Most important financial metric/calculation?

wanderlust14 · Post by **wanderlust14** » Wed Nov 18, 2015 11:26 am

This is a pretty broad (and perhaps silly) question, but I wanted to know what other Bogleheads view as an essential (or THE essential) metric by which to measure their progress in the path to financial independence.

For example, is it net worth (NW= total assets - total liabilities)?

For educational purposes, describing the means of calculation and/or the formula itself would be much appreciated! Thanks.

inmymind · Post by **inmymind** » Wed Nov 18, 2015 11:36 am

I look at it similar to op inc. What am I bringing in from all sources minus my spending. Getting that second part under control and stablized will feed to your net worth.

YttriumNitrate · Post by **YttriumNitrate** » Wed Nov 18, 2015 11:41 am

deleted.

kaudrey · Post by **kaudrey** » Wed Nov 18, 2015 11:41 am

One of the most important things to think about is cash flows in retirement.

What are your cash flow needs (aka expenses)?

What are your incoming cash flows sources (pension, SS, rental income, other)?

The difference is the amount that has to be covered by your portfolio. There is a lot of talk about the Safe Withdrawal Rate (see the Wiki), which is the percentage you can withdraw from your portfolio each year and still expect to have enough funds to last until you die. The often quoted SWR is 4%, although there are many discussions as to whether this is too high, or if you should use variable methods etc. This is all in the Wiki in greater detail.

But, to give a simple example, let's say:

Expenses = 50K per year
Income = $30K per year

Amount needed from portfolio = $20K per year. $20K is 4% of $500K; so you'd need $500K to be "safe" for a 30 year retirement.

So, if you know you'll need about $500K at retirement, you can determine how much you have now, how many years you have to save until retirement, and you can determine how much you should save to reach that goal.

Hope that helps a little.

Peculiar_Investor · Post by **Peculiar_Investor** » Wed Nov 18, 2015 11:50 am

With a tip of the hat to nisiprius' signature, I'd also agree cash flow and spending habits.

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

During the accumulation phase of your life, prudently create and use free cash flow to build your investment portfolio and net worth. When you reach retirement, prudently draw down on the investment portfolio, which might reduce your net worth.

Bill M · Post by **Bill M** » Wed Nov 18, 2015 12:36 pm

If you project income (including salary, Social Security, pensions, annuities, interest/dividends, and capital gains) and expenses (including medical expenses and taxes) forward, starting with current account balances and adding income each year and subtracting expenses each year, ... And then pick an arbitrary point in the future (I chose age 105 for us) and see what the remaining account balances will be. It better be positive, and better have stayed positive. And the minimum amount by which it is/was positive is the "safety margin" -- the most important financial metric.

Its not simple to calculate. But important things rarely are.

IlliniDave · Post by **IlliniDave** » Wed Nov 18, 2015 12:37 pm

For me it is probably the total of my invested assets, at least in the realm of things I'm tracking progress on. The other important numbers are my current expenses, and my estimate for desired spending in retirement. Both those numbers are relatively static and therefore aren't metrics I track to measure progress.

The calculation is simply sum of the total value of all my investment accounts. I have no debt, but if I did I would subtract any debt I had from the total except any outstanding balance on my home mortgage.

IA = 401k_balance+Roth_balance+taxable_balance (in my case)

The utility of the number is that one can use some simple rules-of-thumb to estimate roughly how much "income" one could draw from the assets by using the various "SWR" numbers. I typically use 3%.

Income_fr_assets = IA*SWR ( = 0.03*IA) for me

Available "income" is income from assets plus any SS, annuity, or other external income sources

Avail_income = Income_fr_assets + External_income

Then one can compare Avail_income to their desired spending during retirement (don't forget taxes, Avail_income is typically at least part pre-tax).

Alternately, as shown above, one can work it all backward and compute the IA needed and compare current IA balances to the target.

But for me the total value of my investment accounts is the key metric I pay attention to.

small_index · Post by **small_index** » Wed Nov 18, 2015 1:44 pm

Rodc · Post by **Rodc** » Wed Nov 18, 2015 2:41 pm

YttriumNitrate wrote:I'm fond of the metric typically used in Jane Austen novels where wealth is measured by pounds per month/year you get without you doing anything.

As I close in on "enough" this is the basic metric that is most important.

How much in retirement accounts, how much in pension, how much in SS, are really only important in that they contribute to what really matters: what ongoing income could I generate if I retired today or in one, three, 6 years (age 65).

Value of my home - remaining mortgage is important in that I could sell and move somewhere less expensive and generate additional cash, or I could keep the value in the house for later use in the same fashion, or sell to generate cash for assisted living etc. (a slightly different issue, not quite as important as the basic issue of generating income.

FWIW: while Monte Carlo has some value, as long as taken with a huge grain of salt, after you have done enough runs you know the basic answer before you hit the GO button. I no longer have much need or interest.

Added as others have noted I agree one needs some notion of expected expenses, though once you do that calculation it is pretty static compared to things like growing accounts.

Kevin M · Post by **Kevin M** » Wed Nov 18, 2015 2:56 pm

Specifically with respect to "progress in the path to financial independence", if I had to pick one, I think it would be something like:

Code: Select all

retirement savings = 25X residual living expenses in retirement

Where residual living expenses (RLE) are expenses not covered by social security, pensions, and other reliable sources of retirement income.

This is just another handy, dandy way of expressing the 4% withdrawal rate (WR) discussed in an earlier reply, since 1/25 = 4%. If uncomfortable with that, make it 30X RLE (3.33% WR) or 40x RLE (2.5% WR).

Of course there are many complexities, like accurately estimating your RLE, noting that RLE will change as income sources change (e.g., retire at age 55, SS kicks in at age 70), noting that some income sources may not be adjusted for inflation (e.g., pension, non-inflation indexed annuity), how to factor in home equity, etc.

Kevin

michaelsieg · Post by **michaelsieg** » Thu Nov 19, 2015 10:58 pm

I do something similar to Kevin,
I recently started measuring our portfolio size relative to one year of our (estimated) residual living expenses, which I call 100%. We currently plan to reach a portfolio size of 30,000% (or 30x living expenses) and we currently save about one year of residual living expenses per year.

This way of looking at our portfolio essentially showed me, that even a small savings rate increase has a much greater impact on reaching our financial independence than different annual return assumptions, (as we started earning and saving relatively late in life and we can't compound over 20 or 30 years).

ShiftF5 · Post by **ShiftF5** » Thu Nov 19, 2015 11:11 pm

kaudrey wrote:One of the most important things to think about is cash flows in retirement.

What are your cash flow needs (aka expenses)?

What are your incoming cash flows sources (pension, SS, rental income, other)?

The difference is the amount that has to be covered by your portfolio. There is a lot of talk about the Safe Withdrawal Rate (see the Wiki), which is the percentage you can withdraw from your portfolio each year and still expect to have enough funds to last until you die. The often quoted SWR is 4%, although there are many discussions as to whether this is too high, or if you should use variable methods etc. This is all in the Wiki in greater detail.

But, to give a simple example, let's say:

Expenses = 50K per year
Income = $30K per year

Amount needed from portfolio = $20K per year. $20K is 4% of $500K; so you'd need $500K to be "safe" for a 30 year retirement.

So, if you know you'll need about $500K at retirement, you can determine how much you have now, how many years you have to save until retirement, and you can determine how much you should save to reach that goal.

Hope that helps a little.

I like that. Let me try to Simplify it:

Annual Expenses - Annual Passive Income = X

X = Residual Living Expenses

You Need 25X to Retire. 1/25 = 4% a year.

That captures it for me.

LeisureLee · Post by **LeisureLee** » Thu Nov 19, 2015 11:29 pm

Before you retire, I think your retirement savings rate (saved / after tax income) is the most important metric. It tells you how long it'll take you to get from zero net worth to retired. Saving 50%? You'll be done in around 20 years. Saving 25%? About 30 years. If you get a raise and save it, the date gets sooner. If you spend it, the date gets further away.

After you retire, I think your draw rate (drawn this year / portfolio balance) is most important. With the same growth rate assumption decided, it tells you how much longer the money will likely last. 3%? Should last foreverish. 6%? Around 15-20 years. 10%? Maybe 7-12 years.

You do need to pick investment return and inflation guesses for the above to be useful, but there are rules of thumb that are good starting points and they feel like decisions you don't need to revisit often.

Valuethinker · Post by **Valuethinker** » Fri Nov 20, 2015 3:35 am

wanderlust14 wrote:This is a pretty broad (and perhaps silly) question, but I wanted to know what other Bogleheads view as an essential (or THE essential) metric by which to measure their progress in the path to financial independence.

For example, is it net worth (NW= total assets - total liabilities)?

For educational purposes, describing the means of calculation and/or the formula itself would be much appreciated! Thanks.

Until perhaps 10 years before retirement, Net Worth ("the Number") is as good as anything.

But I would exclude my own residence -- the equity therein. I view that as simply a cost (houses cost to heat, maintain) and as a "last ditch" option if my other savings fail to meet my needs (eg for retirement home, legacy if wanted etc.).

Once you get to minus 10 years you have to start thinking about your likely spending in retirement and whether your savings will meet those needs. Either looking at SPIA rates, or applying a conservative 2.5% pa safe withdrawal rate and a life expectancy to at least 90 (more if your partner is female) assuming you have no diagnosed medical condition which would limit it.

sesq · Post by **sesq** » Fri Nov 20, 2015 11:19 am

I agree with Dave Ramsey that Savings rate is the most important one. If only because it means you are saving something and income>expenses.

Beyond that I am fond of net worth as my key indicator of progress. Rate of return is tremendously important, but on a year over year basis its mostly an "let's see what we got" experience.

Kevin M · Post by **Kevin M** » Fri Nov 20, 2015 4:01 pm

sesq wrote:I agree with Dave Ramsey that Savings rate is the most important one. If only because it means you are saving something and income>expenses.

Beyond that I am fond of net worth as my key indicator of progress. Rate of return is tremendously important, but on a year over year basis its mostly an "let's see what we got" experience.

Savings rate is important, but the required savings rate to reach "your number" depends hugely on how much you already have saved and how many years until desired retirement.

Net worth is just an absolute number, and does not tell you anything about whether or not you have enough to meet minimum or desired residual living expenses (RLE) in retirement.

Rate of return also does not matter in and of itself, since it's just another absolute number, and doesn't relate to meeting the RLE goal.

For these reasons, I still think some multiplier of residual living expenses in retirement is a better metric for retirement savings goal.

Kevin

ralph124cf · Post by **ralph124cf** » Fri Nov 20, 2015 6:57 pm

wanderlust14 wrote:This is a pretty broad (and perhaps silly) question, but I wanted to know what other Bogleheads view as an essential (or THE essential) metric by which to measure their progress in the path to financial independence.

For example, is it net worth (NW= total assets - total liabilities)?

For educational purposes, describing the means of calculation and/or the formula itself would be much appreciated! Thanks.

Trying to answer the question you actually asked is somewhat hard. In the purely financial sense your equation is certainly correct, but it leaves out one very important portion of a persons assets.

Human capital (earning potential) may have a very large financial value, and in a younger person may greatly overshadow any financial assets.

A 30 year old radiology resident may have a very large negative net worth due to student loans, but have very high earnings potential. It would not be reasonable to compare his net worth to a 30 year old high school drop out plumber who has been making 100K for the last ten years, without considering their respective earnings potential.

How to account for earnings potential which may never be realized is a controversial subject which I have no answer to.

Ralph

swaption · Post by **swaption** » Fri Nov 20, 2015 7:23 pm

Yeah, I would go with net worth. It pretty much captures the result of everything else. You pay down debt (including mortgage) your net worth goes up. You save a lot, goes to net worth. Investments do well, net worth again. House appreciates, same story. You do all the above, and it just grows over time. Can't think anything more simple than that. When done building NW, maybe switch to SWR.

MathWizard · Post by **MathWizard** » Fri Nov 20, 2015 10:01 pm

Bill M wrote:If you project income (including salary, Social Security, pensions, annuities, interest/dividends, and capital gains) and expenses (including medical expenses and taxes) forward, starting with current account balances and adding income each year and subtracting expenses each year, ... And then pick an arbitrary point in the future (I chose age 105 for us) and see what the remaining account balances will be. It better be positive, and better have stayed positive. And the minimum amount by which it is/was positive is the "safety margin" -- the most important financial metric.

Its not simple to calculate. But important things rarely are.

This is exactly what I do. I have a program
that takes current age, salary, portfolio balance, and ret. contr. and the age that I will take SS, which them calculates the best estimate of what
the spending this will support for each retirement age from current age to age 70.

This gives me an idea of where I stand and what I can expect if I retire at any specific age.

Kevin M · Post by **Kevin M** » Fri Nov 20, 2015 10:10 pm

swaption wrote:Yeah, I would go with net worth. It pretty much captures the result of everything else.

No, it doesn't. It doesn't tell you anything about your minimum or desired lifestyle in retirement. A net worth of $1M could be huge for someone, and someone else might consider it dangerously close to poverty.

Kevin

siamond · Post by **siamond** » Fri Nov 20, 2015 10:52 pm

Sure enough, I closely track our net worth in absolute numbers. But for me, the real metric is closer to a valuation-neutral and inflation-neutral net worth. $1m in 1999 isn't worth the same as $1m in 2009, not only because one needs to think in real dollars, but also because of valuation levels.

Trouble is this is hard to measure as valuations are so tricky to calibrate. But it helps me stay sober about our net worth when I think about it...

As to the rest, sure, one has to know their targeted budgets, withdrawal targets/methods, expectations about future returns, and various other things, but the primary parameter to track is the neutral net worth.

Traveller · Post by **Traveller** » Sat Nov 21, 2015 5:58 am

I focus on two metrics: net worth and savings rate.

The former tells me where I am currently, and the later tells me how rapidly and efficiently I am improving the former. Of course, this assumes you know what your goal is.

john94549 · Post by **john94549** » Sat Nov 21, 2015 6:08 am

Absolutely, positively, and most assuredly, the only calculation worth a hoot is your projected retirement budget. All else is but keeping score. For example, my wife loves to include our principal residence and our Maui condo in her calculation of our "net worth". That said, she is unwilling to sell either.

Long ago, I focused on "disposable" or "liquid" assets when calculating withdrawal rates.

bertilak · Post by **bertilak** » Sat Nov 21, 2015 6:44 am

john94549 wrote:Long ago, I focused on "disposable" or "liquid" assets when calculating withdrawal rates.

Good advice.

It is the liquid assets that one withdraws from. Less liquid assets can be converted to liquid assets but that often involves significant time and some big costs, including emotional ones.

john94549 · Post by **john94549** » Sat Nov 21, 2015 6:54 am

I finally convinced my wife "4% X net worth" was a tad illusory.

Sconie · Post by **Sconie** » Sat Nov 21, 2015 7:29 am

Two, very general, objectives for me:

1. Sufficient liquidity/positive cash flow

2. Annual increase in net worth=CPI + 2-3%

randomguy · Post by **randomguy** » Sat Nov 21, 2015 10:31 am

john94549 wrote:I finally convinced my wife "4% X net worth" was a tad illusory.

So did you convince that it was insanely conservative or insanely aggressive?:)

KlangFool · Post by **KlangFool** » Sat Nov 21, 2015 10:41 am

OP,

The number that I looked is Net Worth (Investment Asset Excluding House) Divided by Annual Expense.

Net Worth / Annual Expense

If the number is closer to 25, the safer that I am. If I am at 30 or above, I am home free. No, I do not look at Social Security Income and so on to calculate RLE. I do not see myself as capable of being fully employed all the way up to age of 62. In summary, I will be forced to early retired before 62 (voluntary or not)

KlangFool

john94549 · Post by **john94549** » Sat Nov 21, 2015 11:01 am

randomguy, she finally agreed that the house and the maui condo should not be in the calculation.

Grogs · Post by **Grogs** » Sat Nov 21, 2015 11:17 am

ShiftF5 wrote:I like that. Let me try to Simplify it:

Annual Expenses - Annual Passive Income = X

X = Residual Living Expenses

You Need 25X to Retire. 1/25 = 4% a year.

That captures it for me.

That captures it for me, too except that instead of 25X I use (90 - current age)X. So it's 25X at age 65, 33.3X at 60, 40X at 50, etc. Right now, I'm at about 2.5X, so I'd be ready to retire if I was 87.5.

The reason for my more conservative numbers is that I anticipate having a non-inflation adjusted pension as part of my passive income, so in reality X will become a bit larger each year as inflation erodes the pension away.

MathWizard · Post by **MathWizard** » Mon Nov 23, 2015 3:52 pm

One other metric that is important is ER. I'm surprised that did not surface yet.

Grt2bOutdoors · Post by **Grt2bOutdoors** » Mon Nov 23, 2015 4:12 pm

KlangFool wrote:OP,

The number that I looked is Net Worth (Investment Asset Excluding House) Divided by Annual Expense.

Net Worth / Annual Expense

If the number is closer to 25, the safer that I am. If I am at 30 or above, I am home free. No, I do not look at Social Security Income and so on to calculate RLE. I do not see myself as capable of being fully employed all the way up to age of 62. In summary, I will be forced to early retired before 62 (voluntary or not)

KlangFool

Are you accounting for taxes in your annual expense? Since I don't really know what my true tax liability will be, I add a buffer of 25% to the "home free number" of 40 for me. So my true home free number is 50 or a 2% draw rate. Nearly bulletproof according to Dr. Bernstein.

KlangFool · Post by **KlangFool** » Mon Nov 23, 2015 5:05 pm

Grt2bOutdoors wrote:
KlangFool wrote:OP,

The number that I looked is Net Worth (Investment Asset Excluding House) Divided by Annual Expense.

Net Worth / Annual Expense

If the number is closer to 25, the safer that I am. If I am at 30 or above, I am home free. No, I do not look at Social Security Income and so on to calculate RLE. I do not see myself as capable of being fully employed all the way up to age of 62. In summary, I will be forced to early retired before 62 (voluntary or not)

KlangFool
Are you accounting for taxes in your annual expense? Since I don't really know what my true tax liability will be, I add a buffer of 25% to the "home free number" of 40 for me. So my true home free number is 50 or a 2% draw rate. Nearly bulletproof according to Dr. Bernstein.

Grt2bOutdoors,

No. My annual expense is low enough that it won't matter in the first order approximation .

KlangFool

larklea · Post by **larklea** » Mon Nov 23, 2015 6:13 pm

For retirement planning, I'm with Kevin.

I track the ratio of retirement assets divided by projected annual expenses. I got 'turned on' to this metric by Otar's book.

Once you're north of 25 with this metric, then you're below the 4% number that we hear so often. Of course, as others have stated, 4% may be too high, especially for younger retirees.

ShiftF5 · Post by **ShiftF5** » Mon Nov 23, 2015 8:13 pm

Grogs wrote:
ShiftF5 wrote:I like that. Let me try to Simplify it:

Annual Expenses - Annual Passive Income = X

X = Residual Living Expenses

You Need 25X to Retire. 1/25 = 4% a year.

That captures it for me.
That captures it for me, too except that instead of 25X I use (90 - current age)X. So it's 25X at age 65, 33.3X at 60, 40X at 50, etc. Right now, I'm at about 2.5X, so I'd be ready to retire if I was 87.5.

The reason for my more conservative numbers is that I anticipate having a non-inflation adjusted pension as part of my passive income, so in reality X will become a bit larger each year as inflation erodes the pension away.

W. Bernstein recommends min. 25X at age 60, min. 20X at age 65, and min. 17X at age 70.

I trust his numbers, while yours provides a little extra cushion.

Best wishes.

XdUzHa3NtSeIkBkIGPVn · Tue Nov 24, 2015 5:29 pm

I like this question because it forced me to condense different metrics into a single concept. Net worth is not sufficient because it doesn't relate to your individual needs, and it doesn't account for different interest rates and equity performance (risk being equal, I'd rather have 500k in a 3% real return environment, than 1M with 1% real return).

The one metric I would use as it relates to Financial Independence is "how much passive real income can I get for the rest of my life expectancy?". So add SS, pensions, investment returns, and withdrawal of capital. Depending on whether you'd be willing to annuitize your home equity (e.g. reverse mortgage), you can include that income as well. Is it more than your acceptable level of expenses? Then congratulations, you're financially independent.

Peter Foley · Post by **Peter Foley** » Tue Nov 24, 2015 5:37 pm

I use withdrawal rate of 4% or 3% of "investable" as applied to assets. (This excludes primary residence, second home [if any] and personal property. I calculate my withdrawal rate based on expenses, not on a hypothetical replacement of 75% - 80% of salary.

Goldfinger · Post by **Goldfinger** » Wed Nov 25, 2015 12:49 pm

My favorite metrics?

(Pre-retirement)

1) NW of investable assets

2) LMP/projected annual expenses

3) RC/projected annual expenses

(Post-retirement)

4) 1/(95-age)

Simple Simon · Post by **Simple Simon** » Wed Nov 25, 2015 2:48 pm

Investible assets minus all liabilities, expressed in terms of labor and commodities. For example my net investible assets might buy 12 years labor (at median wage) + 10,000 barrels oil.

I am accumulating these assets so I can buy services and goods in the future, so I like to think in those terms rather than $

White Coat Investor · Post by **White Coat Investor** » Wed Nov 25, 2015 3:13 pm

wanderlust14 wrote:This is a pretty broad (and perhaps silly) question, but I wanted to know what other Bogleheads view as an essential (or THE essential) metric by which to measure their progress in the path to financial independence.

For example, is it net worth (NW= total assets - total liabilities)?

For educational purposes, describing the means of calculation and/or the formula itself would be much appreciated! Thanks.

Savings rate

Money not spent / money earned