Net Worth is Good, but Cash Flow is Better

You might have seen some TV ads recently where people literally carry their retirement “number” with them. Each person’s number varies, but it’s usually in the $1-2 million range.

I like these ads because they reinforce the importance of setting a measurable retirement goal. But merely having a “number” like the ones in these commercials isn’t enough. Why not? Well, in the first place we don’t know what the number represents. Is it net worth? Is it investable assets?

Second, how does that number pay for your retirement expenses? In our previous article we discussed how retirement expenses can be grouped into two general categories: lump sum purchases or ongoing expenses. Lump sum purchases include such things as a house, cars, possibly a big trip or vacation. Ongoing expenses are recurring living expenses – monthly utility bills, food and clothing, regular insurance payments, etc. Somehow your “number” has to cover both categories of expenses. But how?
Some assets generate cash flow and some don’t. That’s the missing ingredient.
Retirement “numbers” usually refer to net worth, which is a measure of your wealth. Let’s say your number is $1.5 million, and it represents your net worth at retirement. There are many combinations of assets and liabilities (debts) that result in a net worth of $1.5 million but to keep things simple let’s assume further that you have no debts. So you have $1.5 million in assets and no liabilities. You are a millionaire with no debts. Nice going! But we still need to make another assumption – about the composition of your assets.

Some assets generate cash flow and some don’t. That’s the missing ingredient. Cash flow-generating assets can be used to pay for ongoing living expenses. And if your assets generate enough of a regular income stream – enough monthly cash flow – to pay for both your ongoing expenses and your periodic lump sum purchases, then you will have become financially independent.

That’s really the ultimate goal, isn’t it…financial independence? Having a large net worth “number” – having wealth – is good. In fact, it’s necessary. But it might not be enough to pay the bills. For that you need assets that generate cash flow. That’s even better.

But why wait until retirement to acquire assets that generate cash flow? Wouldn’t it make sense to start accumulating them when you’re younger?