Most people look to the day when their net worth is large enough that they can retire with relative ease. Of course, accumulating the necessary funds to do this is no easy task, and it can be difficult at times to determine whether or not you will achieve your retirement goals if you continue on your current path. The following methods have commonly been suggested as a reasonably reliable means of evaluating your current net worth.
Thomas Stanley and William Danko, authors of the bestselling book "The Millionaire Next Door," suggest that you simply take your age and multiply it by your current annual income before taxes from all sources (except for inheritances, which are only paid once). Divide the total by 10, and the quotient is what your net worth should be at that point in your life.
There are some who critique the previous method, because it fails to take some life circumstances into account, such as a recent graduate with lots of student loan debt or those who earn low income over a lifetime. They instead espouse a slightly more complex formula that takes greater account of any increase in income that the person has had over the years. First, you must add up the total of your earnings for the last 10 years and then divide by 10 to get an average number. Subtract a minimum living wage, such as $20,000, and also subtract another $5,000 for every other member of your household. Multiply the remainder by your age and divide this number by eight to arrive at what your net worth should be. For example, if you are 35 and married with one child and your average income for the past 10 years was $60,000, then subtract $30,000 from your average income and multiply the remaining $30,000 by eight to get $240,000. This would ideally be about what you are actually worth at this point in your life.
A simple time value of money calculation may be the most straightforward means of assessing your retirement savings progress. If you do not own or do not know how to use one of these, there are several good TVM calculators available online. This method does not require you to find your current net worth. Instead, you will simply project how much your assets will grow and how much your liabilities will decrease between now and your projected retirement date.
You are 40 years old and have $250,000 saved for retirement. You make $60,000 a year and contribute 10% to your company retirement plan each year. You would like to retire at age 67 with $1 million in liquid assets, not counting your house and other possessions, with no debt. You have $150,000 left on a 30-year mortgage that you took out five years ago.
- $250,000 present value of retirement savings
- $6,000 annual contribution
- 27 years to retirement (67-40)
- 6.5% projected average annual growth of retirement savings
If you plug these numbers into a TVM calculator, it will tell you that you will have about $1.1 million dollars by age 67. You seem to be on track for at least that portion of your plan. Since your mortgage will be paid off by retirement, then you should be close to debt-free as well.
The Bottom Line
If your calculations show that your current net worth will not get you to where you want to be, then you will need to either increase your retirement savings contributions in some fashion or divert extra money toward debt reduction. For more information on how to assess your net worth, consult your financial advisor.
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