Compute Your Net Worth Once a Year

The following is a guest post from Marotta Wealth Management. I actually compute my net worth once a month. I'll be discussing my year-end 2011 net worth soon on an upcoming post.

Since the end of last year, the U.S. markets went up and then down and then back up to end the year sideways. Market volatility was especially pronounced in the European Union as sovereign debt and the struggle to enact austerity measures whipsawed the markets, although not as a result of any changes in the underlying fundamentals.

If you are within 20 years of retirement (age 45 to 65), it's critical to get your retirement planning updated. Computing your net worth annually is like taking a sextant reading to chart your course toward financial security. The changes of the past year provide another incentive to take stock of where you are in relation to your goals and readjust your asset allocation and savings rate.

Net worth gives you a snapshot of how much money would be left if you converted everything you owned into cash and paid off all your debts. Compute your net worth by creating four lists.

• Liquid assets: An asset is something you own that has significant value. A liquid asset can be sold in a matter of days. Include personal bank accounts (checking, savings and money market), certificates of deposit, bonds, mutual funds, stocks and exchange-traded funds. Use values as of December 31 of the previous year so all of your amounts are calculated on the same day.

• Nonliquid assets: Nonliquid assets are those things you own that incur a penalty when they are sold. Include the value of your retirement accounts (IRAs, 401ks, 403bs, SEPs, profit-sharing plans and pension plans). Add real estate investments as well as the market value of your home. Use the assessed value.

Other nonliquid assets may include proprietorships, partnerships or company stock in a firm that is not publicly traded. Add the cash value of any life (nonterm) insurance. Some people include jewelry, collectibles, cars and boats in this category. Although these items often have a high retail value, their true worth is often a small fraction of their initial cost. I do not recommend including personal property.

• Immediate liabilities: List what you owe to creditors. Immediate liabilities include credit card debt, car loans, student loans, other loans and any bill or debt that must be paid within two years.

• Long-term debt: For most people, long-term debt is primarily their home mortgage, but it may encompass other real estate or business loans.

The first time you gather all of this information will be challenging, but it gets much easier each subsequent year. By keeping an annual record of your net worth, you're creating a valuable financial planning tool.

Next compute three additional values. For your total assets, add your liquid and nonliquid categories; for your total liabilities, add your immediate liabilities and long-term debt; and finally, for your net worth, simply subtract your total liabilities from your total assets.

Use these net worth numbers to compute other values useful for reaching your financial goals. For example, your emergency reserve (liquid assets minus immediate liabilities) should be at least half your annual income. Any extra 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 most of your debt.

If you are trying hard to pay off your mortgage ahead of schedule instead of making a huge effort to save and invest, your attempts are laudable but mistaken. The quickest path to wealth includes holding a home mortgage you could pay off but you choose not to in order to take advantage of the tax benefits. The rich leverage wisely and invest.

A net worth statement helps you measure your progress toward retirement. At age 65 you can only withdraw 4.36% of your portfolio to maintain your lifestyle. In other words, to keep the same standard of living, you will need about 23 times what you spend annually.

Take your net worth and divide it by your annual take-home pay. The result shows you how many times your annual standard of living you have amassed in savings. If you are younger than 40, the number probably comes to less than five, which is adequate for now.

By age 45, you should be worth about seven 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 the method described here will approximate your progress. This list shows by what age you should have saved different multiples of your annual spending.

    Age: 26; Annual Spending Saved: 1
    Age: 31; Annual Spending Saved: 2
    Age: 34; Annual Spending Saved: 3
    Age: 38; Annual Spending Saved: 4
    Age: 41; Annual Spending Saved: 5
    Age: 43; Annual Spending Saved: 6
    Age: 45; Annual Spending Saved: 7
    Age: 47; Annual Spending Saved: 8
    Age: 49; Annual Spending Saved: 9
    Age: 51; Annual Spending Saved: 10
    Age: 53; Annual Spending Saved: 11
    Age: 54; Annual Spending Saved: 12
    Age: 55; Annual Spending Saved: 13
    Age: 57; Annual Spending Saved: 14
    Age: 58; Annual Spending Saved: 15
    Age: 59; Annual Spending Saved: 16
    Age: 60; Annual Spending Saved: 17
    Age: 61; Annual Spending Saved: 18
    Age: 62; Annual Spending Saved: 19
    Age: 63; Annual Spending Saved: 20

If your net worth is higher, congratulations! You may be able to retire earlier than 65. For every 1 unit you are over, you could consider retiring about a year earlier. Conversely, for every 1 unit you are under your age's benchmark, you may have to work an additional year beyond 65.

Between ages 40 and 50, your net worth should increase by 1 unit of your annual spending every two years. That means your current net worth divided by your take-home pay should be 1 unit greater than it was two years ago. And if you are between age 50 and 65, your net worth should have increased this year by 1 times your take-home pay.

Want to retire younger? Try lowering your standard of living. Most retirees spend about 70% of the gross salary they earned while working. If you can live off 50% of your take-home pay, it's not as essential to save as much.

Need to catch up? Save more than 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 1.5 times your annual income. If your numbers don't match that ideal, an additional 0.3 times your annual income will help you get there. You could save an additional 10% of your income (for a total of 25%) for three years. If that's too much, try saving 20% (an additional 5%) for six years.

Money makes money. By the time you reach your 40s, you should have enough investments to be earning about half of your annual spending each year. Early in life what you save is most important for building wealth, but as you approach age 40 what you earn on your investments becomes critical. While you are young, the best advice a professional can offer is to "save." As you amass significant wealth, it is more pressing to "manage" well what you already have.

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Some thoughts from me:

1. I will be updating my retirement plan soon and will report my progress to you all.

2. I like the fact that he emphasizes saving based on retirement SPENDING and not on current INCOME (which in many cases are not closely related).

3. My net worth is at 24 times my annual spending, so I guess I'm ready to retire. ;-)

4. Key point: "Want to retire younger? Try lowering your standard of living. Most retirees spend about 70% of the gross salary they earned while working. If you can live off 50% of your take-home pay, it's not as essential to save as much." Exactly!!!!!!

5. "Money makes money." Usually this is true. This year, the way the market was up and down, not so much.

Comments

[Jennifer Lissette]

I've been tracking my family's net worth monthly for about two years now. It's been nearly at 0 for almost the entire time as the value of our house plummeted. Now that it's finally seemed to reach bottom, our net worth has been going up. My husband's going to turn 31 next month and our net worth is almost exactly 2x our spending.

It feels good to know that despite the "plateau of despair" (as my husband calls it) that we experienced for 18 months, we might actually be on track. We hope to have our mortgage paid off in the next 3-4 years, then our net worth will really have room to grow.

[Catherine]

I use Mint, so I can tell my net worth at a glance (assuming the imports from Zillow for real-estate values are accurate). No need to make lists.

[Elizabeth]

I need to save more. I'm 3 units under.

[Nashville]

I guess I go against the grain but I check my net worth several times every WEEK! I don't get too frustrated or too excited but treat it as a very factual exercise. I don't want to go an entire month or, heaven forbid, an entire year not "resetting" my thinking. I do ask a lot of questions of my financial advisor but end up making very few changes. I have done this for years but more so as I approach retirement in 77 days.

Net worth divided by annual take-home pay? These kind of formulas always aggravate me. Does my wife's pension count as "take home pay"? Is my current 401(k) contribution part of "take home pay"? I don't know why it would as I don't spend it for current living expenses.

I know that I have 7-figure net worth. I have zero debt. I know my wife gets a very nice Uncle Sam pension along with affordable health insurance for us both. I know what I will draw in SS. In addition to pension and SS, to meet expenses without hurting (and a little splurging from time to time), I can pull 2 - 3% from portfolio every year and should be OK for long, long time. Then we have Long Term Care coverage to take us through the end stages.

[Jake]

I use Fidelity's Full View to manage my net worth. It pulls in all my online accounts and you have the ability to manually input custom assets and liabilities for accounts with no online access.

[billyjobob]

I check my net worth a few times every week. I don't include my house or my car. Both are paid for. From just saving and investments I have 31 times my annual spending. I guess I'm ready to retire. I'm 55, so I'll probably stay for maybe another 2-5 years. Right now my job is just so easy and stress free that I might as well stay. Its nice to know that if things chaged,(job stress) I could leave anytime I want.

[Familyancial]

I calculate my family's net worth every month. It's the only way to truly gauge how you're doing on a monthly basis. I want to see the net worth go up every month instead of going down. If it goes down due to some odd purchases, then i make sure it is made up during the subsequent months.

[Josh Stein]

Yeah, I calculate ours monthly as well, for the reasons you outlined there. Are we doing better? That's the major key for me.

And how quickly?

It allows us to have benchmarks (e.g. this is where we want to be at year's end, month's end, etc etc etc).

[Old Limey]

I keep track of my net worth (excluding our real estate and credit union accounts) every market day. I use my own software to do the calculations and the software that comes with the proprietary database I use in order to generate a graph in which I can compare my results with various funds or market indexes.

[Greg]

"For every 1 unit you are over, you could consider retiring about a year earlier."

I don't think this is true. Instead, for every *2* units you are over you, could consider retiring about a year earlier. This is because by retiring earlier you will have a longer retirement period which requires more assets to support you. Although, if you have enough assets you could probably live off the interest/earnings indefinitely.

[Philip]

At 31 and a ratio of 2, I guess I'm right on track. Most of this post makes a lot of sense. Like others, I track net worth at least monthly, and with a Mint account can see it any time.

I take exception to the following paragraph:
"If you are trying hard to pay off your mortgage ahead of schedule instead of making a huge effort to save and invest, your attempts are laudable but mistaken. The quickest path to wealth includes holding a home mortgage you could pay off but you choose not to in order to take advantage of the tax benefits. The rich leverage wisely and invest."

On the contrary, if you've read "The Millionaire Next Door," the very wealthy hate to borrow and spend much less than they earn. Many of them have paid-off houses. Do I really want to pay $10K in interest to save $3K in taxes?

As Dave Ramsey likes to point out, imagine the freedom you have without a mortgage payment. Imagine the risk it eliminates. It also contributes to the very net worth Marotta Wealth Management and FMF place so much emphasis on, and correctly so.

I am not a cynic, but it's not surprising that a post from a wealth management firm would prefer you to invest than to pay off your house!

[Evan H.]

We also calculate our net worth monthly, although we don't make a distinction between liquid/non-liquid assets and immediate/long-term debt. We'll definitely add these percentages to our spreadsheet for next month and see where we are against the benchmarks above.

[JoeTaxpayer]

The 20X goal implies an 80% replacement ratio. That's probably a good target, but I'm curious where social security fits in, if at all?
Most people will find Social Security replacing 30-45% depending on their lifetime earnings. 40% is what you'd withdraw from 10X annual earnings. Still, I agre with the goals in this article, as one doesn't know what the future will bring. Better to have too much at retirement than to be ill prepared.

[Lucas]

I really was enjoying reading this until I got to:

" The quickest path to wealth includes holding a home mortgage you could pay off but you choose not to in order to take advantage of the tax benefits. The rich leverage wisely and invest."

This is an untrue statement which has been pointed out by Philip above. I am curious to why the author believes this way? It seems to me it is more about making money for Marotta then sound financial advice.

[Rich Schmidt]

One other issue with the article, besides what has already been mentioned: For some reason, in the last section, it keeps equating and switching between "take home pay" and "annual spending." Which is it? Because anyone who is saving anything at all knows that the two numbers are not the same.

[Lisa]

After reading your article I computed my net worth. Did not include my husbands or my pension in the calculation . I did not know how to get cash value on them. Any suggestions

[FMF]

Lisa --

Do you know when you will receive it, how much you'll receive every month, and for how long?

[Lisa]

My husband if he left work right now...at age 55 would receive about 3000 per month. Mine is at 65 and I would receive about $650 per month. and that would be for life.

[FMF]

Lisa --

Others probably have better advice for you than this, but here are my thoughts:

Option 1: You shouldn't count it at all. After all you don't control it and don't have access to it until later in life.

Option 2: You can try and calculate the "net present value" of it and assign it that value. Google it for more info or see this calculator:

http://www.investopedia.com/calculator/NetPresentValue.aspx#axzz1mHUWT7aJ