Retirement calculation - step one

The first step in preparing a workable retirement calculation is to evaluate the current financial position.

A distinction needs to be made between assets and liabilities.

Assets are essentially things which either produce income or which can be viewed as store of value and which can ultimately be looked to as a source of funding in retirement. I realise that this is different from the way an accountant would look at the world, but for our purposes, the test of an asset is whether it will contribute to financing your retirement.

Shares, bonds, mutual funds, property, bank deposits and cash all meet this description. So will pension plan assets and some collectables (art, wine etc). Most cars, furniture and other chattles should not be viewed as assets for present purposes - they do not produce income and they are not a store of value (they cost money to maintain and depreciate in value over time). It has been argued that a person's primary residence is not an asset. I disagree with this view and will explain why I regard an owner occupied residence as an asset in a future post.

Liabilities are future obligations which can be measured in monetary terms. Debt (mortgage, credit card etc) is the most obvious example of a liability. Other examples are accrued but unpaid expenses. An example of the latter in Hong Kong is personal income tax. Hong Kong does not operate a "pay as you go" tax system. Employees are paid their gross salary and get an annual tax bill from the government (payable in two intstallments). Every month that an employee is paid, an obligation to pay tax in the future builds up as a liability.

One issue which needs to be considered carefully is the valuations to put on the assets and liabilities. For some items it is easy - a quick look at a bank statement can show the outstanding balance on a credt card and the amount of money on deposit. Shares can be valued by looking at the closing prices. Other assets can be a bit more challenging - property is illiquid and, as each property is unique, determining an exact value often involves elements of comparing recent prices of similar (but not identical) properties. While an exact number is not essential, realistic numbers are essential if the exercise is to be useful.

The difference between the total assets and the total liabilities is a person's net worth. The personal balance sheet (assets and liabilities) and the net worth figure are the starting point for preparing a workable retirement plan.

As a working example, we will use the following assumed information:

1. ownership of a residence worth HK$7 million with and outstanding mortgage of HK$5 million due over a remaining term of 16 years;

2. other investments of HK$1 million divided among a small share portfolio (HK$320,000), a retirement scheme (HK$180, ooo) and bank deposits (HK$500,000);

3. no other debts or assets which would be relevant for present purposes.