A primary purpose of creating wealth is to achieve financial independence, which is the point when you can afford to choose not to work.
Net Wealth is the key measure of your progress toward financial independence and therefore is important to understand and track.
Net Wealth = Investments less Debts
In the above formula:
- Investments includes superannuation and non-superannuation.
- Debts includes all lifestyle and investment debts.
It’s important not to confuse your net wealth with your net worth, which is a separate measure. (Net Worth = Own less Owe.) If you prefer not to sell lifestyle assets to fund your ‘retirement’ lifestyle then net worth is not a useful measure of your progress to financial independence.
Set your net wealth target
To estimate your net wealth target first define the following three key variables:
- The age you want to achieve financial independence
- The annual cost of your desired lifestyle
- To what age you want to be able to continue to fund that lifestyle. (I recommend plan for your money to last at least until age 90.)
There are online calculators to help you calculate your target or alternatively refine the number in collaboration with a financial planner.
A useful starting point is the ASFA Retirement Standard, which estimates that a couple will need to accumulate $640,000 and a single $545,000 to fund a comfortable retirement.
When you’re starting out and have lifestyle debt such as a home mortgage, your net wealth typically is negative.
By inspecting the formula we can see that repaying debt is just as effective at increasing your net wealth as a new investment. In fact, it may be argued that repaying debt is more effective due to the certain rate of return.
Therefore, to accelerate your journey to financial independence think carefully before taking on new debt, especially for lifestyle items. Plan for the Predictable.