We know the standard “net worth” equation. Total assets – Total Liabilities = Net worth.
Unfortunately this equation makes no sense at all and should be thrown away since it does not tell you anything about your future. We’ll outline a different way to determine how much you are worth. And. Hopefully, change the way most people think about their value as well. This will either be eye opening in terms of being negative or it could be eye opening in a positive way. You could be richer than you think.
Part 1: Starting Calculation… Years of Life Based On Liquid Value
Lets start from the beginning in terms of what your total assets are. We will have *three* classes of assets and each asset class will then be assigned a new “real” value.
Cash & Cash Equivalents: This is the easiest asset class to understand. All of your cash and all of your liquid assets (within a 48 hour period) are included here. This is on a post tax basis. This means your 401K that is typically included… is now reduced by around 60%. If you wish to include your 401K balance you have to remove all the taxes and also apply a 10% penalty to find the real value. Example: $100K (1-(30% tax + 10% penalty)) = $60K today.
Note: we think the entire 401K balance should not be included but it is fair to include it if one is willing to liquidate it at any time. Just adjust for the tax + penalties.
Long-term Assets: This is the second asset class where you find the net value of your long-term assets. Typically it will take approximately 1 year to liquidate the entire item. In this case you take the total market value * 80% and remove any closing costs and fees. Example: $1M house (1-(80% + 3% closing costs)) = $770K.
Note: if you have assets that are even more illiquid add a discount of 5% per year. Generally, we discount by 20% as it will be liquid at that point. An asset priced 20% below value is close to a fire sale and would be sold quickly. Finally, the market value should be determined by 2-3 third party specialists to avoid emotional overstatement of value.
Liabilities: Every single cent you owe. This is revolving credit (credit cards on a monthly basis), mortgages and any other situation where you owe money (some people could have gambling debt!). So there we have it, our starting point is as follows:
*Liquid Value* = Cash & Equivalents + (Long-term assets * 80%) – Liabilities.
Now the Fun Begins… Years of Life Calculation
Regular people will likely stop there and think the party ends. Unfortunately, that’s simply not good enough because it still doesn’t tell us what your net worth it. All it tells you is how much your *liquid value* is today. That is just the starting point.
Valuing Your Lifestyle: If you’re currently happy, it means your lifestyle goals are met. We are not going to waste time giving our own numbers out. Some people are genuinely happy with minimal amounts of money and others need more.
Here is a quick checklist to determine if you’re actually happy:
1) You are in great health. If your health is in terrible shape, your money is now worth $0. Included in the catch all bucket of health is anyone important to you in your life (can include anyone you wish from family to friends). This means you are living a fun and vibrant life and anyone you care about is also living a similar life.
2) You do not complain about “the system”. A smart person knows how to game a “system” unless they are actually enslaved. The internet has made it possible to find information on every single topic from money to women to correctly playing cricket.
3) You do not care if someone has a Ferrari or a beautiful girlfriend. If you have animosity towards someone who is visibility winning at life, your lifestyle needs are not met because you’re continuing to compare yourself to someone else. You should not care how a successful person chooses to spend his time and money.
4) You are allowed to have a few off days every year. Life is generally difficult at times and no one is going to be thrilled 24/7/365. We’ll go ahead and say ~24 off days per year. This means a couple days out of the month something goes terribly wrong and you’re upset.
5) You do not need to increase your spending. If you were told to never spend in excess of what you spent last year for the rest of your life (inflation adjusted) you would not be emotionally impacted.
Congratulations if you have checked off the entire list. We can now easily calculate the amount of years of life you’ve accumulated.
Basic Years of Life = *Liquid Value* / Annual Spending to Be Content
Example: Joe has a current Liquid Value of $750K, he is entirely content with his life and spends approximately $50K per year. This leads to 15 years worth of life. Joe is now assigned a value of five.
Life Changing Event Adjustments
Now that we have your value in terms of years of life we can make some final adjustments to determine if this can be increased or decreased. Adjustments are probably the most brutal as they can swing your value up and down by many years.
Legal Marriage: If you are married legally in the United States you are immediately hit with a new adjustment. We will emphasize that this means an official contract with the government. If you have a wife but no contract, this does not apply to you because there is no written contract. If legally married? Deduct 25% from your value.
There is a 50/50 shot that a person gets divorced. No one is special. Billionaires to high school sweethearts all get divorced. Since there is a 50% chance you lose 50% of your assets… Then you lose 25% for nothing. This is a net loss of 25% in terms of actual statistics.
Willingness to Move: In this section we will only include places where you have spent at least 6 months living. This is the bare minimum to decide if you can live in a specific city or not. If your current cost of living will likely increase or decrease you can make an adjustment to your years of life. If you are likely to move, adjust the calculation for the cost of living.
Cost of Kids: If someone decides to have kids, that will certainly increase their costs. It is not right to raise a child without the opportunity to succeed (unfit to be parents) therefore another adjustment should be made. You simply subtract the expected cost over ~20 years. Deduct ~5 years per child (incremental cost is variable expenses, assumed to be ~25% of your total costs)
All Future One Time Charges: This will largely be a negative adjustment but it needs to be done. We should also subtract an additional ~6 months from the total value. This will account for negative life events (health issues or otherwise).
Official Years of Life = Basic Years of Life +/- all adjustments
Summary (Part 1): We would note that evaluating your current asset value in terms of “years of life” is NOT a new metric. It is a well known way to calculate one’s net value. In simple terms, as soon as you can obtain a years of life value equal to ~20 years, you’re officially done. The real problem with this equation is it does not encapsulate your current age or your future value as well. With that we’ll go ahead and flip to part two which evaluates the second piece of total value.
Part 2: Current Value.
The second part of the equation begins to encapsulate your current age. In simple terms, having ~20 years of life in stocks/bonds/bank accounts at age 18 is certainly more valuable than age 60. This is also why we don’t include “401K funds” as part of the years of life calculation unless one is attempting to be aggressive. In order to find your future value we have to find the assumed cash flow created by working for yourself.
Average Annual Cash Flow: Most individuals will view their total income on an annual basis. Some businesses are seasonal and some are relatively stable throughout the year, but an average annual rate will help calculate your future value as well. Once we find your current years of life, we’ll go ahead and add additional cash flow for your future value assuming you are younger. As we’ve stated many times in the past, retirement is simply a myth and should be viewed as an irrelevant goal for most.
Years of Life + ((60 – your age) * (Income in Terms of Annual Expenses/2)))= Current Value
The equation above looks complex but it is relatively simple. While some people will have great genes, if you’ve lived a healthy life you should expect to have large amounts of energy until around 40 then steady declines until 60 followed by material declines until death. Yes this is blunt. Yes it is also true. Typically, professional athletes peak out around 30 and begin to see steady declines… by 60 most people have *some* health issues.
Example: Lets say Joe has 10 years of life saved. In addition, he started his own business and can currently live on the income his business generates. The official value is estimated around 1. Finally, we learn that Joe is 35 years old. His calculation would turn out as follows:
10 + ((25)*(1/2)) = 22.5.
We would wager that someone in Joe’s position is extremely happy in life. If he can increase the income from his business to ~2x his annual living expenses, he’ll accelerate his net worth rapidly. He hasn’t quite made it but the light is at the end of the tunnel. In short, the biggest driver for increasing his current value is increasing his business income because it is *recurring* in nature and drives a multiple which is currently set at 25x.
Once this part of the equation sets in everyone will realize the importance of working for yourself. The longer you’re set earning the majority of your money from someone else… the longer this value stays at ZERO. A zero means you’re relying entirely on savings forcing you to move down the insane path of frugality… eating ketchup soup for dinner and lentils all day.
Summary of (Part 2): The major problem with earning all of your income working for another person is you’re trading a vast amount of freedom for nothing. This does not mean you should “never” work for another person, it means that you have to break out eventually. Maybe you find your biggest interest is in technology and work for Google for ~3-5 years. This likely makes sense as you build the correct skills at a major corporation with money to invest in your future.
Part 3: Benchmarks
Now that we’ve gone through all of the calculations we’ll go ahead and provide some goal posts as well. While a years of life value equal to 20 will always be the standard for financial independence we think it’s not enough. Instead, everyone should attempt to see a steady increase in one’s current value until the age of 60. At that point all of your value is tied to overall years of life.
Before Hitting Thirty: While it is possible to hit financial independence well before thirty, we think every year of full effort should result in more than 1 year of life accumulated. To make the math simple “one should get you two”. A fun business axiom is that a dollar in usually results in a three dollars back. If you follow this rule it is factually impossible to be behind the curve by the time you’ve been working 100% for 10 years in a row. You’re done by this time due to investment returns.
Using the Median: Median income is roughly $50K per year. This is why our original standard is about $1M or ~20 years of life by thirty. At that point you’re unquestionably financially independent unless you’ve picked up a material drug or alcohol problem on the way to reaching this mile stone. Many will find this goal to be lofty and we think that is a good thing. If you’re aiming for a lofty goal and only achieve half of it ~$500K… You’re going to be a millionaire by 37 according to compounding interest assuming the principal remains untouched.
Extremely Well Off: The extremely well off section begins at a three multiple. This means you’re able to spend into perpetuity 3x the median wage. This is an enormous amount of money for most and should be the “gold standard” for an individual. If you’re worth $3M or you have a business generating large amounts of income (and you’re young) you can likely achieve this sometime in your 30s as well.
We have made this post a bit shorter as there are a lot of calculations provided in the post. Below is a quick summary of the ideas provided.
– Years of life is the ideal baseline building block
– Years of life are not equal as your ability to enjoy life begins to deteriorate slightly at 30 and materially in your 40s/50s.
– Once you’ve reached 20 years of living expenses you’re set for life and the goal is to increase your total years of life until you reach age 60
– Income working for yourself is the only income counted towards your total value (the only exception is if you are 1,000% satisfied with your profession, most won’t be as it causes them to lose their freedom)
– Somewhere around $3M and you’re at a gold standard for living and it will be difficult to relate to regular people