Your Net Worth Is An Illusion, Sorry To Spoil Your Delusion!

Unless your house is fully paid for, and unless you can access your retirement accounts today, your net worth is an illusion.  Although we’ve recovered quite a long way over the past 18 months, I don’t think we can really count on property, stocks, and private equity investments to be there when we need them.  The recent market volatility reminds us to get realistic!

The only thing we can really count on is cold, hard cash.  I find it very misleading, as well as a little disingenuous that some say they are millionaires, when 70% of their net worth is tied up in an illiquid asset called “home equity.” Your home is only worth as much as someone is willing to pay for it.  Even your 401K and IRA are suspect because those accounts can easily collapse.

A TYPICAL ASSET SIDE OF A NET WORTH CALCULATION:

Cash

Stocks

401K

IRA

Private Investments

Primary Residence

Rental Property

Valuables (Jewelry, Collectibles)

Pet Bunny

For retirement purposes, your assets should equate to CASH + liquid securities you can sell today + MORE CASH.  The way to look at net worth is consistent with my “Going Broke To Win Big” methodology.  Essentially, you want to operate life as if none of your assets except for your cash is dependable. Your retirement goal shouldn’t be a net worth goal, it should be a cash goal.  If your home equity, 401k, IRA, private equity investments so happen to be there when you retire, great!  If not, no big deal because you never counted on it anyway.

Unfortunately, our government is printing cash like it’s no tomorrow to pay off our extraordinary debt thanks to tremendous mismanagement.  Hence, even our cash is suspect in value and it’s smart to buy real assets outside the country with stronger physical systems.  If you can’t do that, I’d diversify your cash into as highest possible yielding rental property as you can.  Rental property is a very powerful asset to make money and hedge during inflationary periods!

As you age, feel free to regularly convert your investments into cash for that bankable guaranteed interest income.  At a steady return of 4%, there is absolutely zero fear once you build that nut.  Can you imagine the pain people felt over the past 24 months for those who had the majority of their retirement savings in stocks?

The liability side of the equation on the other hand is very straight forward.  Only a crook would embellish what they owe.  And since nobody reading here is a crook, we don’t have to discuss the obvious things which should all be included in liabilities!

CONCLUSION

By risking all your retirement savings in the stock market, you’re doing yourself a disservice.  I’m not saying don’t continue maxing out your 401K and IRA accounts every year.  That is a given.  I’m just saying one should think twice before adding MORE of your cash into the stock market.  One of the easiest allocation rules can simply be your age.  A 40 year old should think about allocating 40% of their liquid assets into cash or stable bond funds, a 50 year old should allocate 50% to cash and so forth.

If you insist on including the value of your illiquid investments into your net worth calculation, then take at least a 50% haircut to the value. Have a cash retirement goal and not a net worth goal. You’ll be happy you did.

Readers, what are your thoughts on net worth calculation?  Is there a sense of false security going around in the community?

Keigu,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Follow on Twitter @FinancialSamura and subscribe to our RSS feed.

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. Patrick says

    I think that’s a great way to look at it. The only addition I would add is to be able to account for cash flow in retirement. You may need less cash if you have a stable and steady source of income in your retirement.

    A great example is a government pension (many private pension plans have failed or have been scaled back in recent years). But most government pension plans remain unchanged. It’s even better if you can retire from the military after 20 years of service and bring home 50% of your base pay for the rest of your life – starting around age 40.

    Another, slightly more risky example, is rental properties. These are best when fully paid off, but represent the risk of vacancies, major repairs, etc.

    • admin says

      Hi Patrick – Good to hear from you! I agree regarding your cash flow statement, completely. Ideally, we all will have a bevy of passive income coming our way through rental properties, dividends, hobby jobs and so forth.

      You are SPOT ON regarding the triumph of government pensions (for those who receive them). Have a read of “Fortunes, Fortunes, Everywhere!” where I touch upon the value of pensions, and how long-term government/state employees are going to do very well in retirement.

      My co-writer has a rental property he plans to pay off in 8 years. It’s in a prime location and has never been vacant as a result. Definitely a good positive swing once it’s paid off.

      Thanks for stopping by Patrick. I enjoyed your post on getting an MBA.

  2. David@DINKS Finance says

    Thanks for the shoutout to DINKS! One thing that caught my eye was early on in your article when you said “The only thing we can really count on is cold, hard cash.” Even this can be an illusion! To me personally, the only thing that is really “safe” is gold. Even with that you need to diversify between having physical gold in your possession, gold etfs, and gold offshore at a place like Perth.

    I say gold because the dollar, according to the govenrment, is seeing 4% inflation. People like Peter Schiff (who I hold in the highest regard) say that the government doesn’t give an accurate portrayal of inflation and he sees it at something more like 8-10%. I heard a statistic somewhere (don’t have link so take it or leave it) that the dollar has lost 97% of its value since 1913.

    If you read Schiff’s books like “Bull Moves in Bear Markets” and “Crash Proof” he gives his reasons why he sees the dollar continuing it’s rapid descent to zero. I won’t give a full summary of the books (you’ll have to read it yourself – well worth your time!) but basically it has led me to conclude the only thing that will hold value through thick and thin is gold.

    • admin says

      David – I think you’re right regarding gold. My only concern is that gold doesn’t throw off free cash flow i.e. interest income, hence I can’t survive off my bling bling gold bars!

      Regarding inflation, I too, believe there is a high chance inflation will hit us with a vengeance given all the pump priming and monetary expansion. However, inflation and rates have been trending down for 30 years, despite it all, so perhaps not. Either way, sure the dollar can and will depreciate vis a vis other currencies, but if you’re American, never leave the country, and spend most of your income on domestic goods, then the USD could depreciate further, and it wouldn’t matter.

      • Roshawn @ Watson Inc says

        Don’t say cold hard cash; instead say warm, soft cash ;) I completely agree that you cannt count your retirement portfolio in your net worth calculation if it is in a 401K & IRA…, unless maybe you multiply it times your tax rate plus a 10% penalty.

    • admin says

      Hey Moneymonk! Thanks for stopping by! I was checking out your most popular posts on my blackberry randomly yesterday, and found your topic on cash flow > net worth and I agree. I included your post link in my post :) I really enjoy the style of your site Money Monk. Keep up the good work!

  3. Lee says

    Excellent points. Not being a home-owner I don’t have this particular delusion at the moment. My net worth calculation is based entirely on my (very real!) debts, and cash I have to hand right now. I don’t include cash I have locked away in some fashion – e.g. Zopa – as it’s speculation. I might get my investment back, I might get more than my investment back, or I might end up with nothing. That’s part of the play, and if I’m honest, part of the fun.

    The good news is my net worth is heading to zero! In two more months I will be worth just shy of absolutely nothing!

    And I’m happy about it. I’ll be debt free and ready to begin really looking forwards.

    • admin says

      Lee – Well done for getting your net worth to zero! :) It’s funny to say, but obviously it is great if you have negative net worth. It’s great that you are being honest with your net worth calculations. By being conservative, you only have upside, and upside is what it’s all about!

  4. Lee says

    @admin
    Thanks! I can’t wait for the weight of “being in debt” to be lifted from my shoulders. I will be having a massive blog party that day and everyone will be welcome!

    It’ll be bring your own beer though. ;)

  5. Charlie says

    Yes, I am thinking about CDs and fixed income funds so much more now than putting more money in the stock market. I’m still down 48% on a position in my PA I got into before the bust last year. I’m sure I’ll get back to even and hopefully up some if I wait long enough, well that’s what I keep telling myself at least, I just feel stupid for not just keeping that money in my savings account or a long term CD.

  6. admin says

    @Charlie Hey Charlie – You’re not stupid AT ALL! Practically everybody I know lost a lot of money in the stock market, and it is what it is. We win some, we lose some, but in the long run, things generally turn out ok. Hang in there! I’m sure you’ll do great. Best

  7. archanfel says

    Well, follow the same logic, everything is an illusion. Cash is an illusion since it’s nothing more than paper, inflation can eat away cash very fast. The 4% interest rate is an illusion since it can change at any time. To be more dramatic, the banks can go bankrupt. What about FDIC insurance? Well, it can go bankrupt too. The United States of America can disband. Gold would be worthless since who needs gold when we were in a nuclear winter?

    While I do agree that one should not overestimate home value and stock valuation, I don’t think advocating cash is the way to go. Especially since the interests are subject to income taxes whereas capital gains are tax deferred. Net worth is what it is, it’s an estimation of your financial situation. Nothing more, nothing less. Financial decisions can not be made based on net worth alone, nor can they be made based on the illusion that only cash is safe. Keep a well diversified and balanced portfolio is far more wiser than betting on a single thing, even if it’s cash.

    • admin says

      Hi Archanfel – Well said. Everything is an illusion. Hence, if one has $1 million in cash, might as well spread it out into 4 different banks if you’re really paranoid, given the FDIC insurance is only $250,000. I’ve actually got 6 banks with joint accounts that protect up to $500,000/account where I’ve spread out my cash,

      It’s all relative, and my argument is that cash is less of an illusion than stocks, real estate, etc. For writers who say “look at me and follow my advice” because I’m a millionaire is sometimes misleading.

      Having a well diversified and balanced portfolio in 2008 and the first half of 2009 absolutely crushed many people. If we can be happy with what we have i.e. cash and a 4% yield, it’s hard to get in trouble. The reasons for investing in other asset classes is solely for higher return or a desire for more money.

      Thanks for sharing your thoughts!

  8. Bill in NC says

    Gold has appreciated quite nicely.

    The “cash flow” from gold comes from selling the appreciated coin.

    Sell it on ebay for a premium.

    • admin says

      Bill – What is the unit value of a gold coin? Unless you are an official gold coin dealer, I find that any secondary market, it’s never 1:1 in terms of return. It’s the same thing with stamps, baseball cards, etc. Thnx, FS

  9. BG says

    @admin
    I agree with this post — but I think what you are calling “cash”, you really mean CDs, or some other extremely safe (insured) investment that grows at the inflation rate. Holding cash/currency is not ideal as inflation will eat it up.

    I’d like to point out that a high-networth, with zero cash-flow is still being on the brink of bankruptcy: practically every bank failure involved positive networths but no cashflow…

    (Old and two)

  10. Monevator says

    Ah yes, the dark path that leads to the Kingdom of the Gold Bugs.

    You know I’d have a lot more time for this argument if gold didn’t peak in 1980 at $850 – something like $1800 in today’s money.

    Why does get gold get let off for fluctuating in value? Because ancient Romans used it? Because you can bite it? Madness. Gold may go up and down from here like any other commodity, but for me this class apart stuff is bogus.

    I like this post in as much as it reminds us that all assets except cash cannot be banked upon ultimately. I’m also not going to argue with a big bond allocation, though would point out that very few people could ever build up a retirement fund if they only invested in cash or near-cash assets.

    To return the favour of the link that brought me here, and to show we really don’t disagree 100% as you suggested old chap ( ;) ) check out my article on how *every* investment can fail you.

    • My University Money says

      I always think the same thing Monevator. People look at gold as this “Can’t fail” store of wealth, but its value is just as artificial as a currencies’ is, it’s just that it has had this artificial value for a longer period of time. I still feel more comfortable investing in things that have solid physical backing (even though this definitely doesn’t make them fool-proof). I like to borrow heavily from the Warren Buffet school of thought in that people will continue to need insurance, railways, etc. I would also like to learn more about real estate, as I believe that it is the essential supply-and-demand product that we often forget is simply fundamental to any continued growth anywhere in the world.

  11. Roger says

    Hunh, interesting point of view. I sort of agree with you, but sort of disagree (pretty much as with most of what you write). I agree in that too many people put faith into the price they can get by selling physical assets and investments. I don’t include my car or any other physical assets in my net worth calculations, as there are no truly reliable ways to determine how much I can actually get when I sell them.

    That said… I think you’re overstating how risky individual investments and retirement account actually are. Yes, there is the potential for losses (A higher potential for risky investments or those which aren’t diversified), but including the actual price an asset is worth today as part of your net worth is hardly an illusion. Don’t get me wrong, cash (assuming we are talking about federally insured deposit accounts when we say ‘cash’) is most definitely the safest and most reliable type of investment you can have, but there are investments that are nearly as safe and reliable (bonds and bond funds, for example).
    .-= Roger´s last blog ..Net Worth Update: Christmas Shopping is On =-.

    • admin says

      Roger – Sure cash, and cash invested in US treasuries are pretty secure, but everything else from stocks, to real estate, to anything illiquid is absolutely NOT. The point i’m trying to make is that people are overly secure when they calculate their net worth.

      I read all around the community about folks highlighting their net worth, and it’s scary how overconfident people are.

      Didn’t realize you disagree with everything I right! lol. Best, Sam

  12. Roger says

    @admin
    Well, how boring would it be if I agreed with everything you write? ;) I do tend to agree more with what you say than disagree, but it’s more constructive (and fun) to point out the areas where I disagree, and try to argue my case.

    And don’t get me wrong, there is risk in most types of investment, I just think you were overstating HOW risky said investments tend to be. Of course, that’s just my opinion; it’s possible that you are completely correct, or even understating how much of a haircut to give your stocks in order to come up with their ‘real’ value. I just wanted to put my thoughts out there.
    .-= Roger´s last blog ..The Flaws of the Self-Made Man =-.

    • admin says

      Roger – I overstate how risky investments are? I bet if you ask 100 people how risky investments are over the past 18 months, they’ll say “OMG, SO RISKY!” :)

      Don’t rely on your investments to make you money Rog. Rely on yourself.

  13. Roger says

    @admin
    And if you asked how risky they were two years ago, they’d likely say, ‘what risk?’ Most people have the bad tendency of assuming that the immediate past will dictate how the future proceeds. (And you’ll note I also allowed that you could even be underestimating the risk in investing; I’m far from an expert in gauging investment risk.) I still intend to include my IRA value in my net worth calculations, but I fully understand that when it comes time for me to retire, the value may be significantly lower than I was assuming.

    I do like your last comment; I do intend to rely on myself and my earning power rather than investing. Although, if my investments pay off and help to boost the money I can put into my savings, who am I to look a gift horse in the mouth? ;)
    .-= Roger´s last blog ..Small Business 101: Funding =-.

    • admin says

      Roger – That’s exactly it. ONLY until you convert your investments into cash, can you really bank on that asset for your retirement. Everything is an illusion, and I mean EVERYTHING!

      If you have the mindset to just focus on the cash and the cash conversion, you will be surprised on the UPSIDE when you call it quits, rather than be surprised on the downside.

  14. Jason says

    I think you are overstating the returns on cash. Where exactly can you get 4% return on cash right now (besides reward checking accounts that have max balance limits)? 20-30yr Treasuries, yes, but then you are locked in for that long.

    • admin says

      Jason – You can call USAA for a 7 yr CD at 4%. Take a look at “The DVD Method to CD Investing”. My blended return for all my cash right now is around 5.2%.

  15. Jason says

    @admin
    Ok, yes, but CD’s aren’t immediately liquid without paying a penalty. 4% isn’t bad, but I’d hate to be locked into that for 7 years if interest rates and inflation rise. But your blended return isn’t too shabby, I’ll take a look into the DVD Method.

  16. JoeTaxpayer says

    I think part of the question is “for what purpose”? With an eye toward the day we can retire, I don’t include the full vale of the house in my math. In other words, I subtract the mortgage balance from assets and ignore the house value completely.
    As far as the retirement accounts go, I need to reallocate so at retirement, we have the mix we’re comfortable with. With 7 or so years to go, we’re more heavily into stocks than we plan to be at retirement.
    I don’t know how well I agree with the Age=Cash% rule, curious what others think about that.
    Thought provoking article.
    Joe

    • admin says

      @ Joe – I’m surprised with only 7 years to go, you are moving “heavily” into stocks. What is your rational?

      My other question is, do you see a naked woman or something else in the last picture?

    • DIY Investor says

      I for one have no problem with the age = cash rule as a starting point. With 7 years to go I assume you’re around 58. You need a portion of your assets to last at least 30 to 35 years from now. We’ll likely go through a virulent inflation, see incredible changes in 3rd world countries, and unbelievable advances in bio tech over the next 30 years. With 42% in equities you’ll be able to weather the down turns and participate in the advances. In fact, with nasty downturns like we are experiencing now (ex. if market drops 15% from here) I would add to equities – at least 5%.
      Having said all this, I would suggest starting backward. Figure out your income need and income sources. If you need $20,000/year from your nest egg then divide $20,000 by .03. This tells you how big your nest egg has to be. This works out to approximately $667,000. If you’re there or close you don’t have to take as much risk.
      Finally, don’t retire at the top ofthe market,i.e.like 2000 or 2007.

      • admin says

        There’s no inflation that’s why rates are so low. Everything is rational.

        Also, why do you assume people retire at 65? That’s a fallacy.

        I really think most people, with their head on straight can retire after 20 years of work i.e. 42-45 years old.

        • DIY Investor says

          If you can retire at 42-45 go for it. I’m not sure 65 is a fallacy though for
          most people. I would think 55 is doable.
          If you have kids, want to live in a school district with good schools, take nice
          family vacations etc. it costs a lot.
          The .03 is the 3% safe withdrawal rate. I’m not sure if that’s what you were
          referring to in terms of interest rates being low.

  17. Early Retirement Extreme says

    I’m sure Argentinians would consider cash an illusion as well. (Venezuela just devalued and froze their exchange rates: one for the government and one for everybody else.) Or consider the recent history of Iceland with bank debt of a few banks exceeding GDP. Since the budget of the US resembles that of a banana republic, maybe we go the same way. Being in my position cash flow is my only valuable metric. However, it is only valuable to an extent as money is only a medium of exchange and you never know. What is truly valuable is clean water and air, a dependable food supply and shelter. Tools and the skills to use them could also quickly turn out to be more valuable than $200 to buy a DVD player. I do not consider it completely unlikely that in the future I would only take someone’s money if I needed wall paper. People are already using pennies for flooring. (It’s durable, looks pretty good, and surprisingly not that expensive.)

    • admin says

      @ ERE – Sounds good man. Good thing the USD is the reserve currency of the world, and I’m bullish on the USD at this level!

      Cash flow is key, and the ability for cashflow to buy necessities.

  18. JoeTaxpayer says

    @admin

    My comment was “With 7 or so years to go, we’re more heavily into stocks than we plan to be at retirement” as in we need to shift from the current ‘too heavy’ weighting to a retirement mix. Moving away, not toward.
    Sam – If I squint just right, I can see a naked woman in damn near anything.
    .-= JoeTaxpayer´s last blog ..A Real Disaster =-.

  19. everyday tips says

    I am 42, and probably too heavily invested in the stock market. It’s difficult to know what to do, because I was ‘raised’ to believe that stocks were the best investment overall. However, I think rules are being broken all over the place these days, going back to the tech bubble. Our economy is definitely changing with all the global competition and I think new rules may need to be written. I just don’t know what they are yet.

    At least I am buying at perceived low prices! :)

    • admin says

      What would you estimate your net worth percentage is allocated in stocks? Have you always been a stock investor?

      I’ve had good and bad experiences with the market, which is reflective of the past 10 years performance.

      I believe in 4-5% guaranteed returns for the big portion of my cash/liquid investments i.e. 80% of it. I’m happy to punt around the remaining 20% of my liquidity in the market, but not more.

      • everyday tips says

        I am probably 65-70 percent in stock right now. Too much I am sure, but I am not ready to make adjustments at these prices. I am in no hurry, but I do plan on switching out of some of my stock funds once prices recover some.

  20. Rob Bennett says

    I don’t agree with you, Sam.

    When you say that only cash counts, what you are really saying is that only stable asset classes possess a real value. Because the nominal values of things like stocks changes so much, they are said not to possess a real value.

    Stocks possess a real value. All that you need to do to know the real value is to determine the amount of overvaluation and then do the necessary math. Stocks were priced at three times fair value in 2000. Those who had portfolios with a nominal value of $300,000 certainly did not possess $300,000 of real wealth. But the entire $300,000 was not illusory wealth. $200,000 of that total amount was illusory wealth. $100,000 was real.

    Stock wealth is every bit as real as cash wealth. It’s just that you need to factor in the amount of overvaluation present to know how much wealth is actually present in your stock portfolio at any given time.

    Rob

    • admin says

      Once you get to a certain level of cash accumulation, I start NOT wanting to take too much risk anymore. If you have $1mil cash earning $40,000 a year in interest, that’s good enough. It’s not worth it to me to potentially win or lose 20% or $100,000 in the markets.

      I see what you’re saying, but I’m happy to have a minority of my net worth in the markets.

  21. DIY Investor says

    This post is a sign we are near the bottom. Bloggers in 1999 would have been saying to go 100% in stocks. Markets make opinions, opinions don’t make markets.
    Young people should be dollar cost averaging in at today’s prices.
    If you can get the kind of retirement you want with returns on CDs etc. then go for it. Most people I know can’t.

    • admin says

      I hope you’re right that this post is a sign we’re near the bottom! I’m all about asset allocation frankly, and not so much stock picking.

      I’ve believed in a heavy cash earning 4-5% return allocation for about 7 years now. I continue to believe in cash and stable investments.

      • DIY Investor says

        I agree that asset allocation is the most important thing. It is also important
        to have a plan which you obviously have. The thing to avoid, as Dalbar
        points out every year, is for investors to get caught up in emotions. They
        tend to sell at the bottom and buy at the top.
        As this market moves lower keep in mind Rothschild’s maxim to buy when
        there’s blood in the streets.

        • admin says

          Don’t think it’s quite too blood yet. In fact, I think things feel down right chipper in the real world! Gonna put up a post sometime soon to share.

  22. James says

    you make some great points the market is down even just this last week it has got down a lot. the numbers for unemployed and the status of the global economy might make the rest of this year an up hill climb for the stock market

  23. Jon DeGroff says

    I agree. I don’t understand why people will put every dime they have into the market, and just “hope” for the best, and rely on these numbers to calculate their net worth. Myself, I have a lot of money in a permanent life insurance vehicle from an extremely strong mutual company, and my cash reserves grow every year. Of course, that will bring out the “you don’t get the cash when you die! and the “you only gain 2%” and the “your rep was just trying to make money!” comments, which I will gladly debate each and every argument. However, I put as much money as I can into my IRA every year, and I also have a pension. But what I’m looking for is access to cash, which is what my permanent life insurance provides to me. I don’t want to have to miss opportunities because I’ve locked up my all my cash in a vehicle that has no access or guarantees. Every year, my net worth actually increases with my cash values, and that is a number I can count on.

    Great post.

    • admin says

      Hi Jon, thanks for sharing your thoughts, and good to see you see the light as well!

      I like the idea of a permanent life insurance vehicle from a good, little chance of going bankrupt company. USAA is one of those.

      Liquidity, and a REAL guaranteed return is key. Furthermore, in an environment where there is no inflation, or frankly, deflation, 2-4% returns or just fine thank you very much!

  24. Len Penzo says

    I agree that it is folly to include your primary residence in your net worth calculations, Sam. I never did understand that line of thinking. I would include equity in second homes in my net worth calculations though.

    Best,

    Len
    Len Penzo dot Com

    • admin says

      I wouldn’t. No equity or perceived equity allowed in your net worth calculation! The idea is to not rely on anything! That way, you will have upside, and live your life with measured prudence.

  25. Money Reasons says

    My only problem with money is that it’s paper and backed by government sensibility. If we keep printing money like it’s wallpaper, inflation will eventually rise (no skyrocket) and the dollar today will be work 5 cents tomorrow. So even though there is some value in money, it’s still at the mercy of an intelligent responsible government.

    Note, I’m not predicting that the us dollar is going to be work 5 cents in the future, it was just an example. For a great example consider Zimbabwe’s 100 billion dollar that’s worth USD $80 (that was back in 2008, it might be worth less now). Sad huh…

  26. Dividend Monk says

    In terms of identifying wealth, I primarily focus on cash flow.

    Stock prices and home prices are subject to the opinion of the market. So while a “net worth” calculation is good to know, it’s not too meaningful. Having an expensive home and other expensive assets doesn’t work out so well if there isn’t cash flow to keep the game going.

    Cash is good, but subject to risk as well. As you’ve pointed out, federal and state mismanagement has led to printing of cash, plus there are deficits, etc. Having too much worth in cash makes inflation risk the largest risk to a portfolio. Plus, perhaps the biggest risk for the average person is that they are unable to save enough for retirement- so having too low of a rate of return is a risk in and of itself. Cash is just a promise that is only as good as the organization making the promise- the US federal government (or other countries).

    Buying assets and products that generate cash flow, to me, is the most “real” sort of value. Dividend paying stocks, interest paying bonds, distribution paying partnerships, ownership stakes in private companies, and rental property, are assets that produce cash on an ongoing basis. Diversifying into numerous sorts of asset classes reduces total risk- stocks, partnerships, and rental property hedge against inflation risk, while bonds help smooth out volatility and act as a cushion during recession. Most corporations today are in better financial shape than countries are, and large stock price drops don’t affect the ability to pay dividends and distributions- only the success or failure of those companies’ fundamental operations determine that.

  27. My University Money says

    What does everyone think the recent effects deficit/debt talks at the highest levels of government will be? Is there room for compromise when one side refuses to raise taxes and the other refuses to cut services? I do like the pressure this puts on simplifying the tax code, but can there be meaningful debt reduction in the coming days/months? How important is it to get this one right over and above the usual partisan politics, because I honestly feel like this could be a bit of a turning point for the States. If the USA continues down the path of non-cooperation where one side cuts taxes when they are in power, and the other adds services when they are in power, yet all sides borrow to fund these projects, is there any doubt China will look at not recognizing the USD as the reserve currency for the world?

  28. traineeinvestor says

    While I don’t disagree with you on the volatility risk faced by those who have to sell assets to meet living costs (and may be forced to sell in a downturn), I very strongly dislike cash as an asset class for the longer term – unless you believe in a return to deflation (very unlikely), it offers negative real retruns. The USD has lost most of its value since the Fed was created in 1913 – it would be a very brave investor who would gamble their financial life on that trend not continuing.

    For a retiree who does not have the benefit of a taxpayer funded pension, a portfolio of assets offering negative real returns requires either accepting declining living standards as one ages or a significantly higher amount of accumulated savings (which will at least delay or, at worst, frustrate, the timing of your retirement).

    I’m happy to go with 2-3 years worth of living expenses in cash/near cash and take the real loss on that investment so that I don’t end up being forced to liquidate assets at unfavourable prices, but everything else is going into higher yielding risk assets – real estate and equities which have at least the potential to grow over time. The emphasis is on yield (without making the mistake of reaching for it). If the cash flow is good enough, what the assets are worth on any give day is irrelevant. In the context of a 40+ year retirement, I’ll sleep a lot easier at night holding mostly equities and real estate than I will if I have my life savings in assets which I know will lose a little bit of their real value each and every year.

    • Financial Samurai says

      Lol, I was going to publish it today, but then I read over the weekend another bailout offers mortgage payments for one year and had to write the Free $50,000 post! Will go up Wed prolly.

  29. Thomas | Imperial says

    You know this has to be one of the better posts I have read. I would have to agree that CASH should be your ultimate factor when determining your net worth. I mean after all it all boils down to what you can use in the end. If you don’t own a house or even if its paid for you can all use the money once its sold or what ever loan you can get against it in the end.

  30. Chris says

    Well I disagree that any investment aside from one’s principle residence should not be counted as part of their net worth. I see net worth as changing over time, and as long as it is in the positive direction, then I am better off. If it went down, I could analyze and see if it was due to stocks and adjust accordingly.

    Likewise, this is also age dependent as well. For instance, someone who is relatively close to retirement age (say 59 1/2 because that’s where one can draw down their 401k/IRA), then it becomes more valid to include investments as part of one’s net worth.
    After all, if one is nearing “traditional” retirement age, and they have the investments to sustain their livelihood after retiring, they have just achieved the same as anyone who retires earlier.

    In the past, I would count housing (both mortgage & valuation) into my net worth. I don’t see that as being realistic, since I have to live someplace. If I were to sell the place maybe it doesn’t sell as quickly as I like, or sells significantly below what I thought it would, etc. I also don’t want to pay for an evaluation of my home every year or so, just for the sake of updating my net worth.

    With all the above being said, it is very quick and easy using a tool such as Quicken or YNAB to provide different reports that either include investments and/or housing into one’s networth calculations.

    And as you and another user posted, it is a great feeling to have a zero net worth, and then to look to the other side where you’re in a positive net worth is even that much more enjoyable.

    There is a somewhat well written book by Ralph E Warner titled: “Get a Life: You Don’t Need a Million to Retire Well”
    Now, if one has a million, then they are that much more comfortable in retirement or semi-retirement.

    • Financial Samurai says

      My point is for people not to be deceived and think they have more than they really have come liquidation/draw down time. It’s too dangerous to get comfortable. The economic Armageddon of 2008-2010 should be a great wake up call.

      People laugh that I have a million bucks in CDs averaging 3.5%-4% for the past 4-5 years. I don’t care. That’s $35,000-$40,000 a year in stress free, guaranteed income spread across three banks. I’ll take it!

  31. Chris says

    Of course, on the other side of the coin, a band called Styx once wrote a song called “Grand Illusion” that fits pretty well with the entire idea of networth. :-)

  32. Marcel says

    Sam,

    I’m a new reader and love this site. So many interesting points of view.

    So for you and all the readers any thoughts on this allocation?

    650k SF apartment – own 100% equity and net yielding about 4% in rental income
    700k cash – crappy yield of .25%
    400k in vanguard bond fund – about 2.75% yield
    400k in stock mutual funds – about 2% yield

    Is this too conservative? Any thoughts on what to do with the cash?

    I’m 41, currently not working, and, as you did, trying to find my “next” career.

    Thanks,

    Marcel

  33. David Landen says

    As many of us learned over the past couple of years our home equity can change drastically! I agree that your home value shouldn’t be counted towards your net worth until after you sell it and pocket the money!

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