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Inside Your Household Balance Sheet – The Financial Preserve from Lonier Financial Advisory LLC
Conscientious Financial Planning and Retirement Income Management | 201-741-9528
from Lonier Financial Advisory LLC, Osprey, FL

Inside Your Household Balance Sheet

Inside Your Household Balance Sheet

Your household balance sheet provides a baseline for your retirement income plan.

Last time in this series on Lifetime Financial Planning (“Can I Afford to Retire?”), I discussedretirement-readiness as the ratio of your projected annual expenses in retirement, less your social security and pension income, to your savings. If your annual expenses net of SS and pension income is 3.5% or less of your savings, you are well-funded. If it’s more than 7%, you are under-funded. Between 3.5% and 7%, you are in the caution zone.

This a rough yardstick for retirement-readiness. A lifetime financial plan tailored to your goals and family resources is necessarily more specific. Your household balance sheet is a key tool in planning, one that puts the focus of your plan on your family’s standard of living not on your investment portfolio, which is where the financial services industry has its focus. In this post, I show how to set up and use your household balance sheet to understand your retirement-readiness with greater clarity.

The Typical Net Worth Statement
The typical financial net worth statement many planners use nets what you owe (liabilities) against what you own (assets). If you have $1,000,000 in savings (+), a house worth $500,000 (+), a $100,000 mortgage (-), and $50,000 in student loans (-), your net worth is $1,350,000:

[imageeffect type=”frame” width=”600″ height=”467″ alt=”” url=”https://www.thefinancialpreserve.com/credence-dev/wp-content/uploads/2012/09/networth.jpg” ]


A net worth statement is a snapshot in time. Next year, you may owe less debt or own more assets, and your net worth statement will reflect that change. You can see the change year over year, but by itself, a net worth statement only tells you how much your assets exceed your debt. It doesn’t tell you how those assets will be used and how long they will last funding your retirement and other goals.

It’s a helpful starting place, but not much help by itself for planning your future. Keeping score of net worth doesn’t solve the planning puzzle.

Constructing Your Household Balance Sheet
Your household balance sheet is more helpful as a planning tool because it adds in future earnings and savings balanced by future expenses, providing a view of your future needs and the total amount of financial capital you need to accumulate to meet those needs.

In your balance sheet, future expenses are converted into a present value equal to the total of those expenses over time factored by the time value of money (the ‘interest rate,’ which is related to the interest rate paid for credit, the estimated inflation rate, and the expected rate of return earned on investments).

Present value is an easy-to-use function in Excel, so don’t let the math put you off. When you convert future expenses to a present value, you can directly compare the anticipated cost of those expenses with your current savings. It becomes easier to see how much surplus you might have in retirement for legacy or other uses, or how much additional savings or expense adjustments you need to make to better match up your savings against future expenses.

Let’s take a look at the household balance sheet for the example we are using.

Previously in the example, we determined that current annual expenses were $161,000/yr, which we reduced by 10% to $145,000/yr for some items that will go away in retirement.

Let’s break the $145,000/yr down further into $95,000/yr for essential expenses (housing, food, clothing, healthcare, insurance, transportation, and taxes) and $55,000/yr for discretionary expenses (recreation, entertainment, travel, hobbies, gifts, etc).

Using 30 years as the term and 3% as the rate, both conservative and reasonable assumptions, Excel gives a present value of $1,918,000 to fund essential expenses and $1,009,000 to fund discretionary expenses for the 30 year period—a total of $2,927,000 for both.

Similarly, Excel gives a present value of $888,000 for $44,000/yr in annual Social Security benefits and $202,000 for a $10,000 annual pension. We also used Excel’s future value function to increase the current $1,000,000 savings to $1,246,000 over the next five years, using 4.5% as the growth rate from current age of 60 to retirement age at 65. Add in $120,000 of new savings for the next five years with the same growth rate, and a hoped-for $250,000 legacy for heirs, and the example balance sheet stacks up like this:

[imageeffect type=”frame” width=”600″ height=”418″ alt=”” url=”https://www.thefinancialpreserve.com/credence-dev/wp-content/uploads/2012/09/balancesheet.jpg” ]


You should immediately see how this is more useful than a net worth statement for planning.

In this simple balance sheet, for our example at age 60, you can see the expected value of the example’s household savings at age 65 and the present value of the example’s household pension and social security paired with the present value of the example’s household retirement expenses. Shown in this way, there’s a current $720,000 shortfall between household savings and expenses.

Whew! Quite a difference from the net worth statement above that showed the same example’s net worth of $1,350.000! Shown this way, it is clear that the example has substantial assets and net worth, but also high expenses relative to those assets—and so will need to make adjustments to both savings and expenses.

A Baseline for Building Your Retirement Plan
This balance sheet view does not show the potential growth of the example’s $1,367,000 in savings over the 30 years of retirement, nor the example’s $400,000 in home equity. As a baseline for retirement planning at retirement age, it is more realistic to start the planning process with the current value of liquid savings and secure income (SS + pensions). This allows us to develop a risk-free income plan as a baseline, with home equity in reserve. It also allows us to match up essential expenses with secure, risk-free income and discretionary expenses with riskier assets.

Home equity and other kinds of longevity insurance may enter into your retirement plan as an income option in later life. As a baseline, however, we prefer not to include home equity or to inflate savings with some expected average investment return (say 4.5%/year) that is subject to market volatility.

Depending on your personal situation, this is the age when you may move some or all of your savings out of the market and into various secure risk-free vehicles to create a secure retirement income floor. Your household balance sheet provides a clear and valid starting point for that critical planning.

Next time (“Investing Isn’t Step One”), we will introduce lifetime savings as the core of Lifetime Financial Planning. In future posts we’ll also explore the special risks you face in retirement and how they impact your retirement plan. Understanding these risks and how to manage them sets the stage for setting up your retirement income plan and any upside investment portfolio that fits your situation.

Summary: While net worth provides a useful snap ‘score’ of your financial status and seems comforting, a present value household balance sheet is more useful for planning important lifetime goals such as retirement income. The ratio of your expenses to your savings is far more important in maintaining your standard of living throughout retirement than having a high net worth.

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