Measuring Net Worth – advantages and limitations

WELCOME! This article is my submission to the Canadian Tour of Personal Finance Blogs.

When I discovered the world of personal finance blogging, I was absolutely delighted to find a place where people could talk about actual numbers freely. I still find it very exciting that so many PF bloggers post their net worth, budget, debt and other numbers so that we can all gain a greater understanding of money than can be found in the single case of just your own situation.

I have tracked my net worth with various levels of accuracy for many years now, but this year I am starting to realize that this number is not to single key to success that I once thought it was. Ironically it is my success with increasing my net worth that has led to this realization.

My retirement planning has always consisted of spreadsheets that model income and expenses based on fixed assumptions. During the accumulation phase, my net worth would rise and during the retirement phase it would decline. But this past year, as my net worth passed half a million, I suddenly realized that while I have learned many things about accumulating, I have no clue about how to make the declining phase work.

Regular readers of this blog will recognize a theme that I have been moving toward for a while now. To retire, you need income. Net worth doesn’t pay the bills every month.

So although the time I spent focusing on net worth has been productive, I know that the time is now right to change this focus. I need to start developing a strategy for income and adding new measurements that will allow me to track it. I also have to determine what my goals are for this new stage.

To those who are on a different point in their financial journey, I would suggest that if you are early in your accumulation phase then net worth may indeed be the best number to focus on. But once you have some basics in place it may be better to address the income question sooner rather than later. I am beginning to suspect that I may have unnecessarily delayed my financial freedom date by coming to this issue so late.

If you have come here as part of the Canadian Tour of Personal Finance Blogs, thanks for visiting. I wish you every success in your own journey!

Crap at work

Thanks to s.b. and canadian dream for their encouragement after my terrible day yesterday. Both of them pointed out that developing your interests and focus outside of work is a very good antidote for dealing with crap at work. Wise advice, indeed.

It also fits with advice that canadian dream was giving earlier about retiring happy. To put it in other words, hating work is not enough to guarantee loving retirement.

I never thought I could be one of those people with no life outside of work. I have always had lots of interests and I still do. But certainly work is interfering with those interests more and more often these days. Sometimes I have been so tired that I have wanted to leave my evenings and weekends completely free. But staying at home and doing nothing doesn't make for an enjoyable evening, and when I do this I usually end up regretting it. Actually, going to a class last night was very helpful in keeping my mind off my troubles.

I know that troubles will come, and sometimes the only thing to do is to just get through them. Life is just like retirement savings. You don't solve all your problems in one day, but if you keep doing the right things then it keeps improving little by little. And I'm not giving up!

My terrible, horrible, no good, very bad day

I had a rather crummy day at work today and when I got home all I wanted to do was escape from everything: my job, my house, my life... and anything else that could be escaped from. I hate days like this, when I feel almost ill and I can't stop thinking about what went wrong and whether I could have prevented it. In fact, it's my thoughts that I want to escape from most. I just want it all to be gone.

On days like this I really, REALLY want to stop working forever and spend my remaining days under a palm tree far away from the world. I feel like I can't handle working even one more day and the sooner I am out of it, the better. And so it is days like this that are the driving force behind my, and probably many other people's, retirement plans.

Sigh....

But I am also starting to realize that life isn't designed to be easy. There might be days like this even without work. Some days bad things will happen to good people. And smart people will do stupid things from time to time, which will occasionally come back to bite them in the rear. And this is just a part of life, no matter what.

That palm tree sure sounds good though!

Today's billable hours: 3.0
Today's contracted hours: 0.0

Long Range Housing Plans Part II

After being rather confused yesterday, I got myself on a spreadsheet today before writing the post and I am feeling much better. Using a 3% rate of increase for both house prices and rents, I modelled the value, mortgage, rental income and payments for house #1 (the one that I currently own) and house #2 (the one that I want to buy).

It's a bit hard to describe the results of a spreadsheet, but here are a few observations.

• The longer I wait, the more money I will need as a down payment (because house prices only go up in my model)
• About 10 years before the houses are paid off they go cash flow positive (which actually means that house #1 is paying the mortgage on both houses). The effect of compound interest works on this too - at 5% rental increase it is closer to 15 years. The interesting thing is that this is very close to the same for one house or two.
• I didn't include property taxes, repairs/maintenance, vacancy costs, etc. so this is a bit optimistic.
• On the other hand, I started my rent and property value low compared to what I could get on the market right now.

So basically the biggest barrier to my plan is coming up with a second down payment. But I've been thinking about that.... There is quite a substantial cash position in my company (~$75,000 at this writing) and I have strong receivables as well. And the investment property may actually be better off inside my company than in my personal ownership. So if I sold my house to my company I could make use of the cash in there, and perhaps take back a mortgage as well. I would make sure I have enough left from this to put a down payment on another house in my own name.

And since I have 4.5 years before I want to make this move, that is lots of time to work on the downpayment. If I earmark the current $75K plus $20K per year for this purpose and put it in a high interest savings account or GIC at 3.5% (ING's current rate) I will have $185,000 at the end of 4.5 years. I think that this plan just might work...

Today's billable hours: 8.75
Today's contracted hours: 0.0

Long Range Housing Plans

Following on from yesterday's comments, I am going to start working on a gradual retirement plan. I intend to write this plan in several parts. I want to talk about future expenses, timing, income from work during phased retirement, income from real estate holdings, housing/mortgage, income from investments, income from government sources, taxation, RRSP's, my corporation and more. I would like to come back to the topic of Monte Carlo simulation for testing the resilience of the plan, but for now I will do simple spreadsheet mathematics to make it run.

Today's topic is going to be housing. For as long as I am alive, I will require some manner of housing so it's a critical foundation for being able to retire. Currently, I have a $262,000 mortgage on a $466,000 house. My monthly payments are $1600, property taxes are $210, utility costs are about $350 in the winter, so I expect about $200 in the summer for a monthly average cost of $280. On the plus side, I have $1000 in income from my basement suite. The overall cost of housing for me right now is therefore $1090 per month or $13,080 per year.

I have about 4.5 years left on my current mortgage term, and for that time I anticipate maintaining the same living arrangements. After that, it gets trickier.

In the long term I don't want to be living with tenants under me. So I would like to be able to buy a second place for me and keep this one as a rental. This house has great potential for cash flow, but the problem is buying the other place and when I can afford to do that. And real estate is very pricey where I live, so I will need quite a bit of savings to make this work.

I would like to a find a smaller place, maybe even an apartment, and I would hope to spend about 25% less than what my current house is worth (the market should remain internally consistent even though I can't predict the actual prices). If rents remain strong, it is possible that I would be able to remortgage this place and withdraw enough for a down payment on another place while staying cash flow positive here. The problem that I see is that my personal costs may rise substantially under that scenario.

One solution that I am thinking of is to buy a second place as soon as I possibly can so that I can lock in at today's prices and rent it out to cover the mortgage. But even that is tricky with house prices so high - you need both a large down payment and high rents. (I wish I had been able to keep my old house when I bought this one... but that's another story.) Additionally, there is more work involved in managing a second property and I want to tread carefully there after my experiences with this one.

Hmmm...This planning stuff is tricky! I can see where I want to go, but I can't see the path to get there yet. I think that I will need to ruminate on this more tomorrow....

Today's billable hours: 4.5
Today's contracted hours: 3.0

Do I Really Want to Retire?

An interesting discussion at Canadian Dream on Saturday led to this post on Investoid, which I really liked. He talks about gradually working less instead of completely retiring, which is something that I have started to think more and more about. As I discussed previously there are some very attractive reasons that might make me want to continue working. Additionally, many of the drawbacks of work for me come from the stress of it and the lack of time to do other (sometimes financially beneficial) things. So a reduced work schedule seems to allow me to keep much of the good while reducing the bad.

When I started this blog I knew that I wanted to reach $1 million and to work on the cash flows necessary to stop working. However, these goals are a bit vague because I haven't set dates or specifics. Essentially, I am still missing a retirement plan, or perhaps as Investoid calls it, an "anti-retirement plan". I would like to start putting such a plan together but I always hesitate over the unknowns.

I am now inspired to start the work on this plan over the next little while and see if I can come to some greater clarity in my vision of the future. This blog has been a really good tool for me to think about things more clearly and I hope that I will be able to make a great step forward by tackling this rather daunting task!

Do I want to work?

I seem to be on a break from purely financial topics for a time here to ponder some issues in a more personal way....

My life has been rather stressful in both work and personal ways over the past couple of years, and the work stress in particular serves to make me yearn ever more strongly for the day when I leave it all behind. But when I think of fully quitting, that doesn't make me happy either. There are certain parts of my work that I really like and provide me with fringe benefits including learning, socialization/teamwork, affirmation and more.

Right now I am at a point where almost everything that I am working on has been going on for 8 months or more. That means that the exciting new stuff is long gone and the "just get it done" phase is well under way. At times like this I really want out, but is retirement what I really want? When the projects are fresh and new, my outlook can be very different and work can be a lot of fun.

One of my friends has sold his business recently and is now planning to take some extended time off to pursue his main hobby. When I think of doing such a thing, I mainly imagine having too much time on my hands. And when I have time on my hands I shop. It doesn't take genius to know that not working and lots of boredom shopping is a bad combination.

So I believe that at this point in my life I still want to work, although perhaps much less than I currently am. All this work has been very good for my finances, but I believe that I have built up enough momentum that I don't need to kill myself. Now, hopefully things will slow down and allow me to test this theory. :)

Today's billable hours: 5.75
Today's contracted hours: 1.0

Value added time

These days I seem to be quite a bit busier than I would like, and that got me thinking again about what my time is worth. If I wasn't so busy, I could do a lot of things that have positive impact on either my cash flow or net worth such as:

• house fixes that take more time than material cost
• wiser shopping and eating
• organize my home and finances better to avoid stupid costs like late fees
• sell some items that are just sitting around

And these are just the broad categories. In each bullet there could be as many as 5-10 specific things I could do. Also, there could be other side effects such as:

• if I got my house fixed up I could probably rent out another room
• better eating might be healthier or inspire me to exercise :)
• when I organize or clean I often find items of value that I might have otherwise gone and bought
• getting rid of excess stuff makes me feel better about my home and more likely to continue the positive circle of doing good things to it

If I had more time I would also do more learning and volunteering. There might not be positive financial consequences to those, but sometimes life will surprise you with what you are rewarded for.

So for now, I don't have enough time to do all of these things, but I am slowly starting into the house fixes and I will make a goal to sell my old car in March. And one day, when I am able to work less, more of these options will open to make retirement financially advantageous in certain ways, perhaps offsetting some of its costs.

Today's billable hours: 5.5
Today's contracted hours: 3.0

Monte Carlo Retirement Simulation

Something new that I learned about after starting to read personal finance blogs was Monte Carlo Simluation. Today I decided it was time to play around with my numbers on a calculator so I searched the web and found this one which is accompanied by a nice article explaining what it does and why there is a need for it.

The most interesting thing that I found in experimenting with the numbers is that there is less risk (in Monte Carlo terms) in leaving your investments in 100% stocks (even with the increased volatility) if you have a long retirement planned. I found this quite fascinating actually, as I want to have a very long retirement so all the models I ran had 30, 40 or even 50 years of retirement. What this means is that all the long run assumptions came true for me, although volatility was certainly factored in.

I decided to put very little focus on the accumulation phase, since I want it to be relatively short and instead look at the retirement phase, so I set the pre-retirement years to 0 and played around with the retirement numbers.

One interesting question that arose from this exercise is, what should my target success rate be? The Monte Carlo calculator's main result is a percentage chance that your investment will last a certain number of years. A lot of the examples give you the 50% number, but a 50% chance of failure seems extremely high to me. Kind of scary high really. Ideally, I'd rather have a 100% chance of my money lasting through retirement.

But on the flip side, holding out for a very high success rate means that in most cases you will have saved "too much". This means delaying your retirement to save more and working longer than you really had to. That isn't desirable either. Much as it scares me, I think that it makes sense to choose a lower number. One site suggested that above 80% you aren't gaining much (the 80/20 rule again?) so I have chosen 80% as my target number for now.

Also, the author talks about an "adaptive model" that can choose to delay retirement, cut back on retirement expenses or save more in a bad year. I believe that my retirement will certainly be adaptive because I will be actively keeping track of my money and responding to all changes. In fact, most of the stories of early retirees that I have read tell of actually increasing the value of their investments even though they did not plan to do so, so that their retirement grows more secure as time passes, not less. (if they are aware and intelligent about managing their money)

I am hoping to user Monte Carlo simluation to help me to narrow in on my retirement Number and Date. Today was a lot of playing, and I tried a few calculators (which unfortunately gave varying results) so I'm not ready to hold on to anything particular yet, but I do feel that this is a useful tool that I can work with further.

Today was mostly a holiday for me, but I worked a little:

Today's billable hours: 1.5
Today's contracted hours: 0

Crossover Point

Your Money or Your Life is a great book for those seeking to drop out of the rat race and one of the concepts that I really like in the book is the "crossover point". This is the point at which your investments bring in enough each month to cover your expenses. (A major focus in the book is to reduce your expenses as much as possible to make this point easier to reach.)

I have estimated my monthly needs (with some not very extreme cost-cutting) to be about $2,000 plus mortgage, in after tax income. Since I am hoping that my rental suite will be covering my mortgage I am going to exclude that from the calculations.

I currently have about $275,000 in investments, mostly equity mutual funds. I also have $35,000 in a savings account that ought to be invested, so I will count $25,000 from there for the nice round total of $300,000. At a 4% withdrawal rate, which is universally considered "safe", this amount would provide my with $1,000 per month. I have seen the original author of the 4% calculations quoted as saying that 4.5% or even 5% may be quite reasonable for some cases. In the 5% case, I would have $1,250 per month. I also have about $150 per month in income from my higher risk mortgage portfolio.

By my reckoning that leaves me only $600 per month short of a crossover point. At the 5% withdrawal rate that is $144,000 in investments. With an 8% return I will make half of that in investment gain in 3 years, and the remainder is quite a modest savings target if I continue to work. The outside date for hitting my crossover point is therefore about 3 years. Of course, I think that I could hit it much sooner, but I also know that I have been a bit aggressive in the assumptions on this calculation so I probably need a bit more money as well. The net effect is that I think 3 years to Financial Independence is quite reasonable.

Today's billable hours: 3.5
Today's contracted hours: 1.5

Which way to $1 million?

Even though a million isn't what it used to be, I'd still rather be a millionaire than not and I think it will be a rather momentous day when my net worth hits $1 million.

There are two options that I am considering for reaching this goal:

1. Work really hard for the next 4-5 years and save aggressively. With average returns for each asset class I can project reaching $1 million by 1/1/2011.

2. Work hard this year, then semi-retire, still working enough that I am not drawing down my investments by more than 2% annually. Since 4% is considered a safe retirement withdrawal rate, I figure that 2% should guarantee continued (albeit slower) growth. I will get there much slower under this scenario of course. For example, If my net worth is about $650,000 by 1/1/2008, then I could withdraw $12,000 per year and still reach $1 million by 1/1/2015.

Of course there can also be several variations in each of the above options. ..

I have a slight leaning toward option 2, for obvious reasons. I am thinking that if I give my investments enough momentum (i.e., they get large enough) then so long as I don't interfere by withdrawing too much they should take care of getting me there without needing my input. The real question is do I need to reach $1 million by a certain age. If my ego doesn't need it, then there is no need to kill myself with crazy amounts of work to get there a few years sooner.

Inchoate Random Abstractions: Retirement Savings - The Magic Number

I found this post on The Magic Number at Inchoate Random Abstractions and I wanted to save a link to it. As I mentioned before, I am reading a book on this exact topic, so I will be posting more on this later...

The Number

I am currently reading a book called "The Number", which is about how people think about retirement and what amount they need to retire. When I told my brother that, he said to me that I must have Numbers worked out for 35, 40 and 45 already, for my own retirement. Do I? No, not really...

Money is so fluid and things change so much. I have mentioned in a previous post that my net worth has experienced great gains in the past couple of years. This was not something I predicted and it really showed me that no matter what the graphs look like in books, real finances are not a smooth steady ride to the top. So why would I believe that my retirement projections would be any more accurate? The markets will rise and fall, my needs will rise and fall, (or rise and rise) and all manner of externals will impact me in ways I can not predict. This doesn't mean that I'm throwing my spreadsheets out the window. But it does mean that I have realized that money management is a lifelong process and retirement is just one bend in the road.

In reality, I expect to retire early and often. That is, I will probably retire and then start working again if something comes along that interests me enough, and then retire again and repeat the cycle. Kind of makes the Number a bit difficult to define, doesn't it?

Financial Independence, or, How to Retire Young (my version)

Canadian Dream's post about being financially independent and the links to Violent Acres on the same topic got me thinking...

If someone asked me (which they rarely do) I would certainly say that it is my dream to be financially independent. To go one step further, I believe that I am getting very close to acheiving that dream. Since I'm still very far from whatever number of millions that retirement experts would suggest I need to retire in my early 30's this may seem like a very brash claim. And perhaps it is. But here is my blueprint for retiring young...

1. Cover housing costs with rental income.
I already can rent out my basement to pay for 80-90% of my mortgage. I still need to cover utilities and property taxes but that is a much smaller burden. Within 5 years I believe that I will be able to rent it to cover 100% of my mortgage and within 10 years I am targeting the rent to cover property taxes as well. If rents increase faster I may be covering my utilities within this time as well.

2. Reduce expenses to live very modestly.
In some ways I already do this, but I know that I can do much more. Having time to budget and track will help as well, and I will also be able to shop more carefully. I would like to keep my non-housing expenses approximately equal to my housing expenses (which I will not be paying myself, see #1). Then when my mortgage is over, the rental income will cover them.

3. Find creative ways to fill my retirement with interesting pursuits at a low (or zero) cost.
I'm thinking about ideas like taking up volunteering as a way to get out and do things without incurring costs (wonder if I can travel this way - volunteer to work on humanitarian projects abroad?), finding free ways to pursue hobbies (my local university has a french centre where you can visit for free - cheaper and more convenient than a conventional class) and using my leisure time to do things that I enjoy that save me money (thrift store hunting and garage sales perhaps?).

4. Make a little bit of part time income.
Now some may say that this isn't retirement, but for me it would certainly be. I am picturing something very low stress, probably temporary and perhaps ultra short term as in once or once in a while only jobs. The purpose of this would be to provide me with interesting things to do and just bring in a little cash to supplement or stretch my money occasionally.

5. Work on my portfolio.
Find income producing investments, minimize transaction costs, monitor performance and whatever else is needed to allow my little pile of money to last a very long time.

So that's my plan. I know that it's a bit short on hard numbers but I'm quite convinced that I could do it, and the main reason I haven't is that my business is a bit harder to quit than a conventional job. I am certainly aiming to cut back, but there are still jobs that come along that I want to take, so I guess that I'm not really ready to retire yet from that perspective either. In the meantime, while I am still working I can build my net worth and make my finances as strong as possible to be ready for that day!