By Tom Breiter - Integra Capital Advisors
We’ve all heard the term “millionaire”, which describes someone that has a net worth of $1,000,000 or more. It used to be a big deal to be a millionaire decades ago, but with the passage of time, increasing incomes and generally rising financial markets, being a millionaire isn’t quite the level of panache as it was 20 or 30 years ago. Still, a million bucks is a lot of money, so while nowadays you may need multiple millions to be at the same inflation adjusted level of a millionaire when you were growing up, being a millionaire is a great first step in wealth accumulation goals.
Net worth is defined by Investopedia, as the dollar value of assets owned after subtracting liabilities of money owed, such as mortgages or other forms of consumer debt1. In simple terms, if you sold everything you owned and paid off all you owe, your net worth is what you would have left in cash. Net worth is a measure of wealth, which is very different than a measure of income. Income is independent of worth in that someone may have a very high level of income, but if they spend all the income they earn each year they could have a very low net worth. Conversely, an individual could be a low income earner, but have a very high net worth. An easy example would be someone who works a minimum wage job, but inherited several million dollars from a deceased parent.
For most, the idea of net worth and income become related especially in the retirement years where, absent income from employment, we start to rely on accumulated assets to produce income to support our lifestyle. Net worth is a resource for producing income for needs and wants when you no longer wish to work or to supplement work in retirement.
The ultimate question for each retiree is the relationship of needed and desired income relative to the accumulated net worth, as well as the willingness to assume risk in the attempt to produce income. This is a deep topic with no perfect answers. For example, if an investor owns several million dollars’ worth of raw land, there may be zero income produced even if there are millions of dollars of worth involved. The same net worth invested in developed real estate like homes, apartments, or commercial property may produce a high level of income. Securitized investments like stocks and bonds produce income and may appreciate over time, where the appreciated value can be harvested to use as spendable income.
A “rules of thumb”, based on time tested strategies, is helpful in getting into the right ballpark using traditional stocks and bonds to produce income. One of these is the “Safe Withdrawal Rate” originally researched by California-based financial planner Bill Bengen. Mr. Bengen researched the withdrawal rate that could be sustained over 30 years with adjustments for inflation and provide 30 years of retirement income without the retiree(s) in question running out of money2. The “Safe Withdrawal Rate” is dependent on the performance of financial markets, especially in the early years of retirement. Bengen found even in the worse case scenario, that a 4% withdrawal rate of total principal value, adjusted for inflation would provide for 30 years of income, even if the retiree randomly experienced the unfortunate luck of retiring at a peak in stock market values like in 2000 or 2007. Others have expanded on Bengen’s research and found that the inclusion of international and small-cap stocks increases the "Safe Withdrawal Rate" a bit, but in general we think using a 4 percent or lower spend rate is a great way to start planning.
Some planners believe a lower rate should be used due to the decades low interest rate environment we have been in since the financial crisis of 2008 – 2009. With bond yields low, the implication with a balanced portfolio will produce less return and necessitate a lower "Safe Withdrawal Rate"3. We maintain that the 4 percent withdrawal rate is still reasonable if the investor is willing to build a truly diversified portfolio including some higher yielding private investments rather than just S&P 500 type stock investments and government bonds.
In summary, net worth is a resource for the production of retirement income. How the net worth is invested determines the classification of that income. Some investments pay current cash flow yields. Others require a transactional sale to convert the asset value to spendable income.
Integra Capital Advisors specializes in developing structured retirement income plans that account for your guaranteed sources of income such as Social Security and pension income aligned with the use of investable assets to create the additional income needed to meet your desired lifestyle expenses. Our planning process is known as the Waypoint FORMula – which is designed to relive you of the day-to-day-worry of the financial markets and allows you to focus on the important things in your life. Contact us today to discuss your retirement income plans.