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Net Worth = ? X Expenses
Old 08-21-2013, 07:58 AM   #1
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Net Worth = ? X Expenses

My day for humility.
There seem to be more comments here lately, that include the comment:
Net Worth = ? X Expenses... as in "NW is 8 times or 45 times expenses".

Some (probably dumb) questions:

Is this a well recognized ER formula for safety in retirement income?

Does it have to do with the number of years before SS retirement income?

How does one actualize SS income to net worth?

For early retirees, how to count pensions or annuities that begin at a later date?

Does Net Worth include the house?

It's hard for me to understand numbers, when net worth doesn't count 25K/yr in SS, 30/yr in pensions, and a house that's valued at $300K.

After a year of being here, these questions still confuse me, although seemingly, everyone else seems to understand. Almost all discussions of this end up referencing FIRECALC.

Please be gentle.
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Old 08-21-2013, 08:11 AM   #2
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I believe that "25x expenses" is basically a different shorthand for the 4% rule (4% is 1/25 of your portfolio). And, as I'm sure you know, the 4% rule does not take into consideration income streams like SS, pensions, or other values such as home equity.
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Old 08-21-2013, 08:11 AM   #3
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Well the way I look at it, the bigger the number, the better off you are. Plugging various numbers in FireCalc, I noticed that a 4% withdrawal rate gives you a good chance that your money will last 30 years, while a 3% withdrawal rate gives you a good chance that it will last forever.

A 4% rate would be 25x expenses, where a 3% would be 33x. Actually, even plugging in a 3.5% withdrawal rate gives you a good chance that your money will last forever, but I prefer to err on the side of caution.

In my case, those numbers are just a goal to shoot for. At 33x I'll feel financially independent, but don't know if I'll retire. And for me I'm not including SS or future pension, or equity in the house. I just call that stuff icing on the cake.
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Old 08-21-2013, 08:15 AM   #4
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See below, just one set of replies...
Quote:
Originally Posted by imoldernu View Post
My day for humility.
There seem to be more comments here lately, that include the comment:
Net Worth = ? X Expenses... as in "NW is 8 times or 45 times expenses".

Some (probably dumb) questions:

Is this a well recognized ER formula for safety in retirement income?
It's just the reciprocal of (S)WR. Number of years should be a factor - though we see 25X most often, corresponding to the equally popular 4% SWR, which would have provided a 95% probability of success for 30 years from 1871 to present. Here are some examples of "X expense" for several probabilities and years (length of retirement plan) "25X Spending" variations.

Does it have to do with the number of years before SS retirement income?
It should, but often when people throw around "X expenses" they're not taking SS, pensions or annuities into account - sometimes clearly stated, usually not IME.

How does one actualize SS income to net worth?
It's easy to use PV calculations to convert SS income to equivalent net worth, but I think it's easier for most people to grasp by just laying out projected expenses for the whole retirement planning period, subtracting SS income for applicable years, and then evaluate one's net worth against the year by year shortfall. That would mean one would have a higher % withdrawal rate in the pre-SS years, and lower thereafter. For example, if SS income provides half your planned expenses when it kicks in, you might have 4% withdrawal rate pre-SS, and 2% thereafter.

For early retirees, how to count pensions or annuities that begin at a later date? Same as above. Pensions and annuities are similar to SS, though often not COLA'd, and you could convert them to equivalent net worth using PV calcs. But it wouldn't change the outcome, same end result as green above.

Does Net Worth include the house?
Technically yes, but for purposes of retirement income planning, most people do not include their primary home with net worth (assuming you have to own a house to live in). Downsizing, other properties, reverse mortgage may be another matter.

It's hard for me to understand numbers, when net worth doesn't count 25K/yr in SS, 30/yr in pensions, and a house that's valued at $300K. All accounted for above? Yes you can factor SS and pensions into net worth, but the bottom line is the same either way. And while your house is part of your real net worth, presumably that value is not available for retirement income.

BTW, FIRECALC allows you to enter SS, pensions, annuities and thereby take them into account. You could also enter the value of your home, but it could be a mistake for retirement income planning.

Please be gentle.
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Old 08-21-2013, 08:23 AM   #5
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Quote:
Originally Posted by bo_knows View Post
I believe that "25x expenses" is basically a different shorthand for the 4% rule (4% is 1/25 of your portfolio). And, as I'm sure you know, the 4% rule does not take into consideration income streams like SS, pensions, or other values such as home equity.
It doesn't? Many people either reduce their expenses by these amounts, or annuitize them and add them to their net worth.

Edit: Pensions, anyway. I can understand the reluctance to rely on SS, or at least a full SS.
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Old 08-21-2013, 08:27 AM   #6
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As mentioned by the others, I don't include our old farmhouse in the asset value. In my mind the house is a liability (it was built in 1858, when something goes wrong, it goes wrong on a grand scale).

I wanted to address the SS valuation issue. As an almost 40 year old, I figure there is a chance that SS will not be the same in 25 years, as it is now. I think there is a good chance that SS eventually becomes "means tested". Since I will be depending on investments that I have accumulated since my 20s, I am almost certain that my DW and I will be means tested out. If this doesn't happen there is another chance that SS benefits are reduced somehow. There are too many variables here for me to feel like I can depend on SS.
Those are just my thoughts. I wish I had some of the depth of knowledge and experience that others in this forum have.
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Old 08-21-2013, 08:27 AM   #7
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Originally Posted by bo_knows View Post
I believe that "25x expenses" is basically a different shorthand for the 4% rule (4% is 1/25 of your portfolio). ....
Agreed. It's simply the inverse of the WR.

But the terms need to be a bit more precise to be useful. In place of NW, you really should use 'invested assets' - the investments that produce income, or can be sold for income. And in place of 'expenses' look at 'withdrawals', which would be the net of expenses minus SS/pension, or any other income that does not come from your portfolio.

Most don't include the house, as it is not producing income, and if you sell, you need to buy/rent something else - if there would be a big gain from that, you might include a number for it.

Quote:
For early retirees, how to count pensions or annuities that begin at a later date?
That gets complicated, as it is not a single number, it is changing over time. I don't think anyone really tries to communicate this changing number, it would be very specific to them, and take a detailed chart to explain.

My shorthand for that is - once I've determined a WR that I'm comfortable with (say 3.5%), that is the number I would tell others. But then in FIRECalc, I'll add my SS & pensions, and come up with a WR that matches the safety that a 3.5% WR would provide. So the 'spend' would be constant buying power, but the WR would initially be higher, but later the withdrawals would be reduced by SS & pension. It wouldn't be a precise average or anything, but I think saying it is 'equivalent to 3.5%' is good enough.


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Old 08-21-2013, 08:49 AM   #8
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It doesn't? Many people either reduce their expenses by these amounts, or annuitize them and add them to their net worth.

Edit: Pensions, anyway. I can understand the reluctance to rely on SS, or at least a full SS.
People DO reduce their spending, but I'm just saying that the "rule of thumb" of 4% WR from the Trinity Study, is only calculated on taking 4% from a specific portfolio amount. I don't think SS income is included in the study's findings.
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Old 08-21-2013, 09:07 AM   #9
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Just a word from someone (me) who is in phase II of retirement... This is what I define as the slowdown period of life... between age 75 and 90+... different from the active time. It's whenenver one begins to slow or stop the trips, the entertainment, and the upgrades to the home. As has been said... to simplify.

While in the younger years, most people believe they'll stay in the "homestead" forever. As one ages, the "second floor", the "finished basement", the "guest room" the "whirlpool tub", the "two car garage" and the beautiful flower garden out front, are no longer as important as having a shorter trip between the kitchen and the bathroom.

In the earlier mentioned $300K home, often disregarded because one has to live "somewhere"... changing over to a more efficient apartment @1K per month, could free up a few hundred thousand in cash... ie. net worth.

It's easier to see this, looking back, than it is when it's 10 to 15 years in the future.
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Old 08-21-2013, 09:19 AM   #10
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Quote:
Originally Posted by imoldernu View Post
In the earlier mentioned $300K home, often disregarded because one has to live "somewhere"... changing over to a more efficient apartment @1K per month, could free up a few hundred thousand in cash... ie. net worth.
True, that's what my "downsizing" caveat above was about.

From a purely $ POV (downsizing for other reasons aside), you add $300K to your net worth, but increase your spending by $12K year (rent). If you're 70 and expect to live another 25 years, assuming a 0% real return for example, you will break even at age 95 (25x$12K=$300K). Just an illustration using your numbers which only include home equity vs rent, obviously it's more complex once you add actual (sequence of) returns and operating costs of the house vs operating costs with an apartment (presumably less)...

Withdrawal rates and "X expenses" are just rules of thumb anyway, there's no chance of predicting spending, returns, longevity, etc. - you can only look at historical probabilities vs your personal risk comfort level, and leap.
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Old 08-21-2013, 09:28 AM   #11
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Agree that '25-33-times NW' (or essentially 3-4% SWR) may have become a common benchmark these days. Personally, I've never thought it was any better than a GROSS ballpark estimate for retirement planning. Far too simplistic since it ignores:

- Diversity & liquidity/restriction of invested assets. Big difference between holding well-balanced portfolio vs same current $ in 401k of solely company stock (remember all those unfortunate Enron employees?).
- Reasonably anticipated expenses over time. Frugal older folks with few mandatory expenses likely need smaller nest egg than younger ER's with recurring medical expenses, older home needing regular significant upkeep/repairs, extensive retirement travel plans, etc.
- Other support. Some folks can reasonably look forward to future inheritance, company pensions & retiree benefits, etc., while others have nothing beyond their nest egg. FWIW- I consider SS as a big wild card for FP since many predict gov't will eventually trim net benefits (e.g. increased taxation, 'means-testing', COLA limitations, whatever).

IMHO- No rule of thumb, inc. "X-times NW", is a substitute for solid periodic analysis of one's personal situation.
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Old 08-21-2013, 11:48 AM   #12
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Quote:
Originally Posted by imoldernu View Post
Just a word from someone (me) who is in phase II of retirement... This is what I define as the slowdown period of life... between age 75 and 90+... different from the active time. It's whenenver one begins to slow or stop the trips, the entertainment, and the upgrades to the home. As has been said... to simplify.

While in the younger years, most people believe they'll stay in the "homestead" forever. As one ages, the "second floor", the "finished basement", the "guest room" the "whirlpool tub", the "two car garage" and the beautiful flower garden out front, are no longer as important as having a shorter trip between the kitchen and the bathroom.

In the earlier mentioned $300K home, often disregarded because one has to live "somewhere"... changing over to a more efficient apartment @1K per month, could free up a few hundred thousand in cash... ie. net worth.

It's easier to see this, looking back, than it is when it's 10 to 15 years in the future.
Thanks, your post is a terrific insight. I guess I have more foresight than my peers because I get this at age 36 whereas they do not. Most people my age buy into the notion (incessantly pushed by real estate agents) of the "forever home." I suppose they see their house as the place where they will raise their children and spend the next fifty or so years and, naturally, take out a large mortgage to pay for that house.

My wife and I have a large family, but I bought my house for cash. To me, the "forever home" is an illusion. Life changes, needs change, people change, kids change . . . To me, it's better to have cash around to manage all of those changes rather than a huge amount of money tied up in illiquid real estate.
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Old 08-21-2013, 12:17 PM   #13
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I'd go with 25x expenses not including SS or pensions, as I figure it would give a reasonable safety margin. If you are ERing in your 50s I'd probably go with a bigger number, something in the 30s at least...
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Old 08-21-2013, 12:23 PM   #14
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Quote:
Originally Posted by imoldernu View Post
My day for humility.
There seem to be more comments here lately, that include the comment:
Net Worth = ? X Expenses... as in "NW is 8 times or 45 times expenses".

Some (probably dumb) questions:

Is this a well recognized ER formula for safety in retirement income?

Does it have to do with the number of years before SS retirement income?

How does one actualize SS income to net worth?

For early retirees, how to count pensions or annuities that begin at a later date?

Does Net Worth include the house?

It's hard for me to understand numbers, when net worth doesn't count 25K/yr in SS, 30/yr in pensions, and a house that's valued at $300K.

After a year of being here, these questions still confuse me, although seemingly, everyone else seems to understand. Almost all discussions of this end up referencing FIRECALC.

Please be gentle.
you seem to love abstract figuring, so have at it. But once someone has a few years in, this is not very helpful Take your expenses, and subtract your and your wife's SS and any pensions, and see what you have left uncovered. This is what you must cover from somewhere else- investments, SNAP card, gambling winnings, selling off furniture, whatever you can find.

You've been retired long time; you know how to do this.
Ha
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Old 08-21-2013, 06:35 PM   #15
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Originally Posted by haha View Post
you seem to love abstract figuring, so have at it. But once someone has a few years in, this is not very helpful Take your expenses, and subtract your and your wife's SS and any pensions, and see what you have left uncovered. This is what you must cover from somewhere else- investments, SNAP card, gambling winnings, selling off furniture, whatever you can find.

You've been retired long time; you know how to do this.
Ha
Why don't you say what you really mean.
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