Tuesday, September 12, 2006

Calculating Net Worth

I thought that calculating one's net worth would be pretty simple. Add up the value of your assets and subtract your liabilities (debts) to arrive at your net worth. Having looked through a few blogs, however, I see that the definition is neither simple nor consistent. I've seen one guy who has listed over $50k in automobiles and the value of jewelry as "assets". On the other hand, I was recently reading a book (Getting Loaded by Peter Bielagus) where in calculating net worth, the author deliberately excludes things such as cars and other depreciable assets from the calculation.

I agree with the latter formula. I don't include what I would call non-financial assets as part of my net worth. I wouldn't consider stamp and coin collections, or jewelry to be financial assets. The reality is that while these items do have value, it is not as if I would be willing to sell any of them, or that I would rely on them for income. Similarly, I don't consider my primary residence an asset for the purpose of calculating net worth. In fact, I've seen a few questionnaires (that brokerage houses use to determine the suitability of certain investments) that specifically ask for net worth excluding one's primary residence.

Getting back to the question of net worth, I suppose that if one would exclude the value of their home from the calculation, then one could also exclude their primary mortgage (but not their second mortgage since that is not usually used to finance the house, but other consumer items instead) from their liabilities. Why do people try to inflate their net worth by including miscellaneous non-financial assets? My guess is that is like the game people play with inflating their resumes when applying for a job. You may be able to fool other people into thinking that your net worth is more than it is, but just be certain you aren't just fooling yourself.



mOOm said...

Hi pfstock - I responded to your questions on my blog.

Some definitions of net worth excluded primary residences - for example in one of those surveys on the number of millionaires. OTOH some surveys of net worth include all household goods. I would not exclude a primary residencve though from a standard net worth calculation for the following reasons:

1. You need to live somewhere. If you own a house the return on that asset is the rent you don't have to pay.

2. You can leverage the asset to make other investments and with the tax deductions on mortgage interest for many US taxpayers this is a cheap loan.

3. It is easily saleable at the stated value or could be rented out as a productive asset.

4. It is a potentially valuable piece of an inheritance.

5. There is a potential for capital gain (depending on timing etc.)

6. It can be reverse consumed in retirement by a reverse mortgage if neccessary.

It is just much closer to a real productive financially fungible asset than any of those other things.

However, if you do own a really valuable artwork that might be worth counting too.

pfstock said...

I think that points number 1 and 5 are the strongest arguments in favor of including a primary residence in calculating net worth. I am concerned that many people may have overestimated the value of their home (especially in the recent real estate market), and have an inflated view of their net worth. Counting only income-producing assets, I am comfortable in the fact that I may have erred on the low side. But, I know that I am not fooling myself into thinking that my net worth is greater than it really is.

StealthBucks said...

Net Worth is the total of all assets less all debts. Thus jewelry, cars, homes, stamp collections, and even your vintage collection of whoopee cushions count. I count everything. Having said that you can use an accurate net worth accounting as a life tool. For example, you bought that Hemi Dodge with the gals on the mudflaps for $40K with a loan for $38K. Guess what, you drove it off the lot and its true wholesale resale value is now $28K. Enter that number, I bet you may just think twice about ordering up a Hemi for the misses. All the same applies for every illiquid asset you have. Enter it as a value that approximates liquidation value and you will end up with a great accurate net worth statement and a fantastic lesson in depreciating asset analysis. OK, I'm funnin you a bit but you may be too extreme on your reasoning for keeping out real estate. It is a very real asset. It's just not as liquid as MSFT. Good luck......