How much net-worth do you need to retire?
I’m often asked ‘How much net worth do I need to accumulate before I can retire?’ While everyone will have a different number depending on their wants and needs, let’s try to figure out yours.
Net Worth, Assets & Liabilities
Your net worth (aka net assets, net wealth) is what’s left over if you cashed in all your assets, and paid out all your liabilities.
Keeping things simple, an asset is something of value, and a liability is a debt you owe. For example, if you purchased a car using a car loan then the car’s value is the asset, and the balance of the car loan is the liability.
You can further split your assets and liabilities into two categories: lifestyle and financial. Lifestyle assets are items of value you own for necessity or enjoyment: home, clothes, car, furniture, etc. Lifestyle debt is money you borrow to purchase lifestyle assets. Financial assets are investments you purchase for return, and financial debt is money you borrow to purchase financial assets.
Here’s a diagram that summarises how to calculate your net assets (i.e. net worth):
Are You Rich?
If you find yourself in a situation where your liabilities are higher than your assets then you have negative net worth and are said to be ‘underwater’. Someone who can’t repay their liabilities is said to be insolvent, or more colloquially, flat out broke.
If you’d like to compare your situation against the so-called Joneses, a Credit Suisse report ranked Australia as the richest country in the world, noting that at the end of 2021 the average Aussie had a net worth $410,000. The same report declared there were an estimated 390,000 Aussie millionaires, so pulling out my trusty calculator and dividing by our estimated population of approx 25.5m people, if you have a seven figure net worth then congratulations – you are in the top 1.5% of wealth builders and are amongst the richest of the rich.
Before moving on, have a go at filling in the boxes in the diagram above to tally up your lifestyle and financial assets and liabilities and calculate your net worth.
What Do The Results Indicate?
Here’s a saying to remember: the more you do of what you’ve done, the more you’ll get of what you’ve got.
Your present net worth is the product of your financial mindset and habits applied over time. Therefore, unless you improve your financial IQ and / financial EQ (i.e. the way you think, act and feel about money) then your future is unlikely to be any better than your present, and possibly considerably worse once you retire and cease receiving employment income.
If your current net worth is strong, then well done and keep it up. If it’s not, or you want it to be better, then you’ll need help to up-skill and change your thoughts and behaviours before it’s too late.
What’s Your Magic Number?
My suggested magic number for a net worth number to aim for enough financial and lifestyle assets to afford the lifestyle you want in retirement. The goal is to be debt-free and have no financial or lifestyle liabilities.
It’s important to point out that retirement isn’t necessarily the domain of older citizens. More and more, younger people are quietly quitting or seeking to be financially independent sooner so they can retire early.
Financial Assets
The amount of financial assets you need can be calculated by working backwards. That is, by dividing your desired annual income by your expected average investment return.
For example, if your annual desired income was $80,000, and you had the skill to achieve an 8 per cent annual return, then you would need financial assets totaling $1,000,000. That is, $1,000,000 invested at 8 per cent per annum will generate an income from your investments of $80,000 each year for the rest of your life.
If you’re finding this all a bit confusing then you might find my ’10 and 8 Rule’ helpful. Simply multiply your current gross income by 10 to get your debt-free financial asset goal, and then multiply that result by 8 per cent (0.08) to get your estimated annual investment income. For instance, if you earned $70,000 per annum then your debt-free financial asset goal would be $700,000, and you would have an annual investment income of $56,000 to fund your retirement.
Lifestyle Assets
The amount of your lifestyle assets, such as home, furnishings, car, clothes, etc. all need to be added into the mix. The more extravagant your lifestyle needs, the larger your annual income will need to be to pay for it (and hence you’ll need more financial assets or the ability to achieve higher investment returns), and the bigger the lifestyle asset balance will need to be.
Summary
Taking into consideration everything we’ve discussed, here’s a blueprint you can follow to calculate your required net worth, and that also reveals how much more wealth you need to attract and keep to achieve your goal.
Have a go at filling in the boxes, working across each row left to right. If you end up with a surplus then you already have enough assets, you just need to redeploy them so your money is working harder for you.
Edited extract from Steve McKnight’s Money Magnet: How to Attract and Keep a Fortune that Counts (Wiley $32.95), available now at all leading retailers.
Image credits: Supplied / Getty Images