Your Financial Report Card

July 5, 2010

By Heather Compton and Dennis Blas

Financial Report Card Q:   How can seniors know if they are on track financially?

A:   Check your financial report card!

Your Financial Report Card – Part 1

It’s July, school is over and that means report card time.  Its report card time at our house too!  Every June 30 and each year-end our assignment is to prepare and review a two part Financial Report Card.  Part one is a current Net Worth Statement..

Net Worth Statement

A Net Worth Statement looks at everything we OWN minus everything we OWE.  It is our ASSETS minus our LIABILITIES.  That remainder is our NET WORTH.  We call that our retirement pot or nest-egg.  We calculate a Net Worth statement semi-annually and we prepare it at the same times every year. That way we can measure year over year changes.  Your Net Worth Statement, like a report card, points out where you are doing well and where you have some work to do

Assets

Let’s look first at the asset side of the statement. What assets do you hold?  To complete the asset side of the Statement you need to gather all your June 30 (or December 31) month-end financial data pertaining to assets. That includes investment statements for RRSP or RIF accounts, property value assessments for personal and investment real estate, Defined Contribution pension plans, bank savings accounts, perhaps a new Tax Free Savings Account, maybe even grandma’s valuable diamond broach.

After we list and total the assets we examine the quality of those assets.  Are they long-life appreciating assets such as good quality stocks or investment real estate, or are they depreciating assets like recreation vehicles or televisions that go down in value over time? Do the assets absorb income like your own home or a gas-guzzling truck, or do these assets produce income like rental properties, or dividend paying stocks?

Your home doesn’t generate cash to fund your retirement unless you plan to rent out that basement bedroom!  There are two schools of thought on including your own home as an asset on your net worth statement.  We do NOT include our home, vehicles or personal use assets like jewelry or art – our own philosophy is that because the net worth statement represents our retirement nest-egg it should only reflect those assets we can actually use to feed and water us and send us out travelling.

Now there is nothing inherently wrong with income-absorbing assets like cars and recreation properties or homes but we do have to consider how many income-absorbing assets we can afford to carry on the books when we no longer have the cash flow of a regular pay cheque.  You can retire sooner with a smaller retirement nest-egg if you reduce the assets that absorb income and those that don’t appreciate in value.

Liabilities

Our next step is to gather June 30 month-end (or December 31) credit card statements, mortgage documents, loan agreements – all the financial data pertaining to our debts to complete the liability side of the Net Worth statement.  We list our debts from the highest interest rate debt on down. For some, this will be the first time they’ve read the fine print to discover they are paying 24% to 28% on a department store credit card!  In a perfect world, we won’t carry any debts into retirement.  Mortgage or other debt payments require us to have greater retirement income in order to service the debt.  If we are debt-free we get to retire earlier or certainly more comfortably.

There is no such thing as good debt but there is bad debt and better debt.  If we borrow for investment purposes, for example to buy an investment portfolio or a rental property – the interest cost of that debt is tax deductible.  So we prefer deductible over non-deductible interest expense.  A conversation with an accountant or a financial advisor can help you determine if it is possible to rearrange your financial affairs so your non-deductible interest expenses could become deductible.

The Bottom Line

Add up your assets and subtract your total liabilities – that’s your net worth.  Your mission is to increase or grow your net worth prior to retirement by paying down debt, growing your savings and getting a good return on your investments.  The plan when retired is to draw the pot down at a sustainable rate.

What is sustainable?  How soon do we dip into our principle? The idea is to draw down the pot slowly. But how slowly? Most of us are painfully aware that even if we pick a conservative number like 5%, our retirement pot won’t grow at a consistent 5% every year.

Fidelity Investments studied a portfolio of 50% equities or stock, 35% bonds or fixed income, and 15% short-term instruments or cash. They assumed a constant rate of inflation of 2.25%. Their research shows you could withdraw 4% of the retirement pot in the first year and then increase withdrawals by the forecast 2.25% inflation rate each year and the money would last for your lifetime in 95% of the scenarios generated. There were 5% of scenarios where you would run out of money before you run out of life, but most of us would be pretty comfortable forecasting with a 95% probability.

Keep your eye on the ball – this is a semi-annual exercise.  If we experience a really poor year in the stock market and the value of our assets decline we need to be very aware of it and adapt our spending habits – or perhaps delay that big trip or the new car purchase.

Calculate Your Own Net Worth

OK students, complete that Net Worth statement.  You will find an excel model for a Net Worth statement on our website that you can easily download at Retirement Rocks.. Go the bottom of the spreadsheet to go to the 2nd and 3rd pages to fill out your assets and liabilities. It will automatically calculate your net worth on the first page.

Join us next month for part 2 of your homework assignment!

About the Authors: Heather Compton has presented seminars on financial and retirement lifestyle issues for over 30 years. She retired as Vice President and Senior Investment Advisor with a major financial services company. Heather and husband Dennis Blas co-present retirement seminars for a variety of corporate clients and are the co-authors of Retirement Rocks! Canadian Boomers Invest in Life. You can find their book online or in independent bookstores. See more of their advice at Retirement Rocks.

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