Budget? Me? Heck, I can’t even stand to read the directions when I have to assemble something, you say. Have a written plan for my finances? You’re kidding, right?
If this sounds familiar, we feel you. Budgeting isn’t for everyone. But here’s the thing: You don’t have to follow a budget to keep your finances on track for life-after-work. You just have to keep score.
Track what you own minus what you owe
“Sometimes people get really intimidated by doing budgets, which is understandable. They’re tedious and a pain,” says Charlie Farrell, CEO of Northstar Investment Advisors in Denver. “But if you follow the old practice of removing your savings first from your paycheck, and then you force yourself to live on what’s left, that’s kind of a self-imposed budget, right?”
To measure your progress, you can track your net worth. That’s where the keeping score part comes in.
You simply add up all the stuff you own, including what you’ve saved, and subtract all the money you owe — that’s called net worth. Take the result and keep an eye on it now and then. That will tell you whether you’re on track for a beach and a back rub when you’re ready for retirement.
Your net worth may be a negative number
If you’re just starting out, it may be a jolt to find that your net worth isn’t a positive number.
“It’s always negative in the beginning because you’re going to have more liabilities than assets. It’s discouraging, but it’s reality,” Farrell says.
That’s especially true for those with student loans and early-career earnings.
“I think that’s why net worth is important, because it’s a valid number for where you’re at,” says Dallen Haws with Haws Financial Planning in Sierra Vista, Arizona. “Because if you do have debt, whether it’s car loans or mortgages or student loans, that’s real, and it’s going to stay with you for a long time unless you say, ‘Hey, my net worth is negative. I’ve got to work on this.'”
Haws often works with federal employees. Come retirement time, he says many of them have saved tremendous wealth — despite often modest salaries. “I’ve also worked with some doctors and dentists who make great incomes but can’t seem to save anything,” he adds.
So, income and net worth aren’t always related.
Improve your net worth with more savings, less debt
“Eventually, by the time you retire, you want a boatload of assets and basically no liabilities,” Farrell says.
Retirement savings will make up the bulk of assets for most people: things like a 401(k), 403(b) and IRAs. The key is to ultimately have a sizable amount of assets that generate income that you can live on. And with less debt, such as a paid-off house and a free-and-clear car, more of that income can go to your after-work lifestyle.
“Just hammer away at your savings rate and put yourself on a path to be primarily debt-free … By the time you retire, you’ll see that your net worth basically takes care of itself over the long term. But you need to hit rough benchmarks as you move along,” Farrell adds.
One benchmark is a comparison of your net worth to a multiple of your income. Consider what you make — the amount that currently supports your lifestyle — and know that you’ll need 20 to 25 times that amount to fund your after-work lifestyle, Farrell says. So if you make $100,000 annually, you’ll likely need $2 to $2.5 million to retire with a similar standard of living.
Compounding builds net worth momentum
Whoa. That’s a tall order. Break it down by your age to get some momentum on your side. By age 30, have an amount equal to your annual income in retirement savings, Farrell says. Save three times your current annual income by age 40, and keep ratcheting it up from there.
“If you keep your savings rate relative to your earning power every single year, then the numbers pretty much self-adjust over time,” Farrell says.
Compounding helps build momentum.
“Once you get to two to three times your household income in savings, your portfolio begins to do more and more of the heavy lifting,” he adds. At that point, investment returns combine with current contributions to accelerate the growth of the balance.
Net worth: It’s a long game
Calculating and tracking your net worth sounds simple enough, but there are a few additional considerations:
Say you rent an apartment and lease your car. You’ve got no debt, right? Not exactly. You need a place to live, and rent never ends. And that lease on a car is debt.
There are things that may not seem to factor into a net worth calculation, such as passive income from rent, royalties, dividends and the like. All of these can be part of an income stream that feeds your after-work lifestyle.
With rising property values, net worth can also be skewed by the market value of your house. You may have a ton of equity in your home, but it’s not a liquid asset that you can tap on demand unless you take out a loan — or move. Since debt should be avoided during retirement, you’d have to sell your home and downsize into something cheaper, perhaps by moving to a less expensive area of the country, Farrell says.
“It’s a long game. It takes a while for noticeable results to appear,” Haws says. “It’s the big picture. Are we making progress or not? Are we getting closer to our long-term goals or not?”
Farrell suggests taking a look at your net worth every six months to a year.