Medicated Money

Monday, March 06, 2006

Net Worth - Part I

The safest way to double your money is to fold it over and put it in your pocket. -Ken Hubbard

Many other bloggers write many articles on personal net worth. In my opinion, I think, overall, this is a good thing. On the other hand, it is very interesting to see what many people say their net worth is. Now, let me get one thing on the table very early in this conversation. My view of net worth is probably completely different then the majority. I agree that net worth is:

Assets - Liabilities = Net Worth

The problem that I have is the fact that in the few discussions that I have had with folks on this topic, the assets seem to be over-valued while the liabilities are downplayed. Example of this is with cars. I hear the saying of having a car that is $25,000 in the Kelly Blue Book and only having $20,000 left to pay it off is a +5000 to one's net worth. Looks like a good investment, but in reality with a $20,000 loan, I would argue that $5,000 in hand is not the same as the possibility to make $5,000 through a car transaction. In theory, you can sell the car and it is the same, but it takes an action to complete the theory; and with many theories, they work on paper, but not in actuality. Besides, if you sell the car, what are you going to drive? How's that public transportation in your city?

In my opinion, net worth is really equal to financial risk. And with any situation when evaluating the risk of a situation, the answer can only be reached by looking at it without rose-colored glasses. I try to evaluate all financial decision on the basis of this risk. Thus in this principle an item is an asset or liability because it is either one or the other; never both. There is one example of this that does not stand true; that being a house. I think that you can count a home mortgage and the value of the house as both. Yet, in this sense, you should list the house for the price you bought the house for rather then speculating the cost of sale if you sold it! Example: Financed a house for $200,000, paid off $40,000 with $160,000 remaining; nets a positive $40,000 in net worth. Speculating that the house is now worth $300,000 is just that: speculating. Sure, it has more of a chance of obtaining that number because real estate does not fluctuate like stocks, but one never knows what the market will do; stocks or real estate. As for cars, personal property, and the like, if you owe money on it, I feel that it is a liability.

I realize that this opinion is against the grain, and with this opinion, I might catch some flak for it. But, with everything we have read, sometimes you need to remove the safety net from the tightrope in order for it to truly hit home. For us, this was true when we first sat down and tried to calculate our 'net worth.' We realized that maybe things weren't so bad. The thing is that we tried to rationalized to ourselves that we could continue with many of the same standards of living that we were accustomed to. Believe me, I tried hard to convince myself. Yet, the more we thought of things as not that bad, we could see that things would probably only get worse! So we needed to remove the net, and begin to realize that it was time to start walking the rope.

3 Comments:

  • I guess I take a slightly different approach to calculating net worth. I agree it's assets - liabilities. When calculating our net worth, I think about two things. One is liquidity of assets and the other is what it would cost to turn the asset in to cash.

    So, when I calculate our house value, I always use a conservative number that is 10% below what other houses in our area are selling for today. I believe this gives me a bit of a conservative estimate and also covers me for the cost of selling it to convert it to cash. Obviously, if we ever sold the house, we would update our net worth with the actual cash value once all the transaction costs were paid.

    Besides savings and investments, the only other assets that I count towards my net worth are my two cars and one boat. I update each of their values based on what the real market value is of each. (And they are all paid for so I don't have to worry about subtracting loans etc) Again, I estimate on the low end of each of their value so that I can feel confident I haven't padded my net worth.

    I don't add all of our other assets in to our net worth calculation. I could get really detailed and spend a lot of time trying to figure out fair market value for these things, but I tend to think of all of our other assets as having zero value.

    I use our net worth calculation to help drive our behavior. My wife and I both strive to increase our net worth by minimizing the large unnecessary expenses.

    By Anonymous Hazzard, at 10:39 PM, March 07, 2006  

  • I have to agree with you on the subject of including a car in the net worth calculation...I will always need a car, thus will never sell it. If I do sell, I would just roll the proceeds into a new one. We have 2, both paid off (the last one was new, paid with cash).

    Initially, I didn't include my house either (I need to live somewhere), but now list it on the networthIQ site. THe main reason being that the whole reason I joined the PF blogging community is what drew me in the first place...the ability to "benchmark" others in my same financial situation.

    Having others insight, comparisons , and feedback has helped tremendously...

    By Blogger bored, at 9:29 PM, March 11, 2006  

  • Bored said 'the ability to "benchmark" others in my same financial situation!'

    We believe that this is the main reason a large majority of bloggers blog! Friendly competition! Competition is a good thing (it drives the free market), but I worry about many people creating a new 'Jones!' We are trying to stay honest, and from the previous comments, it looks the same from both of the comments posted. Thanks for the comments, and we continue to look forward reading your sites!

    -MM

    By Blogger Medicated Money, at 12:47 PM, March 12, 2006  

Post a Comment

<< Home