Showing posts with label Retirement Planning. Show all posts
Showing posts with label Retirement Planning. Show all posts

Saturday, October 8, 2016

Projecting your future net worth

Yesterday, I was playfully googling my name maybe out of vanity and boredom. In doing so, I happened to bump into a comment that I wrote to a WordPress personal finance blogger in 2010.

The post reminded me of 3 things:
  1. my household net worth in April 2010 was $330,000
  2. my own mortality
  3. the responsibility to give back.
There is no doubt that I'm going to give away some of my wealth when I die. Not just for estate planning purposes (an estate worth roughly over $5 million dollars is taxed by Uncle Sam), but also for generously extending my legacy.

But what kind of wealth am I talking about? Is this the kind of wealth that will significantly benefit the community, or just my loved ones?  Would this wealth transcend generations potentially changing my family tree?

I really don't know. The most that I can do is to perform a very simple historical projection.

The first step is to determine the average rate my net worth grew for the known periods (i.e. average growth rate). The second step is to apply the same rate to the projected periods.

How to calculate the growth rate

The math involved is very simple.

Say, your net worth last year grew from $100,000 to $130,000. The growth rate for this period is calculated as ($130,000 - $100,000)/$100,000 = 30%.

Formula for calculating growth rate for a specific period:

(Ending net worth - Starting net worth)/ Starting net worth

You can obtain the average growth rate by applying the following formula:

(Growth rate in Period 1 + Growth rate in Period 2 + ... Growth rate in Period n) /
Number of Periods

Determine average growth rate

Here's what else I know, in addition to the number in 2010:
  • Our net worth was over $100K when we purchased our home in 2004
  • Current net worth as of this writing is somewhere around $975K
Running the numbers in Excel, the average growth rate that I came up with is 20%.

This chart shows that we have a net worth of around $328K in 2010. This closely resembles the number that I mentioned in the comment section of the Wordpress blog.

This also shows that my net worth grew by roughly $900,000 in the span of 12 years.

Apply the rate on projected periods

Of course, there are many factors that will affect our growth rate in the coming years, including:
  • Stock market returns
  • How fast my mortgage is paid off
  • Whether my kids go to a public or private university
As far as the first point is concerned, we certainly have no control over the price of MSFT, AAPL or GOOG stocks. But we certainly do have control over our spending.

Hopefully, our mortgage will be paid off in 2024 before the kids go to college. We also have $95K saved up for the kids' education.

If the great recession of 2008 did not stop us from having a 20% growth rate, I don't see any of these factors slowing us down.

Also, we love what we do. We both love our careers. I write financial web application software for a living and I see myself doing it until I retire.

All these considered, I've applied the same 20% growth rate. This is by no means a highly optimistic number.

Here's what the chart looks like for our last 15 working years:

The projected net worth when my wife and I both turn 60 is an astounding $15,000,000. At 3% inflation rate, this is equivalent to 10 million dollars in today's money.

In this chart, our net worth is projected to grow by 10 million dollars in the next dozen of years. Contrast this to the first chart where it grew by only $900,000 for the same length of time.

This phenomenon is referred to as the "power of compounding interest"- where the interest applied on top of the interest works exponentially in your favor.

Let's go much further than that and do a projection of our ending net worth, with the assumption that we both continue to live until the age of 90.

Applying a lower growth rate in retirement

Age 60 to 70 years

Here we stop working so growth rate is cut by half to 10%. But with 15 million dollars and no mortgage to pay off, we can afford to travel the world once every quarter. With this kind of money, the interest alone when invested at 5% is worth $750K annually. Our retirement income will be supplemented by dividends and rental properties that we will buy in cash. Half of our assets will be in fixed-income investments like bonds and CDs.  It is also in this period where my wife's pension will start to kick-in. Projected net worth is $42,000,000 by the end of this period. At 3% inflation rate, this is roughly equivalent to 20 million dollars in today's money. Thanks to a low-key lifestyle and continued allocation in stocks for the significant portion of our portfolio.

Age 70 to 80 years

Growth rate is cut by half to 5%. At this age bracket we probably will be less active. But hopefully we can continue to travel the world at least twice a year and enjoy other leisure activities. We will also start taking the required social security distributions maximizing the value. Majority of our portfolio will be in very conservative investments like bonds and CDs. I am also hopeful that by then interest rates will be higher. Projected net worth at the end of this period is $72,000,000. At 3% inflation rate, this is roughly equivalent to 25 million dollars in today's money.

Age 80 to 90 years 

Growth rate is -5% because this is the wealth reduction phase as we will start giving generously to various charities that we care about. We will continue to enjoy a good life not available to many. Health problems may kick in but this is hardly a financial concern when you have insurance and millions of dollars in the bank.

At the end of this period, our estate would still be worth roughly $48,000,000. This means that we have given away around 13 million dollars in today's money. Because at 2% growth rate, it would have grown to $91,000,000, if we weren't as charitable.

By then we would have already established a charitable trust that will distribute our assets to our heirs efficiently without the cost, delay, and publicity of probate court. There would still be over 12 million dollars in today's money to leave for my heirs to enjoy.

Instead of dying quietly, we will have the rare opportunity to greatly impact the lives of the people around us in a positive way.

It is in this phase that we will give like no one else in my family tree.

Only time can tell if my projection is right on the money.

Sunday, August 28, 2016

400 weeks

Coming up with a successful pre-retirement strategy involves detailed planning. For starters, you need to list down some goals. Not just one goal but many goals. For us, the ultimate financial goal is to retire comfortably, so we're able to live our dreams before the age 60. But this goal is too broad to be useful. Breaking this down into many sub-goals at midpoint should help provide details that make it more tangible.

In a healthy relationship, the wife should always be involved. So in my case, I had to sit and talk to my wife before coming up with the following:

  • We want to have the option to quit our jobs and start our own business by age 52
  • We want to have at least 2 million dollars in investible assets.
  • We want our mortgage paid off by the time our eldest daughter, Maddie, goes to college.

All three, I believe, can be accomplished in 400 weeks!

Paying off our mortgage is key. However, I don't want to get too crazy paying it off because the interest is a miniscule 3%. In comparison, the stock market has returned more than 10%, on the average, between 1970 to 2015 (here's a calculator).

The only reason I'd like to have some additional money to cover the principal is to provide some diversification as we're already heavily invested in stocks (I will cover the asset allocation of our portfolio in a future blog).

Here's a projection of when our 15-year mortgage will be paid off if I keep paying an additional $300 towards the principal:

On May 1, 2024 the outstanding balance will be $0.0. The year that Maddie goes to college, our mortgage will be paid off.

Her little brother goes to college 4 years later. So there should be no overlap of college expenses on our part:

Should they decide to attend private school (which I will strongly discourage them to do so), it wouldn't be a problem. We've already saved up more than $90K in their 529 accounts, and we have no mortgage to worry about by then.

This is why how we spend, save and invest our money within the next 400 weeks is crucial.  It's a huge step towards our lifelong dream to become truly financially independent.

But this is just half of the 800 week journey. We'll both be 60 after the next 400 weeks (of the first 400 weeks). I'm confident that by then, we'll be more than ready to retire completely from being self-employed. If the past 12 years can be used as an indicator, my guess is that our net worth would be somewhere between 10 to 15 million dollars.

That folks is an example of how you do long-term planning!

Do you think this is too ambitious? Let me know what you think.