Many people dream about reaching the million-dollar net worth milestone, as if that lofty benchmark somehow guarantees a strife-free financial life. Preposterous! Net worth — the value of your total assets minus your total liabilities — is overrated because it’s very misleading, as evidenced by many “paper millionaires” who struggle to make ends meet. Yes, net worth is a terrific indicator for estate planning, or identifying how much insurance you need to cover your assets, but it only provides a partial snapshot of your present financial situation.
The bottom line: Your ultimate goal should be financial freedom — and that requires minimal net worth.
Photo Credit: stock photo
Your last line says it all, Len. I have a brother who has a very successful career. I am sure his net worth is several multiples higher than mine. But he and his wife have so many toys and live so large that he is a slave to his job. I live a comfy but modest life style and wouldn’t skip a beat (at least not for a long time) if I lost my job or my income took a hit.
And that’s precisely why it’s better to strive for financial freedom, as opposed to a million-dollar net worth, Tanya!
To me, a high net worth means I will have financial freedom when I retire (because most of my net worth right now is in retirement accounts). The important thing to me is that my net worth goes up every month, because that means I’m living within my means.
Although, if you include the value of your home as part of your net worth calculation (I do not), then I can see cases where a rising net worth can be misleading. For example, during the last housing run-up, plenty of folks were running up credit card bills, spending more than they earned and getting themselves in financial jeopardy — but their net worth was increasing because the value of their homes was going through the roof. They felt wealthy, and believed they were in good financial shape — but they really weren’t!
It’s all about the cash flow Len.
I must admit that I’m one of those people gunning for the million dollar mark. It’s been my goal for 20 years and I’m slowly reeling it in. I figure with my frugal liestyle and lack of payments, I shouldn’t have too much trouble living on it. Now, if the stock market would only cooperate.
Oh, I’m gunning for it too, Bret! 🙂 I’ll probably have a little celebration dinner the day I finally cross it — just to mark the occasion. In the end though, I realize it’s not necessary as long as I continue to focus on maximizing my income, spending less than I earn and keeping my debt to minimum.
And if you play it right, you can celebrate twice…just make sure you cross it by only a couple bucks, then spend enough on the dinner to take you back *under* a million, then celebrate again when you go back over!
LOL! Clever, AJ. Very very clever. 🙂
Great point. Bret brings up the idea of cash flow and that is so true. Net worth is important, but managing cash flow is even more so.
Agreed!
Just to be clear, I’m not a net worth snob. I do track it because I’d love to retire by the time I am 55 — and it gives me info that helps me figure out how close I am to that goal. I only calculate it once per year though (every January).
net worth is not misleading. these “paper millionaires” who live beyond their means should not take away from how important net worth is for wealth management. there are always people that can’t spend money without digging themselves into a hole.
agree with the paRT about not including your home in net worth though. only investment property should count towards your worth in my book.
I guess we’ll have to agree to disagree then. 🙂
I just started tracking mine monthly a few months back. After the first month or two, I found it to be a bit useless. Granted, it’s a nice ego boost or whatever to see it run up $20K on a good market month, and then depressing following a month like this. It’s tough to envision ever solely “living off my nest egg”; will be interesting to see what’s left of social security, pension, side-income when I reach that age.
When I was younger I used to track it monthly. After a very short while I realized it really wasn’t worth the effort — that’s when I went to once per year.
How funny — I JUST calculated mine for the first time last week!
I’ve always avoided calculating my net worth because, like you, I’ve always believed that what really counts is your monthly passive income. Net worth, I always thought, is irrelevant.
I decided to calculate my net worth last week after seeing so many PF bloggers with Net Worth graphs on their homepages. It made me curious. I couldn’t resist.
And now that I’ve calculated it, I want a million. I want that psychological “win,” even though I know it’s unrelated to my monthly passive income and my financial freedom.
Darn it, I’ve created yet another irrelevant goal for myself, in order to make myself feel better. **Sigh** That’s human nature, I guess.
I’m with you, Paula. Passive income is much more interesting to track — and it provides real rewards too that are extremely satisfying!
By the way, what does that photo have to do with net worth?
Good question. It’s a money bank (from Nepal, I believe — curiously enough). It was either that or another picture of my dog! 😉
“requires minimal net worth”, but it does require a certain net worth, as well as a cash flow. Having a goal of a certain net worth, knowing it will give you a certain cash flow is not a bad thing.
An adequate and reliable cash flow is key; as long as you have enough to cover your living expenses, I can think of potential (if not a bit odd) scenarios where you can arguably be financially free with negative net worth.
I, too, was going to ask about the photo. Looks a bit like a blackface doll or whatever they’re called, in which case doesn’t seem appropriate.
Net Worth is a simple calculation on any financial spreadsheet and I feel that it is vital to track. It is important to see it going up every month because it is a barometer of your spending habits and the growth of your assets (retirement accounts savings accounts, etc).
I don’t include physical asset values in this number (home value, car value, collections, etc.) as they are only worth what you can sell them for. I do include any debts relating to those assets (remaining car payments, mortgage value, or student loans for example).
I am not entirely sure why you wouldn’t be more of an advocate for the use of this tool.
I agree that the net worth is only a partial snapshot, but so is cash flow. Its good to track both. Companies must report both their balance sheet and their cash flow in their annual report because only with both do you obtain the full picture.
In my opinion, if you already have a strong and sensible approach to personal finance and you manage your money well, then net wealth is a very important indicator as it dictates the amount of passive income you can earn through investment.
For anyone with a view to living off their passive (!) income, then building and increasing their net wealth is a very good benchmark to work from.
However, taking your net wealth alone certainly doesn’t give you the full picture of your financial position. Someone who has $5m net wealth, earns 1% interest on 60% of it, but spends $200k per year is going to find themselves in some trouble.
“The bottom line: Your ultimate goal should be financial freedom and that requires minimal net worth.” Explain yourself, sir. I would think a higher net worth in liquid assets (so high net worth combined with a frugal lifestyle) would be the best thing for gaining financial freedom.
Simply put: One can be financially free without a large net worth.
A high net worth in liquid assets would be icing on the cake.
You are right on the mark with this one buddy. It seems so goofy seeing folks in their 20’s and 30’s thinking so much about their “net worth”.
I think its fun to track but just along with other calculations too like percent savings, staying with a certain budget, cost per unit of an item. Its like having high SAT or MCAT scores. I remember living off mostly cookies and coffee in residency and I was so upset despite being the same weight when my cholesterol was over 200. It wasn’t so much the cholesterol value, but that my “number” was off. Anyway, stopped the cookies and the number went down. But I agree in the end is financial independence rather than net worth.
Len,
I agree that cash flow is much more important. I love real estate but some properties don’t cash flow right away and may take years, so while you have assets it might be draining on your pocketbook. Cash flow is everything
A good point. Another one is that people pay much too much attention to the size of their net worth when its structure is more important.
It’s one variable in the equation.
I agree that net worth should not include the house. I go one step further, and I still include the mortgage. In other words, I have my net worth, plus a paid off house.
At the end of the day, income and net worth don’t always correlate. I’ve seen too many high earners not save enough. For those that save 10-15%, they can very well ignore net worth and do just fine as their savings might be on auto-pilot. In my view, the net worth is a tracking device, and a yearly glance should help you understand if you are on track toward your goal.
I agree with the notion of not being obsessed with it, but with the current tools and tech, its hard not to see it daily. Mint tells me at a glance without my wondering or asking every time I sign on. But, I disagree with a few points. Property, as much as I disparage calculating it into my net worth after this recent crash, IS a part of my net worth. Len, you know it is. The elderly going into long term care situations that require them to move out of their home to fund their new old folks sterile room environment know it is. I have 2 properties paid in full (minus annual tax obligations, ha ha). They are mine to sell as long as I make those tax payments. I count them because they will end up funding me (or, rather, defunding me). Lastly, net worth is a threshold or finish line for people that seek financial independence in addition to other sources of information: 25 times your expenses, no debt—FREE. I strive for a bigger number due to factors of inflation that is removed from realized gains. Hey, when I was a kid, a Snicker cost me 25 cents. I now see I have to pay a buck at times. Net worth is an important benchmark for those on the road to achievement. It states where you are going and where youve been and what you can possibly do. Count everything, even at a discount, if the poop hits the fan.
For some reason, it provided motivation probably somewhat out of pure disbelief. I hated 9-5 and knew I’d never be good at it, so I took a crappy job in a crappy (international) locale which did not require much of me, but which also had 5 months of paid vacation. I figured if I was never going to be financially secure at least I’d travel and see the world. The main benefit of the job was the amount of time I didn’t have to be there.
However, through contacts I took on computer-based extra work, and long story short, with housing provided I went from flat broke 8 years ago to within (as of today) $20K of that very goal. I’ve been tracking it in Quicken and watching that number get closer has been highly motivating to keep going. I am one who needed to see it. And yes, I travel, twice a year for months on end (main income is internet-based). The million net worth is neither here nor there, but it’s really more than I need. Sometime soon I’ll retire and leave. I’ll keep the internet thing but reduce it to expenses only. I am well under 50.
Tracking Net Worth is just step one. I found a more useful metric from “The Millionaire Next Door”. Multiply your age times your realized pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be. People whose net worth is twice as large as the formula would indicate are prodigious accumulators of wealth (PAWs), and people whose net worth is less than half their expected number are considered under-accumulators of wealth (UAWs).
Len,
I noticed htat you have not provided a State of the Houshould Net Worth last year 2013 -Did I miss it? Can you send me the link?
Love the blog just found it in the last few months and are catching up on the many archives – keep up the great work.
Sean
Gald you found the blog, Sean! Yeah, my 2013 survey fell between the cracks. I’ll try and post a belated survey next month.
I think net worth equals financial freedom only if you pace yourself and manage to live below your means. Otherwise, it’s indeed overrated!
I assume people who think they are rich based on what toys and salaries they have, do not track their net worth. They probably have no idea how much money they have in retirement accounts, savings, investments, etc. That is probably why they are in debt, they don’t track their net worth which includes spending habits. Tracking your net worth is a valuable tool, how often you do it is up to you.
Actually, net worth cannot be known exactly unless all your assets are liquidated at exactly the same moment.
So, it’s an estimate.
I used to track my net worth every month till i realized it was growing but i still was trapped in the Paycheck to Paycheck lull. Now that i focus on debt reduction and increasing income life has changed significanlty for the better for us.
Knowing your net worth is a terrific indicator for estate planning.
After reading the posts, net worth is meaningless unless you start out as a saver. Do you have an emergency fund? Do have a spouse who shares your financial values? Are you both working and enrolled in a 401K plans putting at least 10 to 15% of your income into it and then save more each month? Is your credit card debt zero? Are you making accelerated mortgage payments? These are just small examples of how you build your net worth. To really build net worth you need to start your own business, the leverage and tax advantages quickly help to build your nest egg. This is not easy and be ready to work 16 hours a day 6/7 days a week, but you will zoom past the million dollar net worth mark very quickly. This is how our net worth has been built into the mid seven figures with a stock portfolio that throws off more than $300,000 in passive income, most of which is reinvested or given to charity. We are both 65 and have no plans to quit working. We both grew up in poor households that valued hard work but had little in the way of financial accum. Teach the value of hard work and savings to your children and grandchildren and then high net worth and personal freedom turns into a self perpetuating cycle.
It depends on what constitute the networth. If is it made of wasting assets, I won’t call it assets
https://lenpenzo.com/blog/id46625-grandfather-says-net-worth-and-real-value-2.html