Net Worth, Retirement and FI Metrics

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Portfolio7
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Net Worth, Retirement and FI Metrics

Post by Portfolio7 » Sat Jan 28, 2017 4:53 pm

I had a nice long post written when the internet burped :confused . Let me see if I can rehash and condense:

Building wealth is a difficult process - moving in the right direction is the most important step. For this reason, most discussion on this site is properly about the investment process and how to make it work. However, once you have a successful process, you then want to understand if you are on track to meet your financial life goals or not. This quickly leads to a discussion of Net Worth. Tracking it can be intrinsically rewarding, but I feel a bit lost when it comes to evaluating my current position. :?:

When people measure Net Worth (or Retirement Savings, as either or may be relevant) they often start with simple rules of thumb. Two come to mind, the 'x Income' method which suggests I should have 5x income saved by age 50 and 10-12 x income by retirement. There is also the PAW measurement which suggests about 7x income at age 50, etc, but isn't really tied to a retirement goal. A third approach I've seen from a few posts here is to simply invert the 4% retirement rule and aim for 25 x expenses by retirement.

Other threads do a good job of tearing down the first two approaches :sharebeer , but a weakness I don't often see mentioned is the lack of consideration of additional resources. For example, my actual income multiple right now is 5.3 including a small cash pension. However, saving itself, rapid increases in income, or significant real estate or business investments can all significantly distort that ratio. The third approach is admittedly very limited (in part because it implies a specific purpose and timing), but it at least puts us on the right track of measuring against expenses (rather than income.)

I am strongly influenced by the PortfolioCharts.com calculations of time to FI that assumes you save half your income. :!: This does a great job of highlighting that the point of saving isn't retirement, it's FI. The sooner you get to FI, the sooner you can retire or simply sleep well.

If you bring these ideas together :idea: , you can track an FI multiple (which doesn't currently exist, that I am aware of - one would have to calculate it based on relevant inputs) against your actual expense multiple over time. Has anyone out there tried to do this? I see this creating two lines, which are unfortunately sometimes almost parallel, but most people just try to make them meet by age 65, and optimally, as for many on this site, they would cross before age 60, sometimes long before then. When they cross, presto, you are FI. Then you can retire if you want to, or keep working towards other goals (i.e. college for the kids, enjoying your job, what have you.) Cash flows could be identified from specific events (sale of a business, etc) and folded into the model (easiest to just let people manually enter that kind of think I suspect). This way a simple model could get a little closer to an individual cash flow model that many of us already build on our own, and therefore it would have more individual relevance as a tool. It would also take into account life expectancy, and demind higher expense multiples if you retired at 40 instead of at 60, e.g. I expect it would be valuable to create sensitivity analysis around the inputs, especially on future return assumptions and future expense assumptions, perhaps also future SS income assumptions, to create kind of a shaded "X" so that the uncertainty inherent in any calculation like this is apparent.

Am I over-complicating things, would such a thing be useful to you (or would it have been useful when younger?) Do you see weaknesses in the thought process, or has someone done something like this already? I don't know how to do all the things I am thinking about, but it seems like a fun project, once I get through my current one. Appreciate any thoughts from the community!
"An investment in knowledge pays the best interest" - Benjamin Franklin

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