Net Worth vs. FI Number: Two Important but Different Measures

BLUF: Net Worth and your “FI number” are two very important but unique financial measures to track. Net worth is a single number to track wealth building. Your FI number defines a finish line for wealth building to know when you have enough.

If you hang around FI groups long enough there are likely three very important metrics that you’ll hear discussed: annual expenses, net worth and your financial independence (FI) number. The three all are related and contribute to answering the main question we care about: how much do I need to retire? Back in January, I discussed how I was tracking my expenses to understand my annual expenses and cut areas of waste. I’ll deep dive into tracking expenses soon since that is a key to understanding your annual spending.

Net worth and your FI number are wealth related metrics but they aren’t the same thing. This article will dig into what they are and how to measure each one.

What is net worth?

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Net worth is quite simply a measure of the wealth of an individual or company. The math isn’t complicated with the formula being: Net Worth = Total Assets – Total Liabilities.

Unlike your FI number, net worth and how you calculate it is a standard thanks to the accounting profession. There isn’t a debate about how you calculate it and what is an asset and a liability is standardized by the accounting profession. I’m sure there’s lots of nuance when calculating net worth for large, complicated businesses but it’s straightforward for most people.

What is an asset?

“An asset is anything of value or a resource of value that can be converted into cash.”¹ It’s all your accounts that already are in cash like bank accounts and investment accounts. It’s also anything tangible that you own that could be sold and turned into cash. Your car, your house, a business, land and fine art just to name a few examples. A few more examples below:

All bank account balances
All retirement account balances (401k, 403b, 457, Roth, traditional IRA etc)
Property value
Car value
Business value
Leisure vehicle value (boat, RV, motorcycle…etc)
Antiques / collectibles / fine art
Anything that you could sell for cash

What is a liability?

A liability is something a person or company owes, usually a sum of money.² All those places where you owe money and make payments? Yup, those are liabilities. Some of the most common liabilities are listed below:

Mortgage
Car Loan
Student Loan
Personal Loan
Business loan
Credit card debt
HELOC balance
Family member loan

Net worth calculation examples:

Your net worth is how much money would you have if you sold everything you owned, turned it to cash and then paid off all the debt that you could with that cash. Lets take simple example from a teenager that has a cheap car worth $2,000, they have $1,000 in the bank and they owe their parents $2,000 for loaning them the money for the car.

Assets = $1,000 cash + $2,000 car = $3,000
Liabilities = $2,000 car loan to parents
Net Worth = $3,000 in assets – $2,000 in liabilities
Net Worth = $1,000

How to track your net worth

There are many options to track your net worth. Since the calculation is simple you can use a piece of paper, a spreadsheet or a variety of programs out there. The thing about net worth is that the number is very dynamic. The more assets and liabilities you have, the more you have to update to get your current net worth. That’s why I prefer using a program that can pull in account information automatically.

Net Worth Tracking Using Personal Capital

I, like many other people, use personal capital (PC) because it’s free and it allows you to easily add all your accounts so that your net worth can be updated automatically. Mrs. MFI and I have 8 different investment accounts, 7 bank accounts, 12 credit cards and our mortgage. That would be a pain to try and grab the latest numbers from each even on a monthly basis.

This is a good time to point out why PC is a nice free service. Well, it’s free because the free net worth tracking that they offer gives them an easy way to find potential clients for their money management services. They can “see” how much money you have an when your investible assets exceeds $100k you get a phone call from them for a free consultation. That $100k number will likely change over time but they have given me a call periodically as my net worth continues to grow. I just ignore the voicemails and they don’t call me back for months.

Here’s the summary sheet showing net worth, total assets, total liabilities and totals for sub groups like cash and investments.

Aside from seeing the numbers real time you can see a graph of total net worth, any sub-group or any individual account over time. That’s a nice way to see the progress that you’re making over time to keep you motivated whether you’re paying down a debt or building an investment account.

Manually Tracking Net Worth with Personal Capital

There are many people out there that do not feel comfortable about storing their account login information in services like PC. You may want to read this article to understand everything that is done to protect your data. Since this free service is their funnel for feeding their money maker, the money management business, they have a vested interest in keeping your credentials safe. That said, you can still use the program to do the math for you and give you pretty graphs while manually inputting the data.

Net Worth Tracking Using A Spreadsheet

The same calculation that personal capital is doing automatically you can do using a spreadsheet. An example of what that might look like is shown below. The downside is that it takes more work. Where I can open up personal capital and let it update net worth automatically, you need to pull up every account balance and manually input it into a spreadsheet. All of these numbers are dynamic so they’ll change monthly at a minimum.

Add up all your assets, Add up all your liabilities. Subtract liabilities from your assets and net worth is what’s left.

What is Financial Independence?

Before we dive into a discussion about what an FI number is, let’s recalibrate on what it means to be financially independent. It’s about cash flow ultimately. To be financially independent means that you have some combination of assets that throw off enough cash to pay all of your monthly living expenses month after month for the rest of your life. That’s what it means to be financially independent. That could be passive business income, rental real estate income or a stock/bond portfolio.

Since business and real estate income are straightforward in figuring out FI (does the income that it generates exceed your expenses) I won’t discuss those areas in depth.

What is your FI number?

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Hang around any FI or FIRE communities and you’ll hear people talking about their FI number. Since many people use stock and bond investing through retirement accounts and brokerage accounts as their way to reach FI, they’re looking for a dollar amount that they need in those accounts to be FI. That total dollar amount in all cash and investment accounts that is able to sustain them until they die is their FI number. This is important because it defines the finish line for us. The point at which we have “enough” and no long need to worry about earning more money. Cue the picture of someone hanging out in the hammock usually on a beach.

Exactly how much you need for that FI number is an interesting topic. People want certainty in life, especially with their money, because it’s a terrifying though to run out of money when you’re old. Unfortunately, the future is uncertain and so we can only talk about the future in terms of probabilities and what is likely to happen.

How to Calculate your FI Number – Rough Target

If you read my article on the 4% rule then you could probably have guessed that it would be the basis for the rough target FI number. A study of past market data highlighted that if you invest in somewhere between a 50-75% stock and 50-25% bond allocation then history has shown that your money has a very low probability of running out in 30 years if you withdraw 4% a year. Withdrawing 4% per year to cover your living expenses means that you need to save 25x your annual living expenses.

For example, if your annual living expenses are $50,000 then your rough FI number would be $50,000 * 25 = $1,250,000.

It’s important to start here because it’s an easy number to figure out once you know your annual expenses. It then gives you a north star to work towards. Because your FI number is a multiplier of your expenses, I hope that you immediately see the power in reducing your annual expenses. Not only does it allow you save more, but every $1,000 less in annual spending is $25,000 less that you need to reach FI. Whoa.

Your FI Number – Advanced Considerations

It would be great if the rough number was sufficient to figuring how much you needed. It would also be great if that number wasn’t dynamic. Unfortunately, neither of these things are true! Time to go into the more advanced considerations when figuring out your FI number. The good news is that you can start thinking about these over time and only start to factor them as you get closer to making a substantial life change like leaving your job.

Your Retirement Expenses vs. Your Now Expenses

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You know what your current annual expenses are, but those are irrelevant unless you’re going to live exactly the same in retirement than you are living now. If you’re retiring early the one item that’s almost certain to go up if you live in the US is your health insurance cost. Many people with W2 jobs have some of those costs subsidized by their employer.

Are you planning a radical life change after you hit FI? Selling everything and hitting the road to be a nomad? Buying an RV and traveling around the country? Buying a vacation house to spend more time near the ocean? You’ll need to project the expenses for the live you WANT to live and make sure your FI number is based off of those expenses. If your future expenses are lower than today then it’s important to know this or you’ll end up working longer than you have to. If future expenses are higher than today then that’s even more important to plan into your FI number.

25x Might Not Be Enough for Early Retirement

The 4% rule is based off of a 30 year time horizon. Data shows that men in the US who make it to age 65 will live on average until age 83³. Women who make it to age 65 will live to close to 86 years old on average⁴. If you’re retiring anywhere in the standard 62 to 65 year old range then the 4% rule is likely far too conservative for you unless you have a history of very long life in your family.

However, if you’re reading this blog you probably are on a path to stop work earlier much sooner. Unfortunately, the probability of your money lasting until you die decreases if your retirement length increases. Early Retirement Now re-did the trinity study but increased the data set (1871 to 2016) and also showed 40, 50 and 60 year time horizons. The 4% withdrawal rate doesn’t look so safe if you expect to spend 40, 50 or 60 years in retirement. 3.5%, however, had a 99% probability of success at 50 years for a 75% stock allocation.

Mrs. MFI is pretty risk averse and so even though our retirement period is likely to be in the 40 year range, I expect her to want to be around the 3.5% withdrawal rate. 29x expenses is a 3.45% withdrawal rate so that’s our target.

Taxes, sigh

Since we all hate taxes this is one that’s a little too easy to bury your head in the sand and ignore. However, it needs to be factored into your FI number unless you have a strategy to legally avoid taxation. All of your tax deferred retirement accounts like a 401k, 403b, tIRA will be subject to taxation as ordinary income when you withdraw the money. Yes, if you’re savvy and very tactical in your retirement plans you can dodge some of those taxes through Roth IRA conversions. However, since life is dynamic I think it’s prudent to plan on having to pay those taxes as normal when figuring our your FI number.

How do you do this? Reduce your current investment balance by the rate of taxation expected. For example, for a married couple that withdraws $60k from their 401k in 2020 the effective tax rate is roughly 10%. If that’s where you expect your annual expenses to be then take 10% off the number in all tax deferred accounts.

For example, if you need $60k annually to live post tax and all your wealth will be in 401k accounts then you need more than $60k * 25x = $1,500,000. $1.5M is what you’ll have pre-tax but after being taxed 10% you’ll be left with $1.35M. You’ll actually need $1.5M / 0.9 (10% tax) = $1.67M in those 401k accounts to net the $1.5M post tax amount that you need.

If you live in state with state income tax you’ll need to factor that taxation in as well. Yeah, taxes suck.

Action Steps:

Figure out your net worth using either Personal Capital, spreadsheet or another means. I think this is the most important metric as it tells you if you’re building wealth over time.
Calculate your rough FI number. If you are working on lowering your expenses, see how lowering them impacts that rough FI number.
Start thinking about the future and how your life in FI might change your expenses. Have a discussion with our spouse if you have one about what you want that life to be life.
If you haven’t thought about tax considerations for tax deferred retirement accounts it’s time to start figuring that into the equation.

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