Just past midlife, many people get super focused on increasing net worth before retirement.
What net worth do you need to retire? It depends on how much money you spend, how your net worth is allocated among assets, the income those assets generate and their potential to increase in value, and other income sources.
In this post I’ll address each of these factors. While I am an Accredited Financial Counselor®, I write what I have learned from almost 40 years of investing, 15 years creating diversified income streams and being fascinated by money for a lifetime.
How Much Money You’ll Spend in Retirement
The starting point in knowing what net worth you need to retire is your expenses.
Feeling in Control of Your Expenses
While it doesn’t always feel like it, the amount of money you spend before or in retirement is something you control.
But, but, but….
I get that there are many financial obligations that don’t feel like you can choose whether to pay or not.
Here is the magic: Simply acknowledging that you are choosing how to use your money removes feeling like a victim to your circumstances.
In other words, if you are helping your adult child it’s because you want to do so. (I completely get there this is a complex issue, and am not suggesting this, only pointing out that if you are, it is a choice.)
You are paying for your doctor out of network or alternative wellness treatments because you want to do so.
You are paying for your insurance even though the cost has increased because you want to keep the policy.
So, before your mind goes to financial obligations due to health, aging parents, insurance, college, mortgages, dependent family members, or other expenses that don’t feel like a choice, own that you do have a choice. From there you can feel in control of your money, not the other way around.
This is a huge step in financial independence, along with many other things in life.
Prioritize how you use your money based on what’s important to you.
Then spend based on your priorities. I explain this more in my post How to Create a Wealth Plan.
Having that out of the way, let’s move to the next aspect of spending in retirement which is much more cut and dry.
Your Lifestyle Expenses
The lifestyle you choose to live determines your expenses. See how much you spend now if you don’t know already.
While there are all kinds of analysis about how much you’ll decrease spending do after retirement, assume you won’t want to spend less if you’re unsure.
Then use this as the foundation for how much income you’ll need in retirement.
Net Worth Allocation Among Assets
Remember that net worth includes all your assets.
While Rich Dad Poor Dad author Robert Kiyosaki argues that a home is not an asset because it creates expenses and does not generate income. In my humble opinion it is just that: an asset that incurs expenses and usually generates no income but it is still an asset.
Fortunately, nowadays, many smart retirees are also generating income from their homes by renting a portion of it through AirBnB.
But for most homeowners, a home does not generate income.
Therein lies the problem with having too much of your net worth in your home. (Read my related post How Much of Net Worth Should Be in Your Home?)
Living Off Investments Aha – The more net worth you allocate to wealth building or income generating assets, the less net worth you need to retire.
Net Worth Home Allocation Example
The huge impact your net worth asset allocation has on how much you need to retire is best understood with examples.
The $1,000,000 Home
Let’s say you have a home that increased in value over the years to $ 1,000,000. It is 80% debt free. But your investments haven’t increased in value much, so your net worth is $1,000,000 including your home equity of $800,000.
In this case, you only have $200,000 worth of investments to live off in retirement.
On the other hand, let’s look at another examples where your home was also 80% debt free and had increased in value over the years to $ 1,000,000.
Recently, however, after prioritizing your expenses, you downsized and moved to a lower cost area clearing $500,000 from the move.
No taxes were owed on that big capital gain from the home sale. That money went into investments.
But you’re no money saint. Just like the above example, your investments haven’t increased in value much, so your net worth is still $1,000,000 including your home.
In this example, you have $700,000 ($200,000 + $500,000) to generate income in retirement and grow in the meantime if invested in assets that will increase in value.
Read my related post Playing Catch Up Retirement Savings with 59 Uncommon Solutions.
Assets That Build Wealth
Because, being older, I am very low risk and tend to write with a lean towards very conservative (realistic) projected returns, I’ll briefly address the probability of assets increasing in value.
Whether the assets will increase in value is a factor of overall market trends, valuations, and the investments chosen. Please don’t assume that investing $700,000 in the stock market will grow at 10% a year based on long term historical stock total returns for anything less than at least two decades.
Click any of my post titles to read more about this super important topic: What Will Stocks Do Over the Next 10 Years, Reducing Risks in Stocks, What Goes Up When Stocks Go Down?, How to Evaluate an Investment and How to Know If the Stock Market Will Go Up or Down.
There is more about assets that build wealth as part of your net worth below.
Income Generating Assets Vs Retirement Withdrawals
Our approach to living in retirement was to avoid withdrawals from retirement savings as much as possible. I call this “living off investments” or alternative income streams Vs “spending your hard earned investment savings” with traditional retirement withdrawals such as the 4% Rule.
(I explain this more in my post Is It Safest to Withdraw of Get Investment Income?)
Having clarified this, let’s see how much income could be generated from the $700,000 from the earlier example.
In a well diversified stock portfolio with high dividend stocks yielding 5.5%, the income would be $38,500 a year.
If a covered call strategy were sold on these same dividend stocks during sideways and bull markets, adding another 5.5% a year would be a very reasonable estimate. This equates to another $38,500 a year.
On the other hand, $700,000 invested in a typical diversified portfolio of U.S. Treasury bonds and a stock income focused fund (mutual fund or money invested with a traditional wealth manager) would yield around 3% these days. This would equate to passive income of $21,000 a year.
There are many other alternative income generating investments that yield more, such as real estate rentals, MLP’s, REIT’s, real estate lending and online businesses to name a few.
I give more examples of income generating assets in my post How Much Do I Need to Invest to Make $10,000 a Month and How to Get More Income from Investments?
Increase in Value = Wealth Building
The potential to for the assets that make up your net worth to increase in value is the next factor to determine what net worth you need to retire.
Again, an example is the best way to illustrate this point.
Net Worth – Example 1
Let’s say your net worth is $2,000,000.
Your net worth includes:
$ 1,000,000 in a money market yielding 1.5%
Your home with an appreciated value of $1,000,000. The real estate market has been rising for 10 years in this example.
There is very little probability that the assets currently making up your net worth will build wealth for you.
Net Worth – Example 2
You have a $2,000,000 net worth in this example, too.
Your net worth includes:
$ 700,000 in stocks that were bought at low valuations following a bear stock market. These stocks yield 4% on average. You’re saving this dividend income since you are still employed and don’t need to income.
A home with a current value of $ 500,000 you bought under market value from an estate that was eager to sell. You lease the garage apartment on AirBnB and make about $ 1,500 net income a month.
$300,000 invested in slightly alternative income generating assets including mostly REIT and MLP funds. They yield 6% and were bought at low valuations so they have a good probability of increasing in value (building wealth).
$ 500,000 in a money market to lower risk and be used for undervalued assets as opportunities arise.
As the 2 examples illustrate, both investors have net worth of $2,000,000. There is almost no chance that the assets will increase in value, however, for investor 1.
On the other hand, investor 2 has a high probability that her assets will increase in value.
While the primary investing focus for retirees is income generation, having assets that generate income and can build wealth leads to having more of both.
It stands to reason that when you own assets that have a high probability to increase in value, logically, you need less net worth to retire.
This topic is covered more in my post Best Assets to Build Wealth.
Other Income Sources
In assessing how much net worth you need to retire, other income sources can completely change the amount needed so this is the next factor to consider.
Sure, in the U.S., social security is available now but there can be so many more income streams.
And many people want to retire before 60.
And the continuation of social security is not an absolute guarantee.
Alternative Income Sources
Income from online business, consulting or working part time is an excellent solution for those lacking enough savings to retire comfortably before age 62 when social security becomes an option.
We had no idea what we were doing when we started an online business and it has been a game changer for us on so many levels.
And given the choice between cross word puzzles and creating income streams for brain stimulation as I age, I’ll pick income streams, at least for the next couple of decades.
Generating Income Vs Retirement Withdrawals
Generating income of $ 24,000 a year is like having another $600,000 of retirement savings in comparison to the 4% retirement withdrawal rule! Here’s the math:
$24,000/.04 = $600,000
Is that crazy? I love the math on this!
In other words, retirement savings of $600,000 generates $24,000 of income using the 4% Rule. Yes, we are comparing different income sources that have some variables.
Yes, retirement withdrawals are passive, and the income generation methods suggested are usually active, but this isn’t always the case; some online income sources generate passive income.
It’s true that there are differences in comparing income generated to retirement withdrawals.
But we’re comparing gala apples to honey crisp apples, not apples to oranges. This is a very valid analogy.
The reality is that we’re living longer and the opportunities have never been better to generate income streams from your skills, hobbies or passions.
Summary for What Net Worth You Need to Retire
We all love cookie cutter rules. They give us comfort.
But as usual at Retire Certain, there is no cookie cutter solution for what net worth you need to retire.
But by creating a wealth plan and embracing your financial presence and future, there are a multitude of options for financial independence these days.
And financial independence means a comfortable retirement is an option, no matter if you’re 50, 60 or 65.
If you’re interested, get my newsletter and grab my free eBook on wealth building strategies that generate income streams in retirement, too.
Disclaimer: Nothing in this post is meant to be taken as personal financial advice. Only you are responsible for your own money.