How do you know if you’re on track for financial independence?
This is often a question on the minds of families I serve. Regardless of the initial issues and decisions they need to tackle, eventually the conversation gets to a question that’s been on the back of their minds.
Some variation of…
”Are we on track? Are we making progress?”
“Are we ok?”
“When will we have enough to retire?”
“How will we know?”
Perhaps that question has been on your mind, or maybe you’re looking for a way to measure progress.
Let’s talk about three things you can focus on to track your own progress toward financial independence:
- Starting with the end in mind.
- Tracking Progress
- Controlling What You Control Most
Start with the End in Mind
The first step of any planning should be starting with the end in mind and working backwards.
What does financial independence or retirement mean to you? Why is it important? What are you really trying to solve for?
Financial independence ultimately means you have total freedom over your time, how you spend it, and with whom you spend it. You have the freedom to work if you want to, but not because you have to. So, how would you like to spend your time, with whom, and how quickly would you want to get there?
What’s your new identity once you’ve stopped seeing patients or left your practice? Or will you continue to practice simply because you love to, even if you don’t have to?
Ask yourself what financial independence means to you with as much detail as you can create. Don’t look at what peers find important, make sure your goals are important to you. At least clarify your own general timeline.
If you’re in your earlier- or mid-career, it’s likely you don’t have a concrete idea of what that looks like. It’s ok, you shouldn’t be expected to. But regularly revisiting what financial independence means to your family and how soon you want to get there at least gives you a framework to start planning around – even if the details are still foggy.
Your values and lifestyle will change over time, and you can adjust your planning along with them.
Track Progress – Total Term
Now that you’ve thought about your definition of financial independence, how do you actually track progress toward that goal? How do you know if you’re on track, or that you got there?
There’s a simple, yet impactful metric you can use to track progress that I and my peers call Total Term:
This is your financial independence metric – a great benchmark to watch and track progress. The score you get tells you how many years of your current lifestyle your net worth can support. How many years of spending have you built up?
For example, if you have a net worth of $1 million and spend $96,000 per year ($8,000/mo), then you have a score of 10.4. Meaning, you’ve built up 10 years of spending in net worth.
Your net worth is all of your assets minus all of your debts. Using your overall net worth is important, rather than simply retirement accounts. All of your assets – including practice equity, rental real estate equity, investment accounts, retirement accounts, and perhaps even home equity – play a part in creating income during retirement.
Focusing on net worth also leads to other questions and decisions. How healthy is your mix of net worth? Do you have an appropriate mix between different types of assets to create your ideal retirement? How does that impact tax planning? Do you have enough liquidity in your life? Are you overweight in any one area? Where is your cash flow going?
Also keep in mind that it uses current spending, not future spending. Your future spending and lifestyle are uncertain. A lot can change between now and retirement. Rather than tracking progress toward an uncertain future target that will likely change, I’d rather track how well your wealth can recreate your current lifestyle.
Over time, your lifestyle will change, and this metric will change with it. If your spending suddenly increases, this metric shows the impact on your net worth. You can then plan around what adjustments to make – increase your net worth at a faster pace or lower your spending.
What’s an ideal Total Term target? There’s no one set answer – it depends on each family’s situation and goals. A general target may be between 20-30. Meaning, your net worth will cover 20-30 years of spending without accounting for growth (or inflation). You can start there and adjust as your goals adjust.
A score closer to or higher than 30 indicates quite a high amount of security – you’re likely to have wealth left over at the end of your life. Closer to or just under 20 may mean retirement is feasible, but it may be more likely you spend down much of your assets during your lifetime.
You can adjust the metric for your own personal planning. If you know you’ll never touch your home equity, then you need to adjust the net worth part of the calculation accordingly. If you have a pension in the household, that impacts the amount of expenses your net worth needs to cover.
Is there a certain pace you should be on track for? It varies, but ideal benchmark scores by age might be:
- 30’s = Single Digits
- Age 45 = 10
- Age 55 = 20
- Age 65 = 30+
However, a lot can change where you should be at each stage of your life. As compounding typically works, your score will likely grow more slowly earlier in your career and much faster later.
This isn’t the beginning and end of retirement planning – far from it. There are a lot of details to plan around for tax planning, creating a withdrawal plan, different income sources like rental income or Social Security, Medicare planning, etc. But it’s a great benchmark to track progress.
What about retirement projections? Don’t you need a big, detailed retirement projection to see where you stand?
The standard practice in financial services – and what many consumers have come to expect – is to provide a big, statistical retirement projection. Get every knowable detail about your retirement and project it into the distant future.
I’ve run plenty of those throughout my career, and still use them where it makes sense. But I question the value of retirement projections, especially if you are in your early- or mid-career.
Think of the variables you have to model in – every spending detail, inflation rates for each category of spending, future returns and bounciness of markets, life expectancies, changes in your income, debts, and ability to save.
How clear are those details if you’re 10, 20, even 30 years away from your ideal retirement age…let alone the 20 to 40 years after that? How can you possibly know what your lifestyle will be at that time? What you’ll value spending money on? Where you’ll even live (I’ve seen grandkids change retirement and moving plans overnight)? How useful is a projection when every variable is inaccurate?
So, I believe detailed retirement projections have a place as you get closer to retirement and the details become clearer, and it’s something to continue monitoring through retirement. But earlier on, I’m not sure they’re as helpful as we’d like. In your 20s or 30s, they’re probably a waste of time.
Control What You Control Most – Savings Rate
Because of the uncertainty about how the future will unfold, focus on making the best financial decisions today. How can you improve your financial health and put you on the right track, adjusting as you go?
Try to focus on the things directly within your control – increasing your income, improving your practice, making wise investment decisions, controlling costs and taxes, staying patient and disciplined.
Among the most important things within your control is how you use your cash flow.
In last month’s newsletter I wrote about metrics to check the health of your cash flow. There are two ways to improve your net worth.
The first is paying down debt. The second, and the one that really drives the growth of your net worth, is your savings rate. That’s the percentage of your income (before taxes) you’re investing for the future – turning that high income into assets.
Total Term – your financial independence metric – is the lagging indicator. It shows progress and results over time.
Your savings rate is the best leading indicator you have. Focusing on increasing your savings rate to a healthy level as soon as you’re able gets you on the right track and helps hedge against a lot of future uncertainty.
Future returns, timing of retirement, your future health and ability to keep working, the success of your business…all of that is pretty uncertain. A healthy savings rate helps to hedge against that. The decision to save and invest is directly within your control, and the best tool you have.
Hopefully this is helpful as you make progress toward financial independence, whatever that means to you!
If you’d like to track these metrics and your own progress, ODs on Facebook community members can use the same financial planning app that I use with clients by clicking here.
