By Adam K. Wright, CFA®, CFP®
Any financial adviser will tell you that the personal balance sheet is a crucial part of understanding your overall financial picture and necessary for building a solid retirement plan. Think about it like a GPS system. Your personal balance sheet is your current location. Once you know where you are you can figure out how to get to where you want to go.
Your personal balance sheet, or any balance sheet, will have assets in a column on the left. This is what you own. Liabilities go in a column on the right. This is what you owe. Assets minus liabilities equal net worth. Start with the easy-to-find items like your cash, investments, real estate, and personal property, and your mortgages, loans, and taxes.
From this one statement, we can determine important financial ratios like your net worth, your debt-to-asset ratio, and your overall liquidity. The balance sheet packs a powerful punch as far as personal financial planning goes.
But there is usually much more to your personal balance sheet than meets the eye. In fact, there are often major components that are left out of the equation. At Wright Associates, we are dedicated to helping clients understand everything they own and owe so that we can create a robust retirement plan to get you to where you want to go with confidence.
Here’s what you need to know about building a balance sheet that has all your assets and liabilities.
Is Your Balance Sheet Missing These Major Assets & Liabilities?
When building a personal balance sheet, it’s easy to list the obvious assets and liabilities, like your retirement accounts, a primary residence, and a mortgage or car loan. These are big-ticket items that most people can name off the top of their heads, but there are major assets and liabilities that often go unnoticed.
For instance, those retirement accounts are not simply a free-and-clear asset to be listed on the left side of the balance sheet. If they are pre-tax retirement accounts, like 401(k)s or traditional IRAs, then there are embedded tax liabilities that must also be considered. Depending on where you are in your career, those accounts can reach significant levels and have a huge chunk owed to Uncle Sam. Forgetting to include this on the balance sheet can over-inflate your net worth and give you a false sense of retirement security. Good retirement planning takes these future taxes into account and tries to reduce them.
Similarly, there are major assets that are often left out. These include the capitalized value of Social Security or pension income for retirees and the capitalized value of career income for younger professionals. Both of these guaranteed income streams are hugely important retirement assets that can transform the outlook of your long-term financial plan if you know how to account for them properly. Build your complete retirement balance to look something like this:
Build a Plan for Your REAL Balance Sheet
After you’ve identified the missing components of your balance sheet and added them into the equation, you can begin to build a retirement plan that accounts for your whole financial situation. Here are just a couple examples of how a realistic balance sheet can influence your overall financial plan:
- Insurance & Risk Management: Insurance is a tool to protect your earning power over your career. For younger professionals, identifying and protecting your lifetime earning ability, through both disability and life insurance, can be a great way to ensure your balance sheet (and net worth) doesn’t take a hit if you were to become seriously ill or injured, or pass away unexpectedly.
- Retirement Planning: Conventional wisdom says that retirees should have a large portion of their retirement portfolios invested in bonds, but as we’ve seen over the last several years, bonds are not the surefire investment they used to be. When Social Security is properly accounted for, it may replace the need for a retirement portfolio that is too heavily allocated in bonds. Same goes for pensions.
- Tax Management: When you know exactly what kind of tax liabilities your retirement accounts will generate, it becomes much easier to develop a tax plan for retirement. You can identify years in which your tax rates will be lower and start to convert pre-tax funds into after-tax funds as a way to slowly get rid of tax liabilities by paying taxes when your tax rate is at a low point.
Retirement Planning Is Much More Than Investing
As the chart below will show, financial planning involves much more than just investing. From the beginning of our working relationship with clients, we prioritize understanding every piece of a client’s financial picture so that the plan we create can truly be all-encompassing and robust.
Our retirement planning process looks at everything from your cash flow, balance sheet, and investments, to your risk management, estate planning, and tax management decisions. We know that decisions around money are complex, but we also believe that they shouldn’t be so nerve-wracking.
If you’re ready to work with a financial adviser who will look at all your financial pieces as part of a larger whole, schedule a complimentary phone call to get started.
Adam Wright is a CERTIFIED FINANCIAL PLANNER™ professional at Wright Associates, helping clients plan and prepare their investments to retire on their terms. If you’re serious about planning for your retirement and investing for your future, his annual process will help you make the right money choices today. Therefore, Adam and his team will proactively manage your accounts while communicating the progress of your financial plans. He believes the retirement advice you receive should be intentional and actionable.Adam has a Bachelor of Science in Supply Chain and Information Systems from The Pennsylvania State University and a Master of Business Administration from University of Pittsburgh, Katz Graduate School of Business. He lives in Upper St. Clair with his wife and two children. When he’s not working, Adam enjoys the outdoors (fly fishing), reading, and taking long runs while listening to a favorite podcast. He’s also currently encouraging himself to take up golf. To learn more about Adam, connect with him on LinkedIn.