Just past midlife, many people get super focused on increasing net worth before retirement.
What net worth do you need to retire? You’ll need enough assets to allow you to cover all living expenses with retirement account withdrawals of 3% to 5%, plus any other income sources, including social security. Also, living expenses should be adjusted for inflation annually when considering this.
In this post I’ll address these factors. While I am an Accredited Financial Counselor®, I write what I have learned from almost 40 years of investing, and 15 years creating diversified income streams about stumbling into early retirement.
How Much Money You’ll Spend in Retirement
The starting point in knowing what net worth you need to retire is knowing your expenses.
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 most financial experts and retirement planners recommend decreasing spending after retirement, I don’t.
- Assume you won’t want to spend less if you’re unsure.
- Determine your ideal lifestyle.
- Adjust your current living expenses for your desired lifestyle and use this as your monthly expenses.
Then use this as the foundation for how much money you’ll need in retirement.
Net Worth Allocation Among Assets
Remember that net worth includes all your assets, not just your investment accounts.
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, nevertheless.
Fortunately, nowadays, many smart retirees are also generating income from their homes by renting a portion of it through AirBnB.
But for most homeowners, however, a home does not generate income. Homes also don’t necessarily build wealth.
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?)
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 which is 80% paid for.
But your investments haven’t increased in value much, so your total 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 example where your home was also 80% paid for 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, so 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 while paying out income.
Read my related post Playing Catch Up Retirement Savings with 59 Uncommon Solutions.
Income Generating Assets Vs Retirement Withdrawals
Our own approach to living in retirement was to reduce, delay or 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 or Get Investment Income?)
Having clarified this, let’s see how much income could be generated from the $700,000 investment capital 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 2.5 to 3% these days. Optimistically going with 3%, 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?
All these assets, of course, have varying levels of risk, including U.S. Treasury bonds, so understanding investing and investment risk is paramount to wealth building in increasing net worth ahead of retirement.
Increase in Value = Wealth Building
The potential 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. It is unlikely the home will rise in value much more. 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 the income yet.
A home with a current value of $ 500,000 which 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.
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.
Other Income Sources in Retirement
In the U.S., social security is available now to those 62 and older, but there can be so many more income streams.
And many people want to retire before 62. They would not be eligible for social security yet.
Let’s look at other income sources next since they can greatly reduce how much your net worth needs to be to retire.
Alternative Income Sources
Online business income, consulting income, or working part time are excellent solutions 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.
All these alternative income sources require effort to establish or maintain, and many people preparing to retire think they’ll have no interest in working.
Given the choice between crossword puzzles and creating income streams for brain stimulation as I age, however, I’ll pick income streams, at least for the next couple of decades.
Next, let’s see just how much having an extra income source or two will affect how much net worth you need to reitre.
Generating Income Vs Retirement Withdrawals – A Huge Aha
Generating income of $ 24,000 a year is like having another $600,000 of retirement savings in comparison to the traditional 4% retirement withdrawal rule!
Here’s the math:
$24,000/.04 = $600,000
Is that crazy? I love the math on this!
Let me explain this equation more: 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.
And yes, retirement withdrawals are passive, and the income generation methods suggested are usually active, but this isn’t always the case; some income sources generate mostly 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.
And just think, your wealth can continue to grow if you’re not spending it to live on 4% withdrawals every month.
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.
Read my related posts Businesses to Start Later in Life and Is It Too Late to Start an Online Business?
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.
That’s because where and how you want to live in retirement will be completely different from where and how I want to live in retirement. And it will be different still from everyone else.
And because the assets you own will be different from the asset that I own, and assets are what make up our net worth.
Start creating your own financial future with my Ultimate Wealth Plan. You can get it here now.
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