Determining the Net Worth at Which You Can Retire

One approach an individual may use to determine the net worth upon which he or she may retire consists of three parts. First, a retiree should estimate that a majority of his or her spending will almost entirely come from income generated from a portfolio consisting of dividend-paying equity investments.

Second, the retiree’s portfolio should have some income insurance, or assets that typically increase in value during times when companies tend to slash dividends. These insurance assets will include longer-term, ultra low risk government bonds. The retiree can then plan to use the gains from these bonds as income replacement during periods of risk aversion.

Third, the retiree should divide his or her costs into two groups. One group covers the amount the retiree would like to spend during good times, and the other group covers the bare minimum the retiree needs during lean times. The projected yield on the retiree’s income portfolio should link to the amount in the first group. The retiree’s projected gains on his or her low-risk bonds should link to the amount in the second group.

For a case study on this approach see Alex Trias, Here’s a Third Way to Determine When you Have Enough to Retire, Seeking Alpha, Dec. 2, 2010.

Special thanks to Joel Dobris (professor of law, UC Davis School of Law)for brining this to my attention.