determine your Net Worth by simply subtracting your Total Liabilities from your Total Assets.
Now that you have computed your Net Worth, you can use these numbers to compute other values useful for reaching your financial goals.
Your Emergency Reserve (Liquid Assets minus Immediate Liabilities) should be at least half of your annual income. Any amount more than this can be invested more aggressively for appreciation. Your Debt Load ratio (Total Liabilities divided by Total Assets) should be under 35%, with your home mortgage comprising the majority of your debt. If you are aggressively trying to pay off your mortgage instead of aggressively trying to save and invest, your efforts are laudable, but mistaken. The quickest path to wealth includes having a home mortgage that could be paid off, but choosing not to in order to take advantage of the tax benefits. The rich wisely leverage and invest.
The most important use of a net worth statement is to measure your progress toward retirement. In order to retire at age 72 and have sufficient funds to maintain your standard of living you need about twenty times your annual spending.
Take your net worth and divide by your annual take home pay. This is how many times your annual standard of living you have amassed in savings. If you are under 40, the number is probably less than five. That’s ok; it is supposed to be.
Progress toward retirement is not a linear function. To those of you wondering if the math you studied in high school is useful, the following equation was determined by quadratic regression. It estimates how much of your current net worth you should have saved given your age. This gives you a benchmark for determining if you are on track to retire by age 72.
Take your age and divide by 166. Then subtract fifteen hundredths (0.15). Finally, multiply the result by your age. The resulting number should be between zero and twenty. That number is how many times your current annual income you should be worth.
Pull out your calculator and follow an example. If you are 45 years old then forty-five divided by 166 equals 0.2711. Subtract 0.15 to get 0.1211. Then multiply by 45 again. The result is 5.45. By age forty-five you should be worth about five and a half times your annual spending. More sophisticated retirement planning includes the difference between taxable, tax deferred and Roth accounts as well as Social Security guesses and defined benefit plans, but this is a good approximation of your progress. Here is a table that shows by what age you should have saved different multiples of your annual spending.
Age, Annual Spending Saved
- 30, 1
- 35, 2
- 38, 3
- 42, 4
- 44, 5
- 47, 6
- 49, 7
- 51, 8
- 53, 9
- 55, 10
- 57, 11
- 59, 12
- 61, 13
- 63, 14
- 64, 15
- 66, 16
- 68, 17
- 69, 18
- 70, 19
- 72, 20
If your net worth is a higher: Congratulations! You are on the path to retiring earlier than 72! For every 0.5 you are over, you could consider retiring about a year earlier. Conversely, for every 0.5 you are under your age’s benchmark you may have to work an additional year beyond 72.
Between the ages of 40 and 60 your net worth should increase by one unit of your annual spending every two years. That means that your current net worth divided by your take home pay should be one unit greater than it was two years ago. Alternately, if you are between 40 and 60, your net worth should have increased this year by half of your take home pay.
This is because money makes money, and by the time you are in your 40’s you should have enough investments to be earning about half of your annual spending each year. The compounded growth of your investments does the lion’s share of the work while you only need to contribute 15% of your current earnings. If you save 15% of your take home pay between age 20 and age 72 you should have sufficient savings in retirement. This is despite the fact that you will have saved less than 7 years worth of pay and many of those years will have been at a lower rate of pay. How much you save and invest is the primary determination of your financial future.
Want to retire younger? Try lowering your standard of living. In retirement, most people spend about 70% of the gross salary they earned while they were working. If you can live off 50% of your take home pay, you don’t need as much savings to maintain that lower lifestyle.
Need to catch up? Save more than the 15% of your take home pay. Determine how far you are behind and what additional percentage you can save each year. For example, at age 30 you should be worth 1.4 times your annual income. What should you do if you are only worth 1.1 times your annual income? Normally, to stay on track you need to save 15% of your income each year. In order to catch up you need an additional 0.3 times your annual income. One option would be to save an additional 10% of your income for three years. If saving 25% of your income is too much, try saving 20% (an additional 5%) for six years.
All of financial planning begins with a clear understanding of your net worth. We have a template in PDF format on our website (www.emarotta.com) that you can use to help you compute and keep track of your net worth each year. Contact us or visit our website to receive a free copy.
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Ha! Compute net worth once a year? I compute mine monthly!
I score fairly well on his list of measurements. Here are the details on where I stand on some of the benchmarks he discusses above:
- Emergency Reserve (Liquid Assets minus Immediate Liabilities) should be at least half of your annual income -- Mine is four times my annual spending (which is different than my annual income, but is a more relevant measure in my estimation.)
- Debt Load ratio (Total Liabilities divided by Total Assets) should be under 35%, with your home mortgage comprising the majority of your debt - I have no debt other than credit cards which are paid off monthly.
- Net income at my age - He uses both annual income and annual spending in his formulas, and for people who spend less than they earn (and can live on less than they earn), this make a big difference. I use annual spending when estimating retirement needs and the like because it's more accurate -- it reflects what I actually need. On this basis and at age 42, my net worth should be 4.33 times my annual spending. It's currently at 13 times my annual spending, so I'm doing fairly well here. This makes me eligible (based on his formula) to retire 17 years "early" (as defined as age 72 by him.) So maybe I should start planning to kick back at 55, huh? That's only 13 years away. Cool! (And scary!!!)
- Between the ages of 40 and 60 your net worth should increase by one unit of your annual spending every two years - Due to the power of compounding, my net worth is increasing at the rate of one time my annual spending every year.
One more thing I want to comment on is this quote:
If you are aggressively trying to pay off your mortgage instead of aggressively trying to save and invest, your efforts are laudable, but mistaken. The quickest path to wealth includes having a home mortgage that could be paid off, but choosing not to in order to take advantage of the tax benefits. The rich wisely leverage and invest.
I generally like his advice, but disagree with this statement for a number of reasons. My path has been to pay off all debt (including my mortgage) while saving a good amount as well, then super-charging my saving once the house was paid for and I've done pretty well. Yep, I miss out on the tax "savings" of deductible mortgage interest, but do you know what else I miss out on? Paying the interest itself. And the interest is MUCH more than the tax savings. Besides, while his advice to keep a mortgage and save at the same time may still make sense mathematically, I've never seen it applied practically to any good result. As such, I'm a "save a bit and pay off debt" proponent. If you're interested in my thoughts on what to do in what order, see The 10 Best Money Moves You Can Make.
There's a discrepency in the top portion of the article. Is the multiplier to be used for annual income or annual spending? The article seems to flip between the two, as if they the same.
Posted by: savvy saver | October 14, 2006 at 09:32 AM
Agree with paying off the debt...Freedom is measured in many ways and debt free is a great place to be. I am almost debt free and find I can save more money without a mortgage payment. At some point, the tax savings for me were not substantial as the longer towards an ammoritization schedule end date, the less tax savings as the interest is much less than the principle. Also, not having debt allows me to over-save on a weekly basis and drive into investments. I am still not buying into the debt culture and while some debt is required as a mortgage, not having one allows me many other options in my life.
Posted by: Simplicity in Kansas | October 14, 2006 at 10:51 AM
Remember, good debt is debt that earns more than it costs. A 6% mortgage after taxes and inflation would be something like 1-2%, 3% tops, real. You can't earn a real return more than that investing? Shame on you. The point is not to pay it off, but to be able to pay it off whenever you need to and investing should allow that. No where else will you ever be able to invest so cheaply.
Posted by: Lord | October 14, 2006 at 02:28 PM
This is the best of the net worth Vs age formulas I've seen, assuming it really is based on spending and not income which is not entirely clear from the description. Also is more reasonable in that a 20-year-old is not expected to have one or two year's income saved up instantly as some of these type of formulas suggest.
I agree with the recommendation that personal property should not be included in calculating net worth. How much could I really get at a garage sale? For my house, I value it at 75% of the tax appraisal, to account for any overvaluing and the costs of selling the property.
I doubt that many people try to factor in the taxes that could reduce the proceeds from a tax-deferred acount like a 401K. I expect the vast majority just plug in the 401K balance and regard the entire amount as an asset. That would be reasonable if you're at retirement and only have $40K in tax-deferred savings -- spread out over several years the annual withdrawals could be less than your personal exemptions and standard deduction ($8450 for a single person). But at some point past that, withdrawing $1 of tax-deferred savings can cause $.50 or $85 of social security to be taxed, effectively increasing your marginal tax rate. Conceivably you could pay a much higher tax rate in the future than what you're deferring this year. And if I really tried to liquidate now I'd have to pay a 10% penalty plus being put into a high tax rate.
Personally, I devalue my tax-deferred savings balances by my current marginal tax rate when I calculate my net worth, which I also do monthly. I can do this since I use a spreadsheet I've set up instead of Quicken, Money, or similar program. Even after this adjustment, my net worth is 13 x spending putting me about 10 years ahead of the point I should be.
I also chose to pay off my mortgage early, reducing 30-year notes down to around 15 years. Perhaps I could have made more by investing the extra payments, but it's nice having to only write 2 checks per year instead of 12. (Still have to pay the taxes and insurance. Well, perhaps not the insurace.) The money I had been sending on my mortgage principal and interest now goes into retirement savings.
I'm not following the logic that having an extra 1/2 a year's spending saved up would allow you to retire an entire year earlier. Particularly since in the age range where most people retire you're expected to accumulate an additional 0.6 -0.7 year's spending each year. Once retired, you stop accumulating and start drawing down, and even with some appreciation your spending is likely to exceed that.
Posted by: Mike | October 14, 2006 at 02:28 PM
I'm in the "keep the mortgage and invest savings" camp. Our taxable investments have grown at about 10-12%/year, which is far more than our mortgage's interest rate, so we're happy with our financial arrangements.
That said, we're happy that we crossed the threshold where we could pay off our mortgage with post-tax money a few years ago, so it's a "money management" decision for us to keep it.
As for the rest of the article, it's very good, although, like many retirement discussions, it's waffly on "take home pay" versus "living expenses" (or "standard of living"). I do wish writers of these types of articles would be as careful with definitions as they are with numbers. I think part of the reason they get away with this imprecision is many people _only_ save for their retirements by using 401Ks and IRAs, and don't have much in the way of taxable savings.
Posted by: Foobarista | October 14, 2006 at 02:51 PM
I like that formula a lot- unlike the other one you've mentioned (from Millionaire Next Door?) it works even if you're fairly young. At ages below 25, the number is negative, though- so by that standard, having a positive net worth, I'm doing pretty well!
Posted by: Meaghan | October 15, 2006 at 01:13 PM
I've witnessed plenty of people who don't pay down the mortgage and invest the difference, but for the vast majority of homeowners the mortgage serves as a forced savings plan. A healthy financial statement in my opinion often includes a mortgage along with liquid assets equal to or greater than the mortgage balance. That said, I can understand the added sense of security in paying down the home loan.
As for frequency to compute net worth, between the ages of 18-35 I would do so monthly. From 35-50 I would do it quarterly and from then onward maybe twice a year or yearly. After a certain point the measurement reflects volatility more than performance and requires a wider window of observation.
Posted by: Duane Gran | October 16, 2006 at 09:01 AM
One other thing I would point out is that although 15% savings should be enough, it never is. There are too many problems that occur during life, accident, illness, divorce, unemployment. These can prevent reaching your goal saving only 15%.
Posted by: Lord | October 16, 2006 at 11:44 AM
'If you are aggressively trying to pay off your mortgage instead of aggressively trying to save and invest, your efforts are laudable, but mistaken. The quickest path to wealth includes having a home mortgage that could be paid off, but choosing not to in order to take advantage of the tax benefits. The rich wisely leverage and invest.'
I can tell this was written before 2008.
Posted by: Ryan | June 12, 2012 at 09:29 AM