I often see this question pop up once in a while:
If we track our net worth, but our residential property is in our net worth, how do we make sense of our retirement with our net worth tracking?
Whether it is net worth, or in my term net wealth, it refers roughly to the same thing.
Your net wealth can be calculated by taking your total assets minus your total liabilities. Your net wealth shows the “equity level”, in the finance-speak, of your life.
It may be ego-boosting to see your net wealth going up but I can understand why some of you will struggle to make sense of it.
One of the main reasons is that some items that go into your net wealth fund long-term goals that are so rigid that usually you wouldn’t change them.
Your long-term residential property is one of those goals. Your eventual goal most likely is to have a base where you have paid off the mortgage, don’t have to worry about rent and because of that, it is likely you won’t sell it off to re-allocate to your other goals.
This will mean the equity in your residential property is dead money.
Another possible one is your CPF, which is a government pension. The government pension has a very specific purpose and there is not much you can do about it. Your CPF LIFE is an annuity to be meant for essential expenses from 65 and beyond. Your Medisave can never be taken out in your lifetime and meant more as a medical sinking fund.
We can consider money that is beyond the full retirement sum at 55 to be part of something more useful.
The overall net wealth, is still something good to track because that whole figure is just easy to track but less meaningful.
So what do we track that may be more meaningful?
I would track a subset of the net wealth that we have the ability to manipulate and re-allocate easier to fulfil our financial goals.
Sometimes, I would refer to this as my liquid net wealth.
What are the items we can re-allocate more easily:
- Cash-like stuff like cash, time and fixed deposits, SSB, treasury
- SRS funds (you might suffer a penalty, but technically, you can take it out. At your retirement age, you can take it out and re-allocate as well)
- Investment property (that may be meant for speculation or buy-to-let for income, but the goal is for capital appreciation or financial independence and not to live in. You can re-allocate it)
- Managed investments such as unit trust, ETFs, private funds
- Individual securities such as bonds, stocks
- The business that generates income, that you can eventually sell-off
- Monies in CPF OA and SA that is less off the CPF Full Retirement Sum
The common theme among them is at some point, you can intentionally re-allocate them from one financial goal to another. They either serve to pay for a one-time spending or provide an income to pay for a periodic spending.
This liquid net wealth will amount to a subset of net wealth but how do we make it more useful?
In my article about perpetual income, I share with you that Americans and British measure wealth differently. Americans measure by the lump sum, while the British measure by the income that it can generate.
I do find the British way to provide more utility or more relatable to you because you get an income periodically, you spend a sum of money periodically and that is your frame of mind.
Most people wish to find out how much residual income they can generate, outside of their work.
So the thinking is mainly income-based. But lump sum is useful in some context, but I just feel the British way is more useful.
If the income-based way is more useful, how do we convert our net wealth to income?
With the information from the Safe Withdrawal Rate Methodology, you can have rules of thumb on how much income you can potentially extract from your liquid net wealth on a periodic basis to get:
- Income that is inflation-adjusted
- That has some empirical evidence on how long it lasts.
I call this the income potential of your portfolio.
If we use my conservative lens, the safe withdrawal rate can be like the following for a moderate, moderate-to-high and high-risk portfolio:
|Duration||The Initial Withdrawal Rate Use|
|10 Years or Less||7%|
|10 to 20 Years||3%|
|20 to 40 Years||2.8%|
|40 years or more||2.4%|
How do we use this initial withdrawal rate?
Suppose I have accumulated $150,000 in liquid net wealth today.
How useful is that $150,000?
If you look at the percentage, you can realistically track 3% and 2.5% of your liquid net wealth.
The conservative rate for 10 to 40 years is roughly 3%. We don’t have to be super accurate because that is not the point. This is more useful as a rule of thumb with historical research backing. Tracking 2.5% would be useful if you are very interested in inflation-adjusted income that last for a long time.
So we have:
- $150,000 x 0.03 = $4,500
- $150,000 x 0.025 = $3,750
These two figures are annual income, but this becomes more measurable against how much you spend today.
Then suppose your $150,000 grows to $500,000. We then have:
- $500,000 x 0.03 = $15,000
- $500,000 x 0.025 = $12,550
Now, you are able to relate more to your expenses because it has hit the 4-digit realm.
If you keep doing this, you can plot a chart.
Learning from Singvestor’s Tracking
I followed this once Singapore-based blogger who goes by the nick Singvestor occasionally. Singvestor will update his progress in his blog.
Singvestor went over to work in Europe and a year and half ago, he decided to leave a more lucrative compensation job for a start-up job. He earns less than 25% currently what he used to make so his financial reflection is quite interesting.
Aside from the tracking of his portfolio value, Singvestor also tracks how his portfolio relates to his spending.
The chart below comes from his latest update:
It can be a bit confusing so let me explain.
The yellow line and dot show Singvestor’s monthly expenses from Jan 2019 till today. The blue line is a rolling 12-month average expense. This smooths out the volatile nature of the expenses so that we can see a clearer trend.
The green line compares the projected income of his portfolio if he stop work and spend from the portfolio using a 4% safe withdrawal rate.
Why is everything negative?
I guess Singvestor chose to take the cue from the expenses perspective and since expenses is negative, everything becomes negative.
But you can see that as his portfolio accumulates, the green line descends and his $1000 in monthly income is now closer to $3,000.
That is not exactly lesser than the blue line, which will indicate the portfolio in a way covers his current expenses but it helps Singvestor frame the usefulness of his portfolio.
Singvestor probably learn from Vicky Robins who co-wrote Your Money or Your Life. But seeing this chart some months ago gave me enough motivation to do something of my own.
So here is a snapshot of how I do mine:
The liquid net wealth represents the money that is my net wealth less off the CPF, which will include my investment portfolio. The wealth machine is my portfolio.
My chart is positive compared to Singvestor.
How Easy and Useful is Tracking the Income Potential This Way?
If you have tracked your expenses, then it is not too hard to form that expenses line and that smoothed expenses line.
If you don’t track, then maybe it is time to pay attention to your expenses.
If you have data about your accounts over time, it is not difficult to just focus on your liquid net wealth or even your portfolio.
There is no harm in tracking your overall net wealth, your investment portfolio and your liquid net wealth.
You got to ask yourself: Is it meaningful to you to track it? If it is then do. If not, then don’t do it.
The initial withdrawal rate makes it easy for me to determine the income potential. It is just a percentage and I can generate 1%, 2%, 3%, 4%, 5%, 6%, 7%, 8%, 9%, 10% if I want to.
The body of work I have done on the Safe Withdrawal Rate allows me to connect with the income calculated so that I know how realistic and useful it is to you.
For example, how realistic is 2.5% for 40 years or more? You can read the research here:
|Research||Safe Initial Withdrawal Rate||By||Source|
|1||Ultimate guide to safe withdrawal rates - Part 2: Capital preservation vs Capital depletion||Less than 3% to 3.25%||Early Retirement Now||Link|
|2||Sustainable spending rates for Single Family Office||Less than 1.3%||Wade Pfau||Link|
|3||Fecuntity of Endowments and Long-duration Trusts||Less than 2.7%||James Garland, Northwood Family Office||Link|
|4||Perpetual Spending Rate for Foundations, Endowment and Charitable Trusts||Less than 2.3%||Jim Otar||Link|
|5||Income planning in the most expensive market conditions - Greater than 35 times Shiller CAPE||Less than 2.8%||Robert Shiller|
|6||Rivershedge Research||Less than 2% to 2.5%||Rivers Hedge||Link|
|Average Less than 2.4%|
|Generating perpetual passive income||Investment Moats||Link|
If this doesn’t work for you, and you prefer a dividend way, you can do that as well.
The framing to think about is this:
At any point, I can sell off all my liquid net wealth, and put them in a 50% stock/50% bond portfolio, or 60%/40%, 70%/30%, 80%,20%, and I can get roughly this inflation-adjusted income recurringly, which will last me X number of years.
If it is the dividend way, you redefine the statement above.
There is another advantage of that tracking.
You notice that both Singinvestor and my expenses is volatile.
That is the way it is supposed to be.
This thing as enough realism.
We are not saying “Oh the line is above the other line, I can quit!”
The goal of tracking is to appreciate the income potential against your spending.
If your spending is volatile, you may not feel comfortable and that is ok.
What if A Large Part of My Net Wealth is in My Residential Property?
That is a problem if you combine capital appreciation and living together.
I don’t have an easy solution.
You may need to live with the unknown.
But one way is to think about what you would eventually retire in.
So for example buying this 3 bed-room condo is for speculation but your base case for retirement is a 4-room HDB flat.
How much is the current value of a 4 room HDB flat? You have a value there. You could take the difference in value and add it to your liquid net wealth.
But it is very problematic because there may be mortgage, and there is CPF and I am not sure if you reach CPF FRS.
It is a confusing mess and I don’t have an easy way.
This method may not work so well unless you make some compromises.
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