Why your net worth may not matter at all
Net worth, net worth!
All we talk about in the PF world is how much money we have to our name, am I right?!?
Well I am here to say that perhaps net worth is not that important as we think it is.
To put it another way, someone who has $50,000 as their net worth and no debt at all is better off than another who has $150,000Â saved but has $100,000 in debt.
They both have the SAME $50,000 net worth, but I’d rather be the former person than the latter.
That person with that $100,000 in debt:
- obviously has interest payments (which chips away at your money)
- is in a more precarious position if they were to let’s say lose their job
- has a lot more liabilities than assets, and is banking on their future to help ease the ratio
- ..and it’s all paper gains anyway until you realize the income as cash in your bank account
Update: Thanks for the catch, readers. My only excuse? #toddlerbrain
BUT WHAT ABOUT EARNING MORE MONEY WITH LEVERAGING DEBT?
Ah.. leverage.
Of course you can say that if we borrow $150,000 at 2% and put it on the stock market to earn 7%, we’re coming out 5% ahead of the game… but these are all (in my mind) debatable, and therefore unreliably fake numbers, because we can only estimate how things will go, but none of us has a crystal ball to see into the future.
Mr. Donald Trump comes to mind for this particular situation:
Via
This expansion, both personal and business, led to mounting debt.
[…]
By 1989, poor business decisions left Trump unable to meet loan payments.
[Source]
Basically, he did what everyone says is the smart thing to do (borrow to get into debt to obtain more assets), and almost paid in blood for it.
He over leveraged himself to the point where I remember reading an article with Ivanka Trump saying that when she was young, her father once pointed to a hobo on the street and said: This man has more money than I do right now.
Things worked out in the end for Trump, but it could have just as easily gone the other way.
He has used bankruptcy as a way to gain more money, which is even more immoral.
What’s real in my mind, is what you have banked, and what you owe (in relation to each other).
This is also partly why I am a big fan of NOT being in debt, unless it’s truly secured at a 0% or 1% interest rate (something that would mean I could stick it in a high interest savings account and make money, like with your student loans when that you can defer while you’re in school).
That said.. your net worth is important as a benchmark for how you are doing for the future to reach your goals.
Not so much as a way to determine your self worth or to laud over others.
13 Comments
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sherry@savespendsplurge.com
Real estate is just a place to live, I am sensing it is less and less of an investment unless you use the rule of 100.
$200,000 = $2000 rent a month or else it isn’t a deal.
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Taylor Lee @ Yuppie Millennial
Ditto on molyb’s comment, I think you might have the assets and debt for person B flipped.
In general I kind of disagree but I also don’t think of debt as a moral issue. Trump is even a good example of it. Even when he was net worth 0, he had significantly greater access to capital, material wealth and comfort, and power. Because of his access to credit, he was in a better material position than a homeless man even if their net worth may have been synced. Realistically, even if all his businesses failed and he’d been millions in the red, that risk is not really that much on him due to bankruptcy laws. I’d posit the average person with 100k assets and 100k debt is probably in a much better position than someone with nothing to their name.
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sherry@savespendsplurge.com
Fixed! My only excuse = #ToddlerBrain
Perhaps. But are they really when the markets tank and interest rates go up?
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Taylor Lee @ Yuppie Millennial
I would argue that yes he has more options and maintains more power even through a downturn assuming he can weather the storm. He could sell off or restructure assets. Also, assuming he diversified his holdings, depressed paper value of his assets don’t much matter if he is making payments on time to his creditors. He could selectively renege on particular debts and their corresponding collateral and hold onto others. Further, even if he loses everything he maintains business contacts with affluent people who are more than willing to buy rights to his brand because of name recognition.
Those with wealth, however illusory, are often better than those with none at all.
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sherry@savespendsplurge.com
That’s a good point. Network and connections, even his name has a cachet.
But someone who isn’t like Trump… like the 99% of the rest of us, would have some issues.
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molyb
I think I must be missing something big here, but how do the 2 people have the same net worth? If net worth is assets-liabilities/debt, then person 1 has a net worth of 50k-0=50k. Person 2 though has a net worth of 100k-150k= -50k, so they aren’t the same- one is positive and one is negative…
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SarahN
Take this example:
– -$300k (debt in a mortgage) for a property (bought for $465k)
-$265k in cash (including retirements funds, shares etc)On the balance, I could have $45k debt and no ‘cash’. But also, that property bought at $465k is worth $600 k on recent market and bank estimates (the former is usually aiming to BS you to the ‘best best’ possible, the latter usually incredibly conservative).
In my net worth calculation though? $485k (a modest $5k pa increase).
Then I’m at a new position of $425k give or take, overall position with a CONSERVATIVE price on my property.
Yep, I have debt. Yep, I ‘waste’ money in interest. But when I sell, I will have the ‘cash’ and the difference between what I sell for and what remaining mortgage.
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sherry@savespendsplurge.com
It isn’t worth anything until you sell it.
It’s all on paper.
We’re currently and CASUALLY looking at the housing market, and places worth by the city at $500,000 are asking $650,000 and not moving. If they put it at $500,000 it’d move, but I daresay on their net worth papers they put $650,000.
Other places that are new, are asking for $400,000 for instance, but can’t move it, even with GIVING MONEY as a rebate (up to $50,000), for a total of $350,000, which is $50,000 below the city assessment.
Real worth? $300,000 maybe. But on paper, it says $400,000.
All paper money.
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SarahN
Fair enough – but you are saying they have some inherent value. Be it $200k for both examples. Can you not bank on that to some extent in a net worth assumption.?
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sherry@savespendsplurge.com
Sure! As long as people don’t consider that they hypothetically could get $400,000 for the place, I’d put at least a number on the asset. A fire sale number if you will that you know it will definitely sell at.
I’m not against putting a home in your net worth, but I find people tend to overinflate the number.
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Revanche @ A Gai Shan Life
Off Topic: Can I just morally object to the fact that I had to see that turfnugget’s face on your blog because it doesn’t belong here? Because ew.
(If you can’t tell, I’ve had it up to here and beyond with our current election cycle that will never end and particularly with that embarrassment of a candidate.)
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ArianaAuburn
Net worth matters when it is mostly CASH. Or at least some liquid assets that can be converted into cash. Having a large net worth matters when you or a loved one needs medical access or treatment and your godforsaken health insurance denies it. It doesn’t measure self-worth yet it is used by people to judge others. Because let’s face it: we are all trying to survive and money helps in survival.
As for real estate….property assessments change and prices go up or down. A nice lot or house could be sitting on top of a environmentally toxic area, a geological fault line, a flood zone or a place near a sink hole. Yeah no one realizes those things when purchasing real estate.