When people talk about retirement planning, it's common to hear the term "net worth" tossed around. And it's natural to track your net worth with the hope of growing it over time.
But if you want to set yourself up for a secure retirement, net worth isn't the figure you should be focusing on. Instead, you should focus on a completely different number -- your savings.
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Why your savings are the true measure of retirement readiness
To understand why you shouldn't focus on net worth in the course of retirement planning, it's important to understand how that number is calculated. Your net worth is the total of your assets minus your debts.
Let's say you have the following assets:
- A home worth $500,000
- An emergency fund of $50,000
- A retirement account with a $450,000 balance
All told, that's $1 million in assets. If you also owe $200,000 on your mortgage, your net worth is $800,000.
The reason you shouldn't use your net worth to measure your retirement readiness is simple. Not every asset of yours becomes spendable cash in retirement.
Take your home, for instance. You might have $300,000 worth of equity in it. But unless you sell that home or borrow against it, you don't have a way to convert that equity into money you can use to pay bills.
Accounts like IRAs, 401(k)s, and brokerages, on the other hand, can be used to fund your retirement. You can cash out investments for money or spend the dividend or interest payments you receive.
Similarly, any money you have in a savings account is money that can help pay for your retirement. That's why it's these accounts you should focus on when determining whether you're ready to retire -- not your net worth.
Your net worth might also be inflated
Another reason not to focus too much on net worth in the course of retirement planning? In recent years, home prices have risen rapidly in much of the country. But at some point, home prices could creep downward, impacting many people's net worth.
Let's return to our example. A home worth $500,000 with a $200,000 mortgage gives you an $800,000 net worth when coupled with $50,000 in savings and $450,000 in an IRA or 401(k) plan. But if your home value drops to $400,000, your net worth drops to $700,000.
This isn't to say that you can't use home equity to your advantage in retirement if you need to. But generally speaking, you can't spend your net worth the same way you can spend cash and investments. And since your retirement depends on assets that can serve as a reliable income source, it's important to know what number to look at when figuring out whether you're set for retirement or need to work and save longer.
