Wednesday, May 09, 2007

Retirement Planning - Focus On SPENDABLE Net Worth

I notice many personal finance bloggers focus on Net Worth. The definition of net worth is assets minus liabilities. A simple definition of an asset is any thing that you own. A liability is any debt that you have. For me, a more important number for retirement calculations is what I call Spendable Net Worth. I define that as spendable assets (e.g. stocks, bonds, and cash) minus liabilities.

I do not use my entire net worth to estimate retirement readiness. This reason is because some parts of net worth, such as a house and personal belongings, can't easily be used to fund a retirement. To illustrate, consider the following two hypothetical people and whether they could retire immediately.

Ima Saver decided to rent her home and live a modest life. Her biggest asset is her savings. Lot O'Stuff decided to spend most of his income on tangible assets - a nice home, a vacation home, nice cars and nice furnishings. Both have the same net worth of $1,050,000.

CategoryIma SaverLot O'Stuff
Personal Property
Net Worth$1,050,000$1,050,000
Spendable Net Worth$1,000,000

Suppose both get an offer to retire in the next year. While both have the same net worth, spendable net worth is the best indication of ability to retire. Ima is in a position to consider the offer. For Lot, his options are to continue working or to sell off his assets to fund retirement, which is not likely.

For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

This is not financial or retirement advice. Please consult a professional advisor.

Copyright © 2007 Achievement Catalyst, LLC


Medicated Money said...

Interesting point! This is one main reason we do not include personal property into our net worth calculation.


Dimes said...

I wouldn't include personal property into net worth calculation, though I do count our vehicles. Possibly I should take them out?
A house is most definitely a frozen asset.

CRM said...

A bit of a problem: If all else is held equal, your math's wrong. Assuming they have the same income, Ima Saver couldn't have saved up $1M and still paid rent. Best case, Ima has $500k in savings (the amount of the other guy's mortgage). Ima's net worth by your calculation would be $550k, whereas Lot O'Stuff's net worth would be $50k--$550k in assets less $500k mortgage.

CRM said...

If all else is held equal, your math's wrong. Assuming they have the same income, Ima Saver couldn't have saved up $1M and still paid rent. Best case, Ima has $500k in savings (the amount of the other guy's mortgage--she had to pay out rent at market rates, which are subject to inflation, wherease Lot's mortgage payments *could* be fixed). Ima's net worth by your calculation would be $550k, whereas Lot's net worth would also be $550k, ($1M house + $50k savings minus $500k mortgage).

Super Saver said...

Medicated Money and Dimes,

Thanks for your comments. I know there is a lot of debate in the blogosphere on what should be included in Net Worth. Maybe there should be a new term - Liquid Net Worth. There seems to be a number of people using this value instead of the standard Net Worth.


Thanks for you comment. I agree with your point if Ima chooses the same lifestyle (expensive home, cars, vacations, low savings) as Lot. Although I didn't show detailed numbers, there are scenarios of equal income (with different lifestyles) where Ima would save one million and Lot would save very little. For my example, I assumed Ima lived a "modest" lifestyle and put the difference in savings. Modest could be a 1 bedroom apartment, older used cars, and saving 20% of her income.

The Trader said...

I think another key point missed is the saver will continue to have to pay increasing rent while O'Stuff can pay off his mortgage and only have to pay taxes and upkeep which is much less over time. Throw in appreciation and I still think O'Stuff made the wiser moves aside from the vacation home. ;)

Super Saver said...


Thanks for your comment.

Without debating the point too much:-), your scenario is a possible one. Also, in my experience, property taxes seem to be ever increasing at rates faster than inflation. So if Ima rents a modest house or apartment, Lot's retirement housing costs might still be higher than Ima's. However, without actual numbers, these are all just possible scenarios.

The Trader said...

True - I guess I'm more of somewhere in the middle - Modest house + modest car + 12% in 401k since I started working + invest the best I can with my after tax $.

Btw, I like your blog and have added a link from mine.

Super Saver said...


Thanks for the link and welcome to the Investors Blog Network.

I typically update my blogrolls at the end of the month and will add a link to My Trader's Journal at that time.

threadbndr (karla) said...

I also don't include personal property/furnishings/vehicles in my net worth. I do include my house, but I tend to do two calculations. The first one is the 'classic' net worth - with the house and with all my 'accrual' accounts (for upcoming house project, car repair and replace, property tax - etc).

The other one is my 'adjusted' net worth without the house and accrual accounts - what the poster above calls 'liquid net worth' (though I don't consider the retirement accounts particuarly liquid). THAT's the one that I like to see going up.

J at IHB and HFF said...

Hello. I agree that net worth is unhelpful and I recently called the issue “Practical Wealth V. Phantom Wealth.” I also posted "Biggest Net Worth Mistakes" just a few days before your post here (coincidentally), so feel free to visit (click my name link) and comment. Thank you.