An interesting Wealth Exercise to do on yourself?

[sash]

I just developed an interesting wealth exercise which gives insight as to whether you are perpetual money machine....or a squander!!

Here are the steps:

1. Add up the total amount of earning to date. The person I did this on earnt $1.8m over 20 years.

2. Add up the amount of tax paid over the last 20 years worked. The person I did this exercise paid about 620k.

3. Add up your living costs (you will have to estimate)...in my case study it was about 905k.

So based on the above this person has earnt $1.18m NET over 20 years. Their saving after living costs over this period is $375k. But their current networth is less than 300k...INTERESTING...

If this person has a net wealth of $750 to $1.12m (2 to 3 times their NET savings) they are doing very well. Obviously, the ability to make money is driven by savings.

A very interesting exercise indeed. I did this exercise on myself and found it very interesting....

 

[HotRod]

Depending on what you assume as expenses/earning it will vary greatly.

From experience most people:

Earning - Tax - Expenses < 0

And that will be fairly common.

i.e. most people live beyond their means.

 

[sash]

True...but I am talking about net left over from normal tax deductions not artifical - i.e. depreciation, paying interest in advance, etc.

As for most people living beyond their means...true....but try explaining to a poster on this site called China.

Depending on what you assume as expenses/earning it will vary greatly.

From experience most people:

Earning - Tax - Expenses < 0

And that will be fairly common.

i.e. most people live beyond their means.

 

[kum yin lau]

Hi, I'd done this kind of calculation in a similar way but not as structured.

I think I'm fairly typical.

I end up with just under 2x my 'savings'.

i've to add that I did not include family commitments as part of "expenses", only what was needed to keep myself.

In the earlier years, all my earnings went towards kitchen rehab for the family house, rebuilding the family home, living expenses for my parents, education for my younger siblings etc etc

An interesting exercise towards understanding our own habits!

KY

 

[pennyk]

1. Add up the total amount of earning to date. The person I did this on earnt $1.8m over 20 years.

2. Add up the amount of tax paid over the last 20 years worked. The person I did this exercise paid about 620k.

How do you remember what you were paid for the past 20 years? I'm not sure I can remember last year, but i could at least look it up. But unless you're a hoarder, you wont have tax returns from 20 years ago..

 

[tess85]

Thanks sash, interesting exercise indeed, looking at the return on your savings.

You can break it down further if you are so inclined.

For example, I know that the $35k that I spent on a car is not going to yield anything investment-wise. Eventually the return on the $35k will be 0% (depreciating asset).
However the $xxk that I spent on a PPOR deposit has already had a 100% return within 3 years.

Your total return would be the weighted average of the returns across all the different components that you have spent your savings on.

I guess this exercise tells you one needs to buy appreciating assets not depreciating assets!
This realisation has actually helped me to curb my clothes spending quite a bit... when I realised that they were just depreciating assets!

 

[Corey Batt]

I guess this exercise tells you one needs to buy appreciating assets not depreciating assets!
This realisation has actually helped me to curb my clothes spending quite a bit... when I realised that they were just depreciating assets!

Unless you buy a car as a ram-raider and get away with a lot of stolen goods, or you buy expensive clothes in the attempt to catch the eye of a wealthy oil sheikh. Then you will make very good returns on your investment!

 

[sash]

I am hoarder when it comes to documentation...I do have all my tax returns for the last 20 odd years! Though I do throw out or give away old clothes, mags, electronic items every couple of years. Primarily due to space contrainsts.

Even have most of my bank statements. Some of things I found are really scary...for example my average credit card spend has gone from something like $600 in mid 90s to over $2500 per month today.

How do you remember what you were paid for the past 20 years? I'm not sure I can remember last year, but i could at least look it up. But unless you're a hoarder, you wont have tax returns from 20 years ago..

 

[Peter Parker]

If this person has a net wealth of $750 to $1.12m (2 to 3 times their NET savings) they are doing very well. Obviously, the ability to make money is driven by savings.

Only up to a point, and mainly in the first 10 years of serious investing. Beyond that, unless investments perform poorly, capital growth becomes more significant.

This exercise is particularly interesting for low-medium income earners who are active investors.

They may well find their net wealth not only exceeds their savings but it exceeded the sum total of job earnings as well. A great (and rare) achievement in investing terms. If you're in that group, pat yourself on the back - your investments are working harder than you are!

One limitation of the above analysis is it would be desirable to adjust past income, spending and saving for inflation, which is a pain. That's why I most like the much simpler formula of:

Net wealth/Annual Expenditure ratio

In crude (and over-simplified) terms this tells you how many years you'll last on your current wealth at current spending. Eg $1 million / $50k pa = 20 years. Simpler than the 'Millionaire Next Door' formula (which also has age) and I think better.

Reverse the ratio 20:1 and you get 5%. In other words running down your capital by 5% each year. Unless your growth and yields consistently higher than this it's probably not quite enough to be indefinitely financially independent. Especially if you factor inflation's effect, which you'll need to in order to retain real standards of living.

Whereas a wealth/annual expenditure ratio of 50:1 requires only a 2% yield to meet living expenses. In other words each year you start with 100%, spend 2%, and provided it's appreciated (or produced income) by more than 2% then you're ahead (or 5% if you include 3% inflation).

It is most unlikely that your investments will have less than this in yield + capital growth, so a 50:1 ratio is extremely safe to be financially independent however long you live (provided the assets are good quality income producers).

 

[HiEquity]

50 to 1 would require 2.5m net for 50k per year. Would you adjust the calculation if you had say 6.5m assets and 4m debt? Rather than 2.5m outright. If so, how?

 

[kum yin lau]

Hi, if your net wealth is $1M, and yield is 5% and your annual expenditure is $60K, then your $1M never ever gets run down.

That's what financial independence is all about, merely accumulate enough to produce enough so that the capital never erodes.

Which US university has a fund that is based on this principle?

KY

 

[Peter Parker]

50 to 1 would require 2.5m net for 50k per year. Would you adjust the calculation if you had say 6.5m assets and 4m debt? Rather than 2.5m outright. If so, how?

I wouldn't adjust it at all.

Such a leveraged portfolio would have greater capital gains (due to the larger asset base), lower yield after costs (due to interest) and higher risk (due to sensitivity to interest rates and banks potentially calling in loans).

This risk may or may not be appropriate depending on one's circumstances.

 

[BayView]

You haven't factored in things you spent money on that you thought were a good idea at the time, but turned out to be a total waste of money....

And you also have to factor the various rip-offs you have to endure along the journey as well.

 

[marg4000]

Even have most of my bank statements. Some of things I found are really scary...for example my average credit card spend has gone from something like $600 in mid 90s to over $2500 per month today.

Not necessarily - it may simply show how our usage of credit cards has changed.

If it is all discretionary spending then it is a worry.

But I suspect that, like many, you pay bills by credit card and pay off the balance each month.

Our monthly credit card bill is well above that, but we pay it in full at the end of the interest free period.
Marg

 

[sash]

Yes there is an element of that.

The other thing is I try to put everthing on the card and try pay with my Amex...as I get double/triple the points of the Mastercard.

Actually, the amount of spending has been an average of $3500 over the last 3 months.

I find that I can get about 80,000 points on my CBA card within a year. I usually convert this to Flight Centre reward vouchers. Last time I cashed in about 110,000 point for $730 odd dollars in Flight center reward.

I combined with this frequent flyer points for a trip to bali....in the end I paid something like $500 for 5-star accomodation in Seminyak and airfares to Bali..so I was chuffed.

Not necessarily - it may simply show how our usage of credit cards has changed.

If it is all discretionary spending then it is a worry.

But I suspect that, like many, you pay bills by credit card and pay off the balance each month.

Our monthly credit card bill is well above that, but we pay it in full at the end of the interest free period.
Marg

 

[HiEquity]

I wouldn't adjust it at all.

Such a leveraged portfolio would have greater capital gains (due to the larger asset base), lower yield after costs (due to interest) and higher risk (due to sensitivity to interest rates and banks potentially calling in loans).

This risk may or may not be appropriate depending on one's circumstances.

Hi Spiderman

- Greater capital gains - agreed.
- Lower yield after costs - depends on the yield of the assets in question. If it was CIPs for instance the net yield from the assets could be higher than the cost of funds so there could well be a higher yield after costs.
- Higher risk - agreed.

Personally, the higher risk means I would adjust the result so that 50 to 1 would not give me the same comfort here as it would if it was unleveraged. The amount of adjustment required is of course a subjective thing and depends also on the assets in question and their risk profile.

So I guess I'm just providing an example where a 50 to 1 ratio may not be particularly safe for indefinite financial independence...

 

[The Y-man]

Hi, if your net wealth is $1M, and yield is 5% and your annual expenditure is $60K, then your $1M never ever gets run down.

KY

KY, I'm lost.....

5% of $1m is $50k?
So if you spend $60k...??

The Y-man

 

[Peter Parker]

KY, I'm lost.....

5% of $1m is $50k?
So if you spend $60k...??

The Y-man

It adds up all right, provided you do as the spruikers do and put in a fudge figure to make it work.

Eg 7% pa growth not only covers the $10k pa shortfall but also leaves $10k left over (conveniently neglecting inflation)!

 

[kum yin lau]

Hi again, sorry I was a bit fuzzy in the head. It should be 6% of course.

My properties yield about 8.5% in total so I was using that as the yardstick.

Obviously they're not all residential.

In 10 years, the vacancy hasn't been very bad & the average yield is in excess of 8%

So there's no need to eat into the capital once the $1M has been accumulated.

KY