# Net Worth is a Useless Metric

First, the basic definition. ‘Net worth’ is the amount by which assets exceed liabilities. While the term has value and meaning for businesses, it is largely a useless metric for individual families. Why? Because two ‘assets’ that people love to include in their calculation of net worth are their homes (I’m referring to primary residences and not rental or investment properties) and automobiles.  And for too many people the value they assign to their home and automobile(s) form a significant amount of their net worth.

## Focusing on Net Worth

As an example, you might hear a couple say their net worth is \$265,000.00. No doubt that number is quite impressive. However, if you break it down, you might discover that they are assuming they have \$120,000.00 in equity in their home because of some improvements they have made to the home or because of what comparable homes in the neighborhood have sold for in the recent past or what Zillow estimates their home is worth.

Perhaps they have just made the last payment on their cars, zip over to Kelley Blue Book, plug in the relevant information (e.g. year, mileage, condition, etc.) and are apprised that one is worth \$17,400.00 and the second is worth \$12,000.00. Between the home and cars they calculate a value of \$149,400.00. Combine that amount with the \$115,600.00 they have in savings and investment accounts and they arrive at that \$265,000.00.

There are at least three things that should raise a red flag and give someone pause when looking at those numbers. First, no one, I repeat that no one, knows what their house is worth until they actually sell it. What people believe their house is worth is often a lot higher than what someone else is willing to pay.  Second, even if they do sell it at or near the price they believe it is worth, they still have to live somewhere. Assuming they don’t make the sell and buy a tent with the profits, banking/investing the rest, it’s safe to assume they will be using at least some of the profits to use as a down payment and will be taking on another mortgage for some period of time. Third, similar story with the cars. Even if they are able to sell their cars for what KBB says they are worth, I believe it’s safe to assume that most aren’t going to downsize to a bike and bank/invest the rest … they are going to go out and buy another car or two.

Net Worth by Age and Income

At the end of the day, the numbers most people assign to the value of their homes and cars are really irrelevant, particularly with respect to retirement planning. As an example, I am quite certain that the wife and I have about \$50,000 in equity in our home and I would peg the combined value of our cars – both paid for – at ~\$30,000. We are at 10 – 11 years away from retirement. Even if we were planning on downsizing to a smaller home in retirement and going from two to one car, what good does it do to assign a value to our home and car(s) right now? None.

### Marketable Assets or Financial Wealth

So if not net worth as commonly defined, what should be the focus? What is a more relevant metric, particularly with respect to retirement planning? I believe ‘Marketable Assets’ or ‘Financial Wealth’ is the answer. For purposes of studying the wealth distribution, economists define wealth in terms of marketable assets, such as real estate, stocks, and bonds, leaving aside consumer durables like cars and household items because they are not as readily converted into cash and are more valuable to their owners for use purposes than they are for resale. Once the value of all marketable assets is determined, then all debts, such as home mortgages and credit card debts, are subtracted, which yields a person’s net worth. In addition, economists use the concept of financial wealth — also referred to in this document as “non-home wealth” — which is defined as net worth minus net equity in owner-occupied housing.

While the marketable assets or financial wealth number will be lower than net worth, as traditionally measured, and not sound quite as impressive – \$265,000.00 certainly sounds more impressive than \$115,600.00 – the \$115,600.00 is significantly more relevant.

### Final Thoughts

Do yourself a favor and stop focusing on net worth; but if you have to, use either of the modified definitions. Spend your time and energy minimizing your expenses and developing multiple streams of passive and portfolio income; those are the numbers that are relevant for retirement planning.

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.

1. You are onto something. I do use Net Worth with Real Estate assets as a base number. However, I make two adjustments in my retirement spreadsheet. (I do not include cars at all in the equation.)

Our goal is to have ten times our annual salary as the basis for our retirement. If we include our home equity, we are more than over that amount. However, if we back out the equity (because it will have to be invested when we downsize), then there is a more realistic number.) Tracking that is my barometer to retirement. That raw number still shows us as 82.4 percent to goal.

However, I make one additional adjustment. I back out our savings rate from the goal. We are saving about 23 percent of our income (TSP, 401K and Roth IRAs). If we deduct the savings from the goal, then we are now more than 90 percent to Nirvana.

If our current balance earns nothing (and does not go down), we can retire at goal in 3.1 years. I hate seeing those calculators where people assume 8% return on investment. I would rather have an achievable 4-5 percent return with low inflation.

• Great, great feedback. Clearly you’ve given lots of thought to developing and executing your retirement plan. Good stuff!

Thanks for stopping by, my friend.

2. When I saw the topic pop up on my email, my reaction was that I totally agree, but I was actually thinking more along the lines of it’s irrelevant because it’s just a number. If I say I have \$500k net worth, that’s peanuts to some people but that could be enough to retire on to others. I was thinking it’s irrelevant in general for you to know anyone else’s net worth other than your own. Unless you’re helping them with a financial plan.

On your note, I’d agree you can’t include vehicles or any items that really depreciate in value including cars and electronics. I would include have two numbers if you have a house. Your Investable Assets in one number and Net worth (minus cars) with an asterisk in another. You’re house isn’t directly useful financially, but it is always an option to sell and rent which could be a viable option for some situations. If I somehow run low on cash in retirement down the road, selling my house is my last card to play.
I agree though that net worth gives a false sense of security to those that put far to little away for retirement. Investable Assets would be a better wake up call for most.

• Thanks for stopping by and adding another perspective to an interesting topic.

3. I agree that invested assets matters most for retirement planning, but for those of us with other goals, net worth is a good marker for whether or not we’re making wise or stupid choices with our money. I will say that I think that homes/cars should not ever take up more than half of your net worth, even if you’re just getting started, but that’s just my opinion.

• “… net worth is a good marker for whether or not we’re making wise or stupid choices with our money.” I have heard others express that opinion and I don’t completely discount it. However, I have a difficult time really accepting it. As an example, let’s say last year my investable assets were \$150,000, it was determined I had \$30,000 equity in my home, I had a car (paid off) that KBB said was worth \$25,000 and I had debt of \$5,000, giving me a net worth of \$200,000. One year later my investable assets drop to \$149,000, it’s been determined that I now have \$35,000 equity in my home, the value of the car has depreciated to \$24,000 and the debt has held at \$5,000, giving me a net worth of \$203,000; an increase of \$3,000 from the previous year. With respect to being in a better position to draw retirement income, clearly that is not the case as my investable assets did not change and now I am one year closer to retirement; and have I really made wise choices? Am I really in a better financial situation? If I look at net worth as defined by most, the answer would appear to be yes since it increased. I would suggest that my financial well-being has not improved, in fact, I would say it has grown slightly worse.

Sure it’s nice that the [perceived] value of my house has gone up and I certainly would not be upset if I made that much profit or more when it does come time to sell. However, at the end of the day it seems to me what really matters, what really determines your financial well-being is your investable assets.

A few months back I finished Capital in the Twenty-First Century – a book by Thomas Piketty which I highly recommend – which discusses the accumulation and distribution of capital and its impact on economic growth, the concentration of wealth and inequality. The following passage has really stuck with me and I believe is relevant to this topic and conversation. “Housing is the favorite investment of the middle class and moderately well-to-do; but true wealth always consists primarily of financial and business assets.”

• When it comes to wealth building, invested assets is all that matters. I guess if I am to reject net worth, then I want some metric to help me to understand if my capital directed towards consumption is a wise or an unwise decision.

For example, \$65K of our capital plus whatever we put in during renovations is tied up in our house. It’s a trade I would happily make again, but I need some context for this number. Houses and cars are big financial decisions, and it is helpful to say something like, “How will this decision affect my overall financial picture over the course of the next five years?” Net worth, I suppose is a shortcut for that, but I understand the temptation to inflate home and car values could make net worth misleading and therefore worthless.

• A good discussion that shows there are different ways of determining how to view/measure financial progress.

• My alternative shorthand to track progress would simply be investable assets less debts, disregarding the primary residence and car(s). I gave an example in an earlier response to Andy. This might also be called ‘Adjusted Net Worth’ as suggested by Thias. An example …

2014:

Cash – \$25,000
Savings (Emergency Fund) – \$15,000
Investment Accounts (e.g. 401(k), IRA, brokerage, etc.) – \$251,000
Investable Assets – \$291,000
Debt (e.g. credit cards) – \$15,000

2015:

Cash – \$26,000
Savings (Emergency Fund) – \$20,000
Investment Accounts (e.g. 401(k), IRA, brokerage, etc.) – \$291,000
Investable Assets – \$337,000
Debt (e.g. credit cards) – \$13,500

Change from 2014 to 2015 can be easily determined.

I use a Workbook, comprised of a Spending Planner Worksheet and a Retirement Planner Worksheet, that I developed for detailed tracking and assistance with decision-making. In my book, RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit, I walk readers through how to use it, helping them understand what the numbers mean and understand how they relate to one another. However, it is pretty intuitive and most that know something about personal finance can simply plug in their numbers, understand the results, and use right away.

• I’ve been thinking about this quote for a few hours, but I keep coming back to Joseph Stiglitz and externalities. To me, one possesses wealth when he or she and his or her externalities influence the market, which is why I think most (including myself) will never possess wealth. Real estate is one the few investments readily available to the working class. Investable assets, to which you are referring, almost inevitably means stocks–why invest solely in someone else’s wealth and their externalities when I can invest in myself and maintain slightly more control over my own externalities?

• Great food for thought. “To me, one possesses wealth when he or she and his or her externalities influence the market.” Using that definition, no doubt that most would be excluded. I’ll come back to the definition of ‘wealth’ shortly, but first, my thoughts on real estate and stocks (to include in the form of mutual funds). I would argue that it isn’t true that real estate is one of the few investments readily available to the working class. My thoughts on both, real estate first.

I am assuming that when you speak of real estate as an investment, you are referring to homeownership. I don’t view having a home – one on which a mortgage is owed – as an investment. In my mind, a true investment in real estate is purchasing a REIT, a real estate focused mutual fund or perhaps a rental property. It is a real estate investment outside of the primary residence. In fact, I believe one of the problems we have with respect to personal finance in our society is that there are those wholly vested in selling the idea that owning a home is a “great investment.” It’s no wonder that a lot of people bought way more house than they needed, or could afford, in the run up to the recent collapse in the housing market. Too many people were thinking of their home as the centerpiece of their financial/retirement plan.

Bringing it back to the Thomas Piketty quote, my take is that there are those who are already wealthy, or are in a position to benefit from those seeking financial security, via homeownership, who understand that true wealth comes in the form of financial and business assets, not homeownership. Keeping the masses, the working class, ignorant about how true wealth is attained benefits them.

Concerning stocks, particularly in the form of mutual funds, I believe they are readily accessible to the working class. While that was not the case 20 – 25 years ago, it is the case today. I attribute the low participation in the stock market of the working class to two factors: lack of discretionary income [that is a long conversation itself] and financial illiteracy. While as an individual I can’t do much about the former, my books and this blog are part of my own efforts at addressing the latter.

Circling back to wealth. My own definition is an individual [or family/household] is wealthy when they can live their chosen lifestyle on passive (aka residual) and portfolio income and do not require earned (aka labor) income. Of course the income level will vary for all, there is no ‘right’ amount; and certainly someone could be wealthy according to this definition without his or her externalities influencing the market.

Thanks so much for your feedback and sharing your thoughts. Conversations such as this provide a great opportunity to learn about and process new information and see things from a different perspective.

4. I wouldn’t say net worth is entirely worthless, but I think people have placed too much value on it as a financial metric. Just like how you can’t look at just a balance sheet without the context of the income statement, I also think net worth needs to be looked at in the context of a person or family’s income. If someone has a net worth of -\$300k but has an income of \$500k, I’ll take that over a a net worth of \$300k with an income of \$45k any day.

• No doubt that people have placed too much value on it as a financial metric. With respect to planning and the execution of a withdrawal plan it offers nothing. Thanks for stopping by, DC.

5. I completely agree with you! I think the way that most people calculate net worth is worthless, particularly with the inclusion of assets likes houses. A house is difficult and costly to get rid of. And I say this time and again about trying to sell things like houses and stuff: it’s only worth what someone else is willing to pay for it.

• Exactly. More power to someone if they get the price they are asking for and they make a huge profit when they sell their home. However, with respect to tracking finances and planning for retirement – determining streams of income – it’s better forgotten.

6. One thing your investable assets does not take into account, however, is debt, which net worth does. If you only concentrate on your investable assets, you could look like you are in a great situation but you can still have loads of debt to your name.

Net worth is very valuable because it allows you to see your full financial picture in one number. I do agree that tt is not the right number to determine if you have reached financial independence.

I think “Adjusted Net Worth”, in which you remove the equity you have built up in your home and your cars, is a better indicator of your financial position than just looking at your investable assets, which doesn’t show your full financial picture.

• You are certainly correct in noting that debt cannot be completely forgotten. There is nothing that says you can’t subtract any debt from your investable assets to track/measure your financial well-being. However, with that being said, with respect to retirement planning, I believe I could make the case you could account for debt in a better way. An example:

Let’s assume I am one year away from retirement and I have \$1,350,000.00 in investable assets. I have determined that I need \$50,000 annual income. That \$50,000 will cover all the things a typical household spends money on (e.g. food, utilities, gas, clothing, etc.) which would include any debt I’m carrying into retirement. We could say that of that \$50,000, \$5,5000 will be paid toward debt (e.g. credit cards) each year. In order to draw out \$50,000 annually, utilizing the 4% rule, I know that my investable assets need to be at least \$1,250,000.00. They are.

In this example, I am only considering investable assets and I have accounted for my debt as I make plans to retire and account for my annual income.

With all that being said, I can absolutely live with what you refer to as ‘Adjusted Net Worth.’ That works for me.

The biggest problem I have with using net worth is that I believe people give themselves an inflated sense of financial well-being with that metric and it really doesn’t have practical use in financial planning, particularly in retirement planning. As noted in the post, what you – or anyone else – believes your house (for which a mortgage is still owed) and any vehicles are worth when you are some number of years away from retirement is largely irrelevant. What is going to matter when you get down to trying to account for providing yourself an adequate retirement income is investable assets.

Thanks for joining the conversation.

• I totally agree, any net worth calculation has to be accurate. When entering retirement, I think being debt free is important so then net worth really becomes what’s in the asset column. Again minus the value of the primary residence because you always need a place to live

• Agreed. The wife and I have every intention of going into retirement debt free, which would include not having a mortgage. Of course, however, there are always expenses outside of a mortgage associated with a home. Those must be accounted for when determining how large the nest egg – investable assets – needs to be and how much can safely be withdrawn each year. Thanks for adding great thought and insights to the conversation, Andy.

• Now personal finance apps and web pages need to adjust or at least inform people on the calculation of net worth or offer some other way of tracking progress.

• If only I could code that well. My take is that there is an entire industry (think realtors, home improvement stores, contractors, etc.) out there that is wholly vested in selling the idea that a home is a great asset and that people should consider theirs when determining their financial well-being. I’m of the belief that what really matters, again, particularly with respect to retirement, is what ‘assets’ can be converted to income. Obviously your car and home can’t really be converted to income unless you are able to sell them at a great profit and significantly downsize, moving the profits into a checking account/savings account/brokerage account, etc. and eventually into your retirement income stream … or sell them and don’t replace them.

Of course while that is somewhat possible with a car – provided someone lives in a location with good public transportation and/or can walk/ride a bike to most necessary locations – it’s not really an option with respect to housing for the vast majority of people. Think about a car for a minute. Let’s assume someone has a fairly nice car that is in great shape. They own it outright and have decided they no longer need a car; they have retired to a location with great public transportation. They sell it for exactly what KBB says it is worth … say \$20,000. While that sounds nice, utilizing the 4% rule, we can see that amounts to retirement income of \$800 per year or \$67 per month. Not exactly a lot to get excited about, and remember, they no longer have a car. The majority of that \$67/month will now probably be spent on taxis, bus fares, subway fares, etc.

Most people are going to be a lot better served by minimizing debt, saving/investing as much as possible and living in their primary residence and using their car to get from point A to point B; and not worry about trying to tie those two items – a car(s) and primary residence – to determining their financial well-being.

7. That’s an eye catching headline Savvy. While I don’t think networth is “worthless”, I certainly think all assets are created equal. Sure I have to live somewhere, and have reliable transportation, but I don’t see my car or house as being nearly as important as say……a business that has low leverage and throws off free cash flow…..or cash flowing real estate investments….etc. (How was that for a run on sentence.) Anyway, I take it that you meant something similar. I’d much rather have a \$200k asset that pays me…..than three cars valued at \$200k.

Now finding those investments 🙂 That’s the trick. Have a great weekend Savvy!
-Bryan

• Believe me, the headline was not intended to just be ‘click bait.’ I truly believe net worth as a metric is useless for households. Using investable assets as a means to track financial well-being and for planning is much more useful.

I assume – and the passage that follows suggests – you meant that NOT all assets are created equal. Agreed. Thanks for stopping by, my friend and adding to the conversation. Enjoy the rest of our weekend.

• So if net worth is useless for households, what indicator should be used to show progress toward goals? How do I know I am increasing overall from one year to the next?

For me, I used net worth. It was one number I could compare year after year. My net worth calculations did not include cars, house, mortgage (when I had one) or personal belongings. It did include stocks, bonds, CDs, savings accounts, precious metals and anything else I had with the intent of selling it in the future for more than I paid for it.

I don’t carry credit card debt so it was intentionally excluded.

James, back to my question. If net worth is useless for households what metric do you suggest for monitoring overall progress?

• I note in the post that investable assets (cash, saving and investment accounts) is a much better metric. An example …

2014:

Cash – \$25,000
Savings (Emergency Fund) – \$15,000
Investment Accounts (e.g. 401(k), IRA, brokerage, etc.) – \$251,000
Investable Assets – \$291,000
Debt (e.g. credit cards) – \$15,000

2015:

Cash – \$26,000
Savings (Emergency Fund) – \$20,000
Investment Accounts (e.g. 401(k), IRA, brokerage, etc.) – \$291,000
Investable Assets – \$337,000
Debt (e.g. credit cards) – \$13,500

Placing those numbers in a spreadsheet you can easily track your progression – or regression – on an annual basis.

Also, with respect to retirement planning – my primary focus – please see my response to Thias as to how you can easily account for your assets and debt as you head into retirement.

8. I totally disagree with net worth being a useless number. What other single number can be used for comparison to know how you are improving year over year?

I do agree that houses and cars should not be included in net worth calculations. These are purchases not investments. People always need a place to live.

• Whether you realize it or not, we are actually in agreement. You note that, “I do agree that houses and cars should not be included in net worth calculations.” The reality is that those items are traditionally included in net worth. I am making the same point you are … they should not be considered. However, since I can’t change the definition of net worth, I suggest people use something that is much more relevant, ‘Investable Assets’ (cash, savings and investments), to track how they are performing financially from year to year.