How to set a Net Worth Goal is shown here. Why set a Net Worth Goal? Goals are important because they direct our actions and provide a sense of purpose, in this case living the life we wish. A Net Worth goal provides us with the means to someday live our compelling vision of True Wealth.
“If you don’t know where you are going, you might wind up someplace else.” – Yogi Berra
In How to Determine Your Net Worth you determined your Net Worth so you can use your Net Worth as a Lifelong Scorecard. This third article in the Net Worth series starts laying out the path to where you are going, your vision of True Wealth.
What Net Worth Goal Should You Strive For?
The answer is dependent on your vision of True Wealth. We’ll start with an example of a common goal that many do have: a secure retirement at age 65. You can adapt this example to your circumstances and aspirations later.
Working the Problem Backward
One way to quantify this is to set the goal and work the problem backward. With the end in mind, we can better understand what needs to be achieved to reach that goal.
What Net Worth is Needed to Retire Comfortably at Age 65?
That’s a big question and it depends on major assumptions, including:
- The length of time you will live after retirement.
- Living expenses during retirement.
- A margin of safety so you don’t run out of money.
Let’s take each assumption one at a time, baby steps, and see where they lead us.
How Long Will You Live After Retirement?
A good starting point for estimating your lifespan is the Social Security Administration’s Life Expectancy Calculator.
The Social Security Administration’s Life Expectancy Calculator provides a rough estimate of how long you or your spouse may live. Knowing this information helps us make a more informed choice on how long we might live during retirement.
According to the data, a man reaching age 65 today can expect to live, on average, until age 84.3. A woman turning age 65 today can expect to live, on average, until age 86.7. That’s about 19 more years for a man and 21 more years for a woman.
To keep it simple, let’s assume both men and women have about 20 more years of expected life span after retirement.
Those estimates are just averages, and one out of every four 65-year-olds today will live past age 90. For married couples that means there’s a 50% chance (2 X 25%) that either you or your spouse will live past age 90, or 5 years longer than our assumption.
Here we have a couple of options to consider for setting a Net Worth goal: living 20 or 25 years. It’s helpful to pick a most likely case, the 20 year life expectancy, and call it the Base Case. Then we’ll pick the next most likely case, the 25 year life expectancy, and call it the Optimistic Case.
We run both the Base Case and Optimistic Case to learn to what degree it could affect our planning. True, it still doesn’t give us a precise answer, but it gives us something to plan around. That’s much better than nothing.
How Much Will You Spend During Retirement?
Some believe during retirement that their spending will decline compared to the working years, and there may be good reasons for this.
They could pay off the mortgage, their children are now adults and on their own, there are less work-related expenses like commuting, etc.
We’ll get more granular on those points later, but for this example, let’s keep it simple and assume retirement spending remains about the same.
The U.S. Census Bureau reported that Real Median Household Income was $61,372 in 2017. The median is the point where half the households make less and the other half make more.
Let’s take the middle point and round that number to $60,000 annual income. Also, expenses remain the same in retirement to maintain the pre-retirement lifestyle.
How Can You Be Sure You do not run out of Money?
Financial planner William Bengen tested various withdrawal rates using historical rates of return for investments. He found that 4% was a safe withdrawal rate if retirees wanted their money to last 30 years, assuming they invested at least 50% of their savings in stocks.
The 4% rule states that an initial withdrawal rate of no more than 4% of savings, adjusted each year for inflation, should preserve your purchasing power through 30 years of retirement.
Determine how much savings is needed using the 4% rule to provide the $60,000 per year lifestyle we want in retirement.
We can divide $60,000 per year by the 4% withdrawal rate to find our need of $1,500,000 at age 65:
$60,000/.04 = $1,500,000;
That would produce: $1,500,000 x .04 = $60,000 per year
Since this should last 30 years, it covers our Base Case and Optimistic Case.
Adjusting the Median Income to Your Situation
We arbitrarily picked the 2016 U.S. Census Household Income as a starting point, but that income varies widely across households and areas of the country. You may earn quite a bit more or less than the median household income.
For example, if you feel you can live on $30,000 in retirement, one half the median level, you would need to save one half the above amount, or about $750,000.
$30,000/.04 = $750,000;
That would produce: $750,000 x .04 = $30,000 per year
If instead you feel you need $100,000 in retirement, you will need almost $2,500,000:
$100,000/.04 = $2,500,000;
That would produce: $2,500,000 x .04 = $100,000 per year
What About Other Sources of Income?
If you are one of the lucky ones expecting a pension from an employer or Social Security Benefits, that will reduce the savings needed and your Net Worth goal.
A $60,000/year income should generate about $25,000/year in Social Security benefits starting at age 66. So we need to provide the other $35,000/year of income from savings ($60,000 – $25,000 from SS = $35,000). Dividing $35,000 per year by the 4% withdrawal rate, one would need $875,000 at age 65:
$35,000/.04 = $875,000;
That would produce: $875,000 x .04 = $35,000 per year
Plus Social Security Benefits. + $25,000 per year
Total $60,000 per year
There are financial planning tools and calculators available to fine tune these estimates and consider as many variables as you want to forecast.
For now, this fairly straight forward calculation provides a reasonable idea of what you might need to retire at age 65, given your income level.
Now we know how to set an initial Net Worth Goal to retire comfortably at age 65 by breaking the problem down into a few key steps:
- Determine how long we and our spouse might live during retirement.
- Estimating how much we would spend during retirement.
- A rule to help assure we don’t run out of money.
- How to adjust for other sources of income.
In the next article, “Net Worth Milestones,” we’ll look at savings milestones for different points in your life to reach this example goal and how to adjust the milestones to fit your particular aspirations and circumstances.