While growing up, we were always told to study hard and be disciplined so we will be able to get good jobs when we grow up. This mindset followed us all the way from our primary school years to university.
When we finally graduate, many of us will earn close to the median fresh graduate starting pay of $3,733 a month. What we will quickly realise is that we also have to start shouldering many financial responsibilities, and a significant chunk of our salary will go towards paying for them.
In order to plan for our retirement in Singapore, we also need to start building a sufficient nest egg that we can live off after we stop working.
This is the difference between your income and your net worth. Your income is basically the cash flow that you get on a monthly or yearly basis from your salary or investments, while your net worth is how much wealth you have accumulated.
What Is Your Income?
Simply put, our income is how much we receive in cash each month from our job or business, as well as any cash flow we receive from our investments.
While we were programmed from young to think that earning a fat salary was the definition of success, it doesn’t necessarily make us wealthy or enable us to enjoy a comfortable retirement. We could earn $10,000 a month, but spending $15,000 a month will leave us in debt and unlikely to ever be able to retire.
On the other hand, we could earn the median graduate starting pay of $3,733 a month, and by spending only $2,500 a month, we can still gradually build significant wealth and retire comfortably.
What Is Your Net Worth?
Our net worth is the amount of wealth that we have accumulated. It can be defined by this equation:
Assets – Liabilities = Net Worth
What it means is that our net worth is the difference between what we own (assets) and what we owe (liabilities). The larger our net worth is, the better off we are.
It is also important to note that it is quite likely we start out with a negative net worth, mainly due to a home purchase. This should not discourage us from tracking our progress or working to get out of debt.
Planning For Retirement
When planning for retirement, we need to understand that in the best-case scenario, we have 40 years to work and earn an income, which has to go towards pay for our living expenses and accumulating our net worth. The net worth that we have built will then need to last close to 20 years in our retirement where we will earn close to nothing.
Think about it, we only have 40 years to build sufficient net worth to afford 60 years of our lives. This scenario does not even take into consideration any medical emergencies or taking time off work as well as facing inflation or living longer than the average life expectancy in Singapore (which stands at 83 years today). On top of this, if we only focus on doing this, we won’t be able to leave anything behind for our beneficiaries either.
What Is More Important: Net Worth Or Income?
For majority of us, if we are able to afford the things we can today without having to work, we would choose to stop working or focusing on doing the things we really want. Essentially, this is what retirement (or financial freedom) means.
Hence, prioritising and tracking our net worth will help us put in place a better plan for our retirement and show us if we can afford our living expenses without having to work.
Of course, we don’t start out immediately being able to afford our living expenses without having to work. That’s where our income plays a big role.
Even then, while a large income definitely helps, it must be complemented with a prudent budget in place to ensure that we spend within our means. This will help us convert as much of our income into our net worth as possible.
The process of accumulating our net worth has a lot to do with making the right investments as well. Simply saving our income is not going to be enough, we need to invest it.
If we earned the median graduate starting salary of $3,733 a month, and invested 15% of it (at a return of 7% per annum) for the next 40 years, we would be able to accumulate over $1.4 million in investments and CPF Special Account balances. This does not even take into consideration any salary increments over the course of our 40-year career.
In another scenario, if we earned double the graduate starting salary and never invested any of it, we would only be left with what the government has set as a safety net in our CPF accounts. While this would still likely be sufficient for a basic retirement, we would be unlikely to be able to have a similar spending power in our retirement.
Calculating Your Net Worth
So, we know that income is important, but if we don’t put in effort towards building our net worth, we would very likely be unable to afford the retirement we want.
This is why we should periodically track our net worth, ensuring that we are on course to reach our retirement goals. If we want to calculate this figure for ourselves, we can use this table to guide us with the inputs.
As an additional benefit of crunching these figures, you would know how much total liabilities you are carrying. This allows you to purchase adequate life insurance for the benefit of your loved ones, who may be saddled with these debts in the unfortunate event that you pass on.
Make Your Income Work Harder To Build Your Net Worth
Even though building our net worth is really important for our retirement, we should not neglect the fact that a higher income allows us to build more net worth and/or supercharge this process.
A higher income also gives us more freedom to make mistakes, more choices in terms of retiring earlier or later or even choosing to move to another profession we enjoy more.
Lastly, putting in place a budget for our income gives us our cash flow position each month. This depicts the cash inflow (salaries and other inflow from investments) as well as our cash outflow (living expenses and other expenditure). Knowing this will allow us to realise where our money is going, and enable us to cut down on the expenses we need to.
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