Methodically growing your overall net worth is what wealth creation is all about. Your net worth is the culmination of savings, investing, real assets, and liabilities. I’m much more concerned about growing my net worth than only growing my stock portfolio because my stock portfolio is just a portion of my net worth.
Think of your net worth like a battleship during a time of war. As the intrepid captain, you are navigating your net worth to glory through sea mines of temptation and unknown icebergs of economic downturns. The greater you build your net worth, the more careful you steer.
It’s always important to think about your net worth in a risk adjusted manner. Putting 100% of your net worth into the stock market isn’t so bad when you’re a single 28 years old with $150,000 to your name. But if you’re 50 years old with a couple kids entering college, you’re likely not allocating your entire $1 million in assets into the stock market.
When I was in my 20s, I didn’t really track my net worth because I didn’t know better. I was focused on my career and saving as much as possible. My idea of net worth diversification was investing as much as I could away from the stock market given my pay and career were already dependent on the stock market. Every year 20%-30% of my compensation was paid in the form of company stock so there was no escape.
For 10 years this strategy worked pretty well because the stock market really didn’t go anywhere from 2000 – 2010 and real estate caught fire until 2007. Now everything is on fire! Let’s just hope the battle ship doesn’t burn down with so much unbridled mania.
I’ve been much more surgical in managing my net worth in my 30s given it has grown to a point where it throws off an important passive income stream. Not having a day job anymore makes it that much more important to protect my financial nut. If I can grow my net worth by 10% per annum, I’m usually satisfied. To put 10% in context, Bernie Madoff was able to amass $50 billion dollars under management because he delivered fake 10% annual returns!
In this article I’d like to provide several net worth growth targets to consider as well as a net worth growth framework by age. I think if I was able to read this article four years ago, I would have allocated more of my net worth into equities and would have a 10% higher net worth as a result. Hopefully this framework will help many of you build wealth.
NET WORTH GROWTH BENCHMARKS TO CONSIDER
1) S&P 500 Index Performance. The index of 500 large cap weighted stocks was introduced in 1957 and makes up 75% of the total US market capitalization of stocks. In other words, the S&P 500 index is the best reflection of the US economy. Returns have been anywhere from -43% in 1931 to +52% in 1954 to +30% most recently in 2013. The average hovers around 8%.
The only way to get ahead if you are behind the average net worth for the above average person is to grow your net worth faster than the S&P 500 index. Targeting the S&P 500 index as a net worth growth benchmark is generally for middle aged individuals.
2) Risk Free Rate. The risk free rate is the 10-year government bond yield. It is risk free because the US government is the most sovereign nation and will pay you back unless we get attacked by aliens. The current risk free rate is roughly 3%, from a low of ~1.5% in 2012. The risk free rate has been coming down for over 30 years as we’ve managed to contain inflation in the US and enact more effective economic policy.
Given I believe the ideal withdrawal rate during retirement touches no principal, growing your net worth by at least the risk free rate should be the base case goal for all individuals, especially traditional retirees over 65 who no longer have strong earnings power. I wrote a three-part series on US Treasuries if you want to learn more.
3) Industry Specific Indices. Every industry has differing rates of growth. It would be unfair to compare the growth rates of the stable telecom industry with the growth rate of the internet industry. You can track your industry’s annual growth rate through the performance of industry ETFs such as: HDG (hedge fund), XLP (consumer staples), XLE (energy), XLF (financial services), XLV (healthcare), XLI (industrials), IYR (real estate), GDX (materials), IYZ (telecom), XLK (tech), and XLU (utilities). You can be even more specific by tracking your own company’s stock price performance if it is publicly traded.
If you want to expedite your wealth, then a large part of it has to do with choosing the right job in the right industry. This is why it’s important to do well in school so you have the options to choose your destiny. The top industries for MBAs are now tech and internet, as opposed to banking and management consulting in the late 90’s.
The Ideal Scenario: A great goal is to make money in good times and bad times. Based on my net worth growth rate benchmarks, an optimal scenario is to earn the risk free rate of return during down markets and match the S&P 500 growth rate during up markets. In order to do this, you’ve got to break down your net worth and make assumptions across each asset class. You’ve got to hedge out risk. No easy task, hence the ideal scenario. I’ll discuss my ideal scenario strategy in a future post.
ASSUMPTIONS FOR NET WORTH GROWTH FRAME WORK
* Risk tolerance: Risk tolerance decreases the older you get due to added responsibilities, a larger net worth in need of protecting, and less time to make up for investment losses.
* Earnings power: Earnings power increases steadily up until about 50 and begins to decline due to age discrimination, risk of termination, less energy, and the risk of not finding work again if terminated.
* Economic variables: Average historical variables of GDP growth 3%, inflation 2.5%, risk free rate 0.5% higher than inflation.
* Education: Graduated from college or attended a trade/vocational school.
* Employment: Continuous employment or livable income since graduation.
* Savings rate: At least a 20% average after taxes over your entire career.
* Net worth upon entering the work force: $0. I realize many students nowadays graduate with debt, but for simplicities sake we start with a $0 net worth. If you have student loans, then think of the educational capital you have to bring your net worth back to zero.
NET WORTH GROWTH TARGETS BY AGE CHART
18-30 YEARS OLD: EXTREME NET WORTH GROWTH PHASE
Between the ages of 18-30 you should be in the extreme net worth growth phase. If your net worth is $10,000 at the age of 23 one year out of college, it should be fairly easy to double your net worth to $20,000 if you make $40,000 a year and live rent free in your mom’s basement.
You’ve literally got nothing to lose when you’re young. It’s important to take calculated risks in your career and in various investments because you’ve got plenty of time to learn from your mistakes. You’re also able to have a redo by going to graduate school.
Net worth growth rate target per annum: 50%-100%+
31-35 YEARS OLD: RAPID GROWTH PHASE
Age 30 is a big milestone for both men and women. Speaking from a man’s point of view, we either will have “made it” or know we are on the right path to making it at age 30. Income should be much greater than income in your 20s, which should help accelerate savings and investing. 31-35 is the median age where most Americans buy a home.
After 8 to 13 years of contributing to your 401(k), you should have roughly $130,000 – $330,000 if you follow my 401(k) by age chart. You begin to see the growth of your assets make a difference to your overall net worth. No longer is it just about making more money by going to work. It’s about making your money work for you.
Net worth growth rate target per annum: 25%-50%
36-40 YEARS OLD: HIGH GROWTH PHASE
You begin to take risk off the table because you might have dependents. No longer are you going to have a majority of your net worth in stocks when you’ve got a spouse and a little one to put through school. Your parents are likely in their 60’s to 70’s if they are still around and you’d like to set aside some time and money to care for them if needed.
36-40 years old is a great time for income growth as you’ve now got 10-18 years worth of experience. You’re old enough to get real respect from your employees, clients, and managers. In terms of love life, 35 years old is also the golden cross of love for men. Your net worth is much more diversified now with real estate, stocks, bonds, and risk free assets. If you don’t have any dependents, you can afford to take more risk.
Net worth growth rate target per annum: 10%-25%
41-55 YEARS OLD: NORMALIZED GROWTH PHASE
After 20 years of saving and investing you’ve grown a respectable sized nest egg which you’d like to protect. You begin to tire working for the man so the thought of your retirement nest egg losing any value petrifies you to be more conservative with your investments. You’ve got a propensity to hoard cash like the rich.
With 25-45 years left to live on average, you can’t get too conservative. You’re actively looking to generate passive income streams or spend more time on optimizing your income producing investments. Assets that provide yield such as high dividend stocks, annuities, and muni bonds start looking appealing.
Net worth growth rate target per annum: 10% – 15%.
56-70 YEARS OLD: MAINTENANCE PHASE
You don’t necessarily have to be 56-70 years old to be in the net worth maintenance phase. If you’ve achieved your desired financial number at a much younger age, staying in the maintenance phase is fine too because you’ve got all the money you need.
With a minimum net worth return based on the 10-year risk free rate, you are assured to earn at least 3% on your net worth every year. On a large number, 3% is enough especially now that you’ll be able to withdraw from your pre-tax retirement accounts and receive Social Security.
Net worth growth rate target per annum: Risk free rate (3%) – 10%.
71+ YEARS OLD: REDUCTION PHASE
If we spend all our years slaving away at a job and die without enjoying everything life has to offer that would be a crying shame. I conservatively bake in a negative net worth growth rate to allow people to spend their money beyond the risk free rate of return even though the ideal withdrawal rate in retirement doesn’t touch principal. The ideal scenario is to earn enough to happily live off your dividends and interest to guarantee you’ll never run out of money. You’ll also be able to pass down your assets to the next generation and to charities.
If you find yourself with more money than you need, you can afford to take more risk with your net worth if you’d like. However, by this age I think you’ve figured out what makes you happy, and making more money likely is not necessary. It’s much more rewarding using your money to help other people instead.
Obviously everybody’s lives aren’t going to go according to plan or follow my various life stage descriptions. Some may find themselves long term unemployed during their supposed high earning years. Others might have hit the jack pot earlier and decided to de-risk because they’re completely satisfied with what they have.
2013 should be considered an anomaly never to be experienced again. I certainly hope we do see another 30% increase in stocks coupled with a double digit rise in real estate values, but I don’t recommend baking such numbers into your retirement pro forma calculations. It’s much better to be conservative and end up with too much than come up short when you are no longer capable of working.
Once you get to a comfortable net worth level I encourage you to shoot for a 10% annual growth rate. My definition of a comfortable net worth is when you become UNCOMFORTABLE losing any more than 15% of your net worth in one year. A 10% annual growth rate is close to the historical S&P 500 average annual return. 10% is also roughly 3X the risk free rate, which ensures that you are staying ahead of inflation while not putting too much of your net worth at risk.
During bull markets, greed is going to really tempt you to go outside your risk tolerance zone. Definitely be honest with yourself in knowing what you can stomach to lose. During bear markets, fear will make you hoard cash and miss investment opportunities. You might even develop a notion of wanting to spend all your money before the market loses it all for you! In either environment, try and be disciplined to sticking with a net worth growth target. I hope my net worth growth framework helps!
You can track your net worth by aggregating all your accounts on Personal Capital’s dashboard. It’ll provide you a graphical chart to show how your net worth changes over time and an input section where you can manually adjust subjective values such as real estate to come up with an overall picture. They’ll even send you a net worth update once a week by e-mail. It’s so much easier than tracking your net worth in Excel.
Readers, what is your net worth growth for the past 12 months? Do you agree or disagree with my various growth phases and risk tolerance levels by age? Once you reach “your number,” what growth rate are you willing to accept?