Over the past few weeks, we’ve spent a lot of time talking about your retirement wealth gap. We’ve covered everything from inflation and normalizing your income to assuming the ROI of your business and your investment portfolio. Now that we’ve laid all of the groundwork, it’s finally time to identify the wealth gap formula. Today’s article will pull everything we’ve learned to this point, together and show you exactly how to calculate your own retirement wealth gap.
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Early on in this series, I discussed 13 things that keep us, as business owners, up at night. These were the things that cause us to be the most anxious; the most fearful. But, we also realized that many of these stress-inducers aren’t so scary if we understand where we are in our journey. Since then, we’ve uncovered many of the things that we need to understand in order to accurately and confidently prepare for our futures. Yes, there are some assumptions involved. But, as long as we approach each step with the right mindset and detailed information, we can still put together a wealth gap calculation that we have confidence in.
RELATED READING: 13 Things That Keep Business Owners Up At Night & How To Rest Easy
So, the first thing I want you to do is to look at your net worth statement and separate your assets into two categories: income-producing and non-income-producing. What do I mean by this? Well, here’s an example. I don’t consider your house to be an asset. Sure, you could sell it and, potentially, make a profit from the sale. But you will ultimately need to have a place to live. Whether you rent or own, there are costs associated with your home, and you’ll be paying them no matter where you live. So, remove your house and any other assets that don’t produce an income from your net worth statement.
The next part of this calculation is to set clear and quantifiable goals. You know what kind of lifestyle you want. What is it that you need in order to live that lifestyle? Are you planning to increase your current lifestyle? Maybe you want to decrease your current lifestyle. Whatever it may be, you need to be clear in your goals and be able to measure your progress toward reaching them.
For example, at 41-years old, I know that my kids will be out of the house within the next 9-10 years. Let’s pretend that at that point, I’d like to have the opportunity to become a world-class ATV stunt driver. Now, I know that I have about a 10-year timeframe to prepare for that. Your number may be longer or shorter based on where you are in life. The point is, you know when you want to accomplish this goal. From there, I can say that I need $100K, $400K, or even $1MM in annual income to accomplish my goal.
Whatever your number is, you now know your timeframe and how much income you need to pull from your assets. So, if you’re running at $80K, that means you will need to save roughly $2MM over the next 10 years, in order to pull $80K from your assets using the 4% rule. That’s how we develop sustainable income for the rest of our lives. Unfortunately, most people don’t do this. The reason? They’ve never quantified their goals. Friends, you have to have a plan and a direction for your goals. If you don’t, reach out to us. Let us help you quantify your goals and develop a plan to sustain them.
As business owners, we often have everyday expenses like a cell phone, WiFi, or even a vehicle that we run through the business. But what happens when we retire from the business? Are we no longer going to have a cell phone or the internet? Of course not. At that point, we will begin to pay for those items out-of-pocket. That’s what I mean when I say that we must normalize our income. In order to have an accurate picture of how much it will cost to live our lifestyle after retirement, we must factor in the expenses that we currently take for granted.
RELATED READING: Normalizing Personal Income for Business Owners
Likewise, we have to be prepared for the fact that inflation will take place. The value of today’s dollar will almost certainly be less than that of the dollar 10, 20, or even 30 years from now. Therefore, it’s necessary to consider inflationary rates when calculating your wealth gap.
Next, we have to calculate the ROI of our investments. This includes business, real estate, and market investing. With your business, if you’re just starting off, there could be a huge potential for growth. On the other hand, if you’ve been in the game for quite a while, you probably aren’t going to see a whole lot of increase. When making ROI assumptions, this is where we really have to be careful. Assuming the wrong ROI can drastically impact our wealth gap calculations.
Similarly, real estate can offer a wild variance in ROI. Think about all of the property owners and what they’ve gone through since the coronavirus outbreak. As the pandemic took hold, property owners were unable to collect rent, in many cases, and couldn’t evict their tenants. They weren’t receiving an income on their properties but still had to pay for their mortgages and upkeep. This resulted in a much different ROI than they would have realized in 2019.
Likewise, your season of life matters when assuming your ROIs. If you’ll remember the glide paths that I spoke of in my last entry, the older you are the more conservative your investments become. The result is a lower ROI. On top of all of this, we have the absolute certainty of taxes. It doesn’t matter if you’ve got the best ROI, the worst, or anything in between, you will pay taxes. Chances are pretty good that the tax rate will increase between now and your retirement, too.
You see, friends, all of these things that we’ve covered over the last several weeks make up the formula for calculating the wealth gap. I want to leave you with another example to explain the importance of each of these things. I am an avid swimmer. It’s one of the exercises I enjoy the most. Like most swimmers, I look to the bottom of the water and breathe as my body rotates under each stroke. But if I don’t have a lane marker, a boat, or even a wake to guide me, it becomes easy to become disoriented. As I become disoriented, I become fearful. When I become fearful, I lift my head up.
The problem is that every time I lift my head up out of the water, I lose all of the momenta that I had gained. The same is true with our wealth gap. If we don’t have someone alongside us, we can become disoriented and fearful. When this happens, we look up to regain our bearings. Thus losing all momenta that we had toward our goals. If you don’t know how to calculate your wealth gap, then we can help. If you do, great. So, can I. But even I need a coach.
Look, folks, life is good. Life is hard and it’s frustrating, but it’s good. Calculating the wealth gap can be frustrating. But with the right guidance, it can, at least, be financially simple. Let’s go out and make it a great day!
Have questions about the wealth gap formula and preparing for your financial future? Reach out to the Financially Simple team. We are here to help!