By Wealth Foundations

Having a wealth check is equivalent to a medical check-up with your doctor or a physical at the local gym. It’s for people who want to know where they stand financially, but don’t feel comfortable self assessing, and know that their friends’ financial behaviours aren’t likely to be a good guide for them.

Here we demonstrate the power of the wealthcheck framework to assess the financial vulnerability of couples that superficially appear similar, at various years from their desired retirements (or desired time of financial independence). Financial vulnerability is measured relative to a goal of financial independence – the ability to finance your desired lifestyle indefinitely from your investment wealth, without the need to work.

Here we consider two couples, John and Jan Johnson and Greg and Gina Green, who are both seven years away from a desired retirement date. Subsequent articles consider the position of couples who are seventeen and twenty seven years away from a nominated retirement date, demonstrating the applicability of the framework regardless of stage of working life.

“wealthcheck” highlights financial structure vulnerabilities

Both the Johnsons and the Greens have estimated net worth of $8 million. According to most recent Australian Bureau of Statistics figures, this would place them in the wealthiest 0.5% of Australian households. A casual observer could be excused from jumping to the conclusion that neither have anything to worry about, from a financial perspective.

However, when their current financial position and lifestyle expectations and aspirations are examined using the wealthcheck framework, a different perspective emerges. The table below shows the key financial information provided by the Johnsons and Greens for their wealthcheck reports:

There are many similarities in the inputs, particularly the same current income and spending and the same desired spending in retirement i.e. $175,000 p.a. But it is the way they hold their wealth that results in very different assessments of their financial vulnerability.

Wealthcheck calculates a number of key indicators of financial independence based on the provided inputs. The table below provides the “Key measures” output for the Johnsons, together with appropriate comments.

On all measures except the Tax Effectiveness Ratio and Growth Asset Allocation ratio, the Johnsons are at or above the benchmarks for financial independence. The takeaway for them is that over the next seven years to retirement they could potentially enhance their position by directing expected savings to superannuation and increasing their growth asset holdings.

But they are essentially in good shape, as indicated by the following “Summary observations” report that suggests they are highly likely to be able to afford their desired retirement lifestyle.

The Greens’ “wealthcheck” analysis, however, indicates some concerning vulnerabilities. Their “Key measures” output is provided below:

On all measures, they are under the benchmarks. The Greens:

have too much wealth held in lifestyle assets;

have insufficient investment wealth to fund their desired retirement lifestyle;

have taken little advantage of the tax effectiveness of superannuation;

are heavily exposed to growth assets, with an allocation well above their target growth asset allocation; and

have a poorly diversified investment portfolio.

The “Summary observations” report suggests they are likely to fall a little short of their retirement lifestyle expectations:

The Greens’ scenario is typical of many 55-60 year old professionals and executives, although the absolute numbers may differ. The $5.5 million lifestyle assets may consist of a nice home in an affluent suburb, together with a holiday house or hobby farm. The $4 million of investment assets could comprise a couple of negatively geared investment properties (for tax effectiveness) and a relatively modest super balance.

There is generally no awareness that the resultant heavily concentrated investment portfolio is both highly aggressive, as property is seen as a “safe” asset, and inconsistent with their actual attitude to risk (as indicated by the Greens’ 60% growth asset target). The “free lunch” of diversification is largely foregone. Fortunately, time pressures often mean management of their superannuation is outsourced to a body that does appreciate the benefits of diversification.

The vulnerability of the Greens’ position relative to the Johnsons is seen by considering what the situation would look like if there was a sudden, once-off 25% fall in the value of growth assets. The revised “Summary observations” report indicates that despite such a setback the Johnsons are still highly likely to meet their retirement lifestyle expectations:

On the other hand, the Greens are now likely to fall significantly short of their expectations, as revealed below:

To put themselves in a position where they could afford a $175,000 p.a. lifestyle indefinitely, based on current expected annual savings, they would need to defer retirement another 7 years (to when Greg Green is aged 72) or be forced to sell lifestyle assets. We don’t equate the need for such responses with financial independence.

“wealthcheck” shows net worth is a poor indicator of financial independence

Applied to our pre-retirees, the “wealthcheck” analysis demonstrates that net worth may be a very poor indicator of your financial preparedness for retirement. It depends critically on how wealth is held. It also highlights, among other things, that carrying high levels of debt at this stage of life can leave you very financially vulnerable.

Wealth Foundations (ABN 95 965 896 114) is a corporate authorised representative of Wealth Leadership Services Pty Ltd (Corporate Authorised Representative No. 319641). Wealth Leadership Services Pty Limited (ABN 36 121 535 993) is a licensed Australian financial services firm (AFS Licence No. 317369).

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