Monday, February 26

Net Worth without Housing

Somewhere on the internet I came across the term "nest egg" to describe your net worth without including your primary residence. I think that this is a useful measure, since it is very easy to be very well off on paper just by owning property in an expensive location, but this does not mean that you will be able to retire or be financially independent. In fact, unless you also have investments that provide income or you are willing to sell and move to a cheaper location, your home may make your net worth look very good while masking some financial weaknesses that can prevent financial independence.

Currently, my "nest egg" is about $385,000 or approximately 63% of my net worth. I have actually excluded the value of my car and my pianos in addition to my house because they are assets that are not income producing either (even though I intend to sell my car and one piano in the next few months so they will be generating one-time income this way).

I think that this is a pretty reasonable percentage, but if it were higher I think it would indicate a healthier financial position. More precisely I believe that my goal should be 75%. Here's my reasoning: The rule of thumb is that housing should be about 25% of your budget. So if my primary residence is about 25% of my assets, then I should be well-positioned to be financially independent because my (paid-offf, by that point) house will cover 25% of what I need to live on, and my other assets should be able to generate the remaining 75% in proportion to the value of my house.

Simplistic perhaps, but I am prepared to guess that this will work quite well indeed. If my house was paid off and worth about $500,000, then this target would set my other assets at $1.5 million. A 4% withdrawal scenario would have me living on $60,000 a year, which is enough for me to live extremely well. In fact, that's actually more money than I would need with a paid-off house but that can be explained too by the fact that I own more house than I need so that I can rent some of it out.

Following this logic, it might make sense not to start paying down your mortgage until your other assets are worth three times the equity in your house. If you were able to keep the two amounts in correct proportion then you would know that you were ready to retire whenever you finished paying off your mortgage. Very neat!

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