To get ahead financially and plan for retirement effectively, it’s critical to get a handle on your total current financial condition. The best way to do this is to create a personal balance sheet that shows your net worth — the sum total of everything you have and everything you owe.
A balance sheet is nothing more than two columns of itemized figures, with the value of each asset on one side and debts on the other. The difference yields your net worth. When financial experts talk about growing your wealth for retirement, they actually mean increasing your net worth. After all, what good is a lot of “wealth” if you’re dragged down on the liabilities side by ugly, interest-compounding debt?
Everything you own and owe matters because retirement typically means a move from the phase of life when you have a paycheck and are, hopefully, growing your nest egg to gradually cashing in this nest egg to pay expenses during retirement. This fundamental change will probably mean selling your home — the one where you raised your children — and buying a smaller, less expensive retirement home, condominium or townhouse and putting the leftover cash into retirement accounts.
During retirement, most people need about 20 times the amount they spend each year (which is everything post-tax, minus money saved and invested) to be positioned for retiring in their mid-60s with some assurance that they won’t outlive their resources.
Your personal financial situation is no different from the profitability or lack thereof in a business. In both, the proprietor wants to show increasing profit after expenses over time. Primarily because of education loans, the net worth of many individuals (including some with good incomes) is negative in their 20s and 30s. The goal is to pay off this and other debt and invest for retirement, increasing net worth, in your 40s and 50s, when you may be paying for your kids’ college education. This debt should be retired long before you do. As you grow older, your net worth figure should be driven less by liabilities, more by assets.
Here are some things to keep in mind when assembling a personal balance sheet and analyzing it for opportunities to increase your net worth:
• Look for low-growth assets that can be cashed in to pay off high-cost liabilities — always a good move.
• When listing the value of your investments, take a minute to look at how much these values have fluctuated in recent years because of market volatility. Maintaining an investment portfolio with low volatility is critical to getting investment returns that grow your net worth because of the time it takes to compensate for down periods.
• Assess whether investments seem more appropriate in structure and time horizon for cashing in in the short term — for use in the next three to five years paying college expenses for your kids, taking a trip or other goals — or in the long term to pay expenses during retirement 10 or even 20 years away.
• When listing values of assets, be realistic and honest with yourself. List the value of your home (to the extent that you own it) by using the actual value, not the value you’d like it have. To list your home’s value, or the value of the equity you have in it, try looking it up on Zillow.com, which uses comparative values from nearby homes to estimate value.
• Regarding credit card debt, look at specific expenditures to see how much of this debt stems from unnecessary spending. Note how much you can save by making lifestyle changes to rein in everyday spending and curbing your appetite for expensive purchases, particularly impulse purchases.
Creating a balance sheet to calculate your net worth is like visiting the doctor or the dentist for a checkup. The outcome may be highly positive, indicating sound financial health, or you may get some bad news. In the case of the latter, the idea is to find ways to treat your ailing net worth to improve it.
Jamie Cornehlsen and Ted Schwartz are advisors with Capstone Investment Financial Group. Cornehlsen is also president of Dunn Warren Investment Advisors in Greenwood Village. Schwartz can be reached at firstname.lastname@example.org, and cornehlsen at email@example.com.