For those of us that like to think that we are living below our means, there exists an interesting alternative to net worth in determining your wealth level. Mr.Cheap from Quest for Four Pillars does a great job describing this alternative, in his 'An Alternative to Networth' post.
This metric is mentioned in the book 'The Millionaire Next Door' and is an interesting way of looking at one's wealth level, as it factors in your personal cost of living. In essence this formula compares your assets to your lifestyle costs, quite simply - How Long Could You Go Without Receiving a Paycheque. Simply take your net assets (assets minus liabilities) and divide by your monthly expenses. This will give you the number of months that you or your family could go without regular income. I think I will call it 'Net Freedom'
Whether you would include your home equity in the calculation or not depends on personal choice. If you use your home equity as an asset then don't forget to include an amount in your expenses that you would be paying for rent. Also, if you are a homeowner, when adjusting your expenses think about how they would change if you no longer owned a home. If you would choose not to move when you became paychequeless then the calculation becomes simpler. Obviously there are flaws to all of this as many more changes to your expenses could come to light if you suddenly were without a job (ie benefit loss).
When I perform the calculation for our family, our Net Freedom is about 46 months, or 3.8 years. I like this metric because it not only measures wealth, but it measures wealth against lifestyle costs. This allows those who live below their means to score higher and rightfully so, as their financial situation is truly more flexible and powerful than someone who lives high on the hog and earns just enough to get it done. Certainly it is an interesting, and perhaps eye-opening exercise to calculate this for your personal situation. As always, I'd enjoy hearing reader's thoughts on this.
4 comments:
Thanks for the link, posting your thoughts and the name suggestion!
At a certain point your 'Net Freedom' almost becomes infinite (when you can generate a real return from the lump sum which covers your living expenses instead of depleting it to live every month).
I'd imagine this would happen at a net freedom of a little more than 20 for a balanced investor (if they were getting a 5% real return).
hey cheap, thank you for originally posting it and good point about the yield. When Net Freedom reaches 20 years or so you win. However by the true definition you should just represent your value as the number of years you could live without a paycheque assuming you deplete the capital and garner zero yield.
Interesting post. One i have actually thought of since most of us could potentially lose our jobs tomorrow (which would likely mean a large pay cut if i was to quickly find another job).
I used 80% of my house equity (since that is what the banks will allow us to borrow)and 60% of my RRSP amound since taxes will take close to that.
I also adjusted my budget slightly for 0 savings (who saves with no income?) and reduced some expenses that happen when i travel to work.
I did not use any RESP's or sell any vehicles. I was slightly up on MG at around 50 months.
It was actually nice to see that i have some breathing room.
Also assumed 0% return on money being used up from home equity and RRSP.
Good post and repost MR.Cheap and MG
DH
DH,
For your avergae tax rate to be ~40% in retirement (or unemployment if that is when you'd be withdrawing from the RRSP) you'd have to be pulling out (ON for example) over $100k / yr!
Anyway, in our case our number is just slightly lower than MG's. This is a good exercise. It's made me realize that we clearly spend too much!
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