How to Make Net Worth Calculations More Useful

A few years back, I had a little net worth bashing session. Over time (and with increased net worth) my view on this financial metric has softened a bit, but not much. A softer side comes from an increased appreciation for tracking the full value of all of the assets you have. It is hard to know where you are at, where you want to get to, and how long it will take to get there if you do not have something to measure.

What do I still not like about net worth as a financial indicator? Before I explain, first, a quick recap of how to calculate net worth. At it’s simplest:

net worth = total assets – total liabilities

usable net worth

Common assets include: market value of real-estate property, bank deposits, non-retirement investments, retirement accounts, depreciating assets (vehicles, boat, basically any possession you can sell).

Common liabilities include: mortgage/home equity loan debt, student loan debt, auto loans, credit card debt, medical debt, or any other outstanding debts.

With that clarified, the thing that still bothers me about net worth comes from the context in which it is used. 99% of net worth conversations, articles, and online forum discussions are centered around retirement and early retirement. In fact, outside of applying for student financial aid, a new loan, celeb jealousy rants, or bragging in a way that makes you lose friends – I can’t think of any other times that net worth is brought up.

Taking things a step further, net worth is often used as a measuring stick in retirement discussions to judge ones retirement picture. Here’s the problem with that – what value is there in net worth (outside of ego boosting) if you cannot use that net worth to generate income or live off of?

Is there value in including the equity in a $1.5M Bay Area home in net worth, when the owner occupant has no intent to leave?

Is there value in including a debt-free $100K home in net worth calculations, when no matter where the owner moved, they would probably end up paying more for the next home (or increase expenses through renting)?

Is there value in adding the full balance of 401K, IRA, stock options, or other pre-tax deferred compensation in to net worth (as most do) versus a calculated after-tax number?

And is there value for an aspiring early retiree to add in retirement investments if they want to judge their ability to retire early, when they have no plan to withdraw those investments until retirement age?

I don’t think so.

Usable Net Worth

I don’t want to dismiss the net worth metric completely, but I have created a modified version that makes it more useful for retirement and early retirement purposes. I like to call it “usable net worth”.

Maybe it works for you, maybe you’d rather stick to the standard net worth calculation – either way, let me know what you think.

usable net worth = total usable assets – total liabilities

Usable assets include:

  • market value of current home minus estimated market value of next home (if no intent to move, = $0. If a negative amount, add to liabilities)
  • market value of rental properties
  • bank deposits
  • non-retirement investments
  • after tax retirement accounts (Roth)
  • pre-tax retirement accounts and deferred comp AFTER estimated post-tax value
  • non-essential depreciating assets (if you need a car, do not add its value. If you have a boat and intend to sell it, add the expected market value at the time of sale)

Total liabilities include:

  • Mortgage/home equity loan debts (including rental properties)
  • Student loan debt
  • Auto loan debt
  • Credit card debt
  • Medical or any other outstanding debt

You’ll notice that the big differences are all on the asset side. Here’s a little more on each:

  1. Home: the problem with including home value in net worth is that everyone needs a roof over their head. If you have no intent of selling your current home in favor of another cheaper home and pocketing the cash to use or invest, then why add this value to your net worth? What value is there in calculating net worth if 30, 50, 70% of it is tied up in a home or will be tied up in your next home?
  2. Pre vs. Post Tax Balances: I see very few people factor in taxes to their pre-tax (Traditional 401K, IRA) retirement accounts and deferred compensation. You will have to pay taxes on it at some point, so why include the taxable portion in your net worth? For simplicity, I assume my current tax rate. In reality, when I start withdrawing these assets, my tax rate will probably be lower, but I’d rather be conservative and consider any additional assets a bonus.
  3. Depreciating Assets: as noted, unless you intend to sell your current asset, there is no point in adding its market value to your net worth.

What remains, after the modifications, are the assets that you can actually use to invest or cover your living expenses. No ego, no inflated number that has no real world use, just good old rubber-meets-the-road usability that can give you a much more accurate picture of how close you are to financial independence, or secure you are if already achieved.

And isn’t that what’s important?

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