Your net worth is an illusion. Unless your house is fully paid for, and unless you can access your retirement accounts and liquidate your business today, your net worth is not real.
Although we’ve recovered quite a long way since the 2008-2009 financial crisis, we can never fully count on the full value of any of our assets. This is especially true for less liquid assets like real estate and private equity investments. You just don’t really know the truly value until you try to sell.
The only thing we can really count on is cold, hard cash and the cash flow your investments generate. It is a little disingenuous to say you are worth $1,000,000, when 70% of your net worth is tied up in illiquid assets.
Your home is only worth as much as someone is willing to pay for it. And you just don’t know how much someone is willing to pay for it unless you try to sell.
In 2017, I thought I got a great deal selling my rental house for $2,745,000. In 2H2020, a random realtor who believes I left $655,000 on the table! Go figure. Everybody has got an opinion, just like butt holes.
Even your 401K and IRA are suspect because those accounts can easily collapse. When it’s time to withdraw, you don’t know exactly what the government tax laws will be.
Your Net Worth Is An Illusion: The Asset Side Of The Equation
Here are all the assets that may be included in your net worth calculation.
Cash
Stocks
IRA
Private Investments
Primary Residence
Valuables (Jewelry, Collectibles)
Pet Bunny
For retirement purposes, your assets should equate to CASH + liquid securities you can sell today + MORE CASH. With stocks at all-time highs, it’s good to have a cash buffer.
Calculate Your Net Worth Conservatively
The way to look at net worth is consistent with my “Going Broke To Win Big” methodology. In uncertain times, like we are experiencing during the coronavirus pandemic, you want to operate life as if none of your assets except for your cash is dependable.
Perhaps your retirement goal shouldn’t be a net worth goal, but a cash or savings goal if you want to be really conservative. 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 bail us out from this coronavirus devastation. Hence, even our cash is suspect in value. You may want 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 or more risk-free assets like U.S. Treasury bonds or AA-rated municipal bonds for that bankable guaranteed interest income. The wealthier you are, the more you need to focus on capital preservation.
Your Net Worth Is An Illusion: The Liabilities Side
The liability side of the equation on the other hand is very straight forward. Your liabilities are all your debt. Debt includes credit card debt, student loans, auto loans, mortgages, personal loans, IOUs, and more.
In order for your net worth to be properly calculated, you seriously need to make sure you account for all your liabilities.
To better protect your net worth, you should view your net worth like it’s an illusion. It’s not real, so don’t count on most of it.
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.
Related: The Average Net Worth For The Above Average Person
Track Your Wealth For Free
Although your net worth is an illusion, you still need to track it. I recommend signing up for Personal Capital’s free financial tools so you can track your net worth, analyze your investment portfolios for excessive fees, and run your financials through their fantastic Retirement Planning Calculator.
Those who are on top of their finances build much greater wealth longer term than those who don’t. I’ve used Personal Capital since 2012. It’s the best free financial app out there to manage your money.
Your Net Worth Is An Illusion was originally written on 9/18/2009. Time flies when you’re having fun! The bull market has really made so many things better. However, tough times are here again in 2022. Make sure you convert some of your net worth into more freedom and a better life. The YOLO economy is here to stay!
Related posts to your net worth is an illusion:
Your Risk Tolerance Is An Illusion As Well!
Net Worth Benchmarks To Ensure Proper Growth Over Time
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!
Yep! How did you find this post btw? Google?
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
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. :-)
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.
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!
Some people may call your 4.5 to 5% CD rates fictitious. I don’t blame them.
That was back in 2012. Today, the rates are under 1%. See the dates.
Hey Sam! I came to see your mid-year update! ;) I’ll check back tomorrow!
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.
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.
Interesting that you will sleep better holding equities and real estate. Sounds good to me.
Around how old are you?
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?
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.