I don’t necessarily think of one’s finances as a game (unlike, say, Tony Robbins), but more like a process, a challenge, a long task. Perhaps a kind of art.
That said, I also think it’s useful and important to know “where you stand”, to know where you are in relation to where you want to be.
I talk a lot about retirement, and making sure you save enough for it. I also talk about the importance of having an emergency fund enough to cover six months worth of bills and expenses.
Okay, I talk about lots of things.
But how do you put it all together?
One metric used to determine your progress is to calculate your financial net worth.
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Financial net worth defined
Your financial net worth is defined as the sum of your assets less the sum of all of your liabilities. Or, with more pith, “what you own minus what you owe“.
What do you count in what you own? Well, technically you could count every kitchen utensil and piece of furniture you have, but that would be needlessly complicated. So when you think of assets, think of things like:
- Home equity
- Savings accounts
- Retirement accounts
- Other large ticket items
For liabilities:
- Student loans
- Mortgages
- All other debts
So, to use an overly simple example, if a person had $100,000 in savings and owed $30,000 in student loans (and nothing else), this person would have a financial net worth of $70,000.
You can track this value over time to get a sense of your progress. You want this value to go up, and the rate at which this goes up can be used to extrapolate what your financial net worth is likely to be in the future.
Not so fast
When I first started thinking about financial net worth, at first I thought that there wasn’t much to it. But as with all things, the more you think about it, the more complex it gets.
So here are a few complications with the calculation of financial net worth:
- Liabilities of renting and owning are not captured equally. We all have to live somewhere, and we’re either renters or owners. By the standards of this financial net worth calculation, a renter will have no assets or liabilities, but the renter still needs to pay rent. By contrast, an owner might have to pay the same amount in mortgage, but this asset/liability does show up on the ledger. It seems like there is some kind of financial penalty that isn’t captured here.
- How do you count your car? Is a car an asset or a liability? We all know that buying a car is a terrible investment, especially a new one. It hemorrhages value pretty much from the time you buy it until the time you get rid of it. Some would say that because of this, a car shouldn’t be included in the asset category. What is certain is that if you have a car loan, it’s a liability. Whether you treat the car itself as an asset is up to you.
- Do you count pre-tax and post-tax savings accounts differently? If you have $100,000 in a Traditional IRA, is that counted the same as $100,000 in a Roth IRA? They will both certainly result in different net amounts, since the Traditional IRA requires tax to be paid on withdrawals.
I’m sure one could think of more complications, but these are the ones that came up for me. Because of this, I wonder if the metric of financial net worth is a valuable one.
You are not a number
It’s vitally important to realize that we are talking about financial net worth.
Language is a tricky and subtle beast, and our word choice is very important. If you go to the Wikipedia page on “net worth“, you get the definition of financial net worth. Isn’t that interesting?
When I hear the phrase “your net worth“, I immediately think of worthiness, which our overlords at Merriam-Webster define as:
having worth or value; estimable; honorable, meritorious; having sufficient worth or importance
There’s a danger here. Many people today have either zero or negative financial net worth. According to Bloomberg and the Federal Reserve Bank of New York, the figure is 15%, or one in seven. And if you are one of those people, you could run the risk of believing that you have a zero or negative non-financial net worth.
But I can’t stress enough that you are not your finances, and therefore your financial net worth is not equivalent to your net worth.
Your finances don’t define you. Your circumstances don’t define you. Your decisions may shape you, but you are not defined by any of these things.
Your real net worth is always positive. You can see it in the way you affect people everyday. The way your actions and deeds matter to others. Your real net worth has nothing to do with money, and everything to do with the person you are. And in that respect, it is incalculable.
But enough about me. Is the measure of financial net worth a useful one?
