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7 Reasons for (and Against) Tracking Net Worth
| December 11, 2010 | Posted by Roshawn Watson under Uncategorized |
By: Roshawn Watson
The true estimate of your financial intelligence is not how much you make but how much you keep. One measure of how much you keep is your net worth. For the uninitiated, your net worth is simply your assets minus your expenses. Many people graduate from college with a negative net worth. In keeping with the school theme, think of your net worth as your financial report card after college. It is akin to a summary statistic of your progress. The median household net worth is $120,000 according to the Federal Reserve. While it is only one measure of your financial health, tracking your net worth can certainly have its benefits (and limitations). Unfortunately, tracking their net worth has become an obsession for some.
Benefits of tracking net worth
1) Better financial decisions. If only people thought about the long term impact to their net worth before making large purchases, decisions would often be different. Consider how attractive that new car would be if people considered its value would decline substantially after 3 short years. Considering that new cars lose 45% of their value after three short years, your net worth will take a hit for making the purchase. If you finance the vehicle because you couldn’t afford to pay cash, the interest you pay will make you poorer each month and will hurt your cash flow. Less cash flow means you have less available funds to increase your net worth. Overall, the cost of having a car payment can be estimated in the millions when amortized over 3o years. I hope you really like that car! That’s the benefit of factoring net worth into your decisions: it can highlight stupidity or at least naivete cloaked in conformism (everyone has a car payment).
2) Identify weaknesses. If your net worth is constantly going down, especially due to the diminished value of assets or rising debt, then consider your ways. Assessing individual components of your net worth can be tremendously useful in determining areas of financial weaknesses. If your portfolio value is constantly declining, you may have a dog in the bunch that needs to be sold. Similarly, if you financed a car that you cannot afford or purchased a home at peak prices, it is very possible that you may be upside down in the loan (owing more on it than the “asset” is worth). This negative equity would show up on your balance sheet as an increase in debt and decrease in value. Student loans, maxed out credit cards, college funds, retirement and other investments all help determine your net worth. The point is tracking your net worth can alert you to problems that threaten your financial well-being. If there is a problem, you will identify it more promptly because your net worth will be moving in the wrong direction or not increasing significantly.
3) Communicate with family about financial health. Communication with your family is important to your financial plan because it can bring problems or progress towards goals out in the open. The net worth can be a tool to enhance such communication. Even if the financial news is bad, there is value in discussing your financial issues, so that you can come up with creative solutions to the problems. In some cases, actions such as getting an extra job, selling a car, moderating dining habits may be warranted to stop a financial hemorrhage. You may get less resistance if involved parties know why such sacrifices are being requested. An objective barometer, such as household net worth, can help you make your case. Note, while kids and in-laws certainly don’t need to know your net worth, telling them that your portfolio lost half of its value last year may help them understand why you aren’t taking that family vacation this year. In addition, it can be difficult to carry the weight of the financial well-being of your entire household on your own. Sharing your net worth can help you share that responsibility. It is our job to make sure that we make responsible decisions regarding our finances.
4) Motivation. Tracking your net worth can be tremendously motivating. If you are working towards a goal, such as paying off debt or saving for a down-payment, tracking your net worth can help you measure your progress. Believe me, every encouragement can help, especially when your are faced with a challenge that seems insurmountable. Your improved net worth can be a visual reminder as to why you are saving or investing. I remember when I loss forty pounds in ten weeks, the scale was my best friend. It kept me honest and focused. Similarly, performing a monthly financial check up can keep you focused and motivated towards your goals.
Overemphasis on Net Worth
1) Net worth is incomplete. While I do track my net worth, it is certainly not the only financial measure that I follow because it simply doesn’t give me enough information. Looking only at your net worth will not help you identify problems such as lack of liquidity (unless you take a hard look at the individual components). For example, suppose all of your assets are relatively ill-liquid i.e. 401K, non-income producing property, and vehicles, then it is very difficult to come up with the cash necessary for a purchase or an emergency. Maintaining the appropriate level of liquidity is very important and can keep you out of debt. When you maintain adequate cash or near-cash reserves, a water heater breaking will be more of an inconvenience rather than an emergency and reason for you to go into debt. Additionally, the most important word in the world of money is cash flow, so I also monitor my cash flow. Your cash flow shows up on an income statement. By looking at your income statement, you can determine your monthly expenses, predict (and plan for) large annual expenses, and identify areas in your budget where there may be wiggle room or where you may need to cut back. Even if you have an okay net worth, having poor cash flow can still get you into financial trouble, especially if the bulk of your net worth is tied up mostly in ill-liquid assets.
2)Sloppiness. Looking only at net worth can cause you to get financially sloppy. Let’s say you determine your net worth to be higher than the median net worth for your income level. That sometimes means you might have done something right, which is good. However, just because you are doing better than the median doesn’t mean that you have earned the right to not pay attention to your finances. Consider that most of the people that you are comparing yourself to are broke, so being better than normal doesn’t necessarily make you well-off, wealthy, or rich (far from it in most cases). Note, last year a Harris Interactive and Careerbuilder study revealed 61 percent of workers reported that they usually live paycheck to paycheck just to make ends meet. These are the people you are comparing yourself to. Thus, it is important to avoid getting sloppy with your finances just because your net worth is higher than the median or because you have made progress . While it is okay to be content, continue your efforts to build wealth at least until you become one of those who substantially skews the average net worth statistic upward. Then, perhaps you may qualify for being comfortably poor and a little sloppy 🙂
3) Just a snapshot. Your net worth is just a snapshot of your financial health. For example, you could be spending your way into oblivion, regardless of the numerical value of your net worth. Think of all the lottery winners, former athletes and entertainers who quickly spent their way back into the poor house. If you look at their net worth a year or two before going broke, it might have been in the seven figures (or higher). I submit to you that…
Fast money doesn’t generally equate to long-term wealth. NBA stars are the perfect example. They make more money in a few years than most can hope to earn in a lifetime, yet over 60% of them go broke within 5 years after retiring.
It’s the tortoise that wins the race every time. Making sure that you win the race is goal not seeing who can get there faster.
Getting hung up on a static, incomplete, and sometimes misleading financial statistic doesn’t make sense and can be toxic. While net worth is certainly an objective measure of your financial health that is worth tracking, don’t let this tool become an obsession. Like any other tool, it certainly has its benefits AND limitations. Your self-worth is not limited to your net worth. After all, your net worth is just a number.
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Questions
What do you think are the biggest advantages of your tracking your net worth?
What do you think are the biggest disadvantages of your tracking your net worth?
Would you or do you track your net worth?
Would you post your net worth on a public forum (i.e. Net Worth IQ)?
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Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.
I recently came across your blog and have been reading along. I thought I would leave my first comment. I dont know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.Lucyhttp://businesseshome.net
Thanks for the comment Lucy. It's always great to interact with readers through comments. Feel free to ask me any questions or comment any time. I'm happy to help in any way I can.
Shawn,Great post, with some excellent points! Personally, I track my net worth but only on an annual basis every January. I know a lot of bloggers do it every month, but to me that is essentially pointless. Heck, sometimes I wonder if checking it annually is overkill.All the best,LenLen Penzo dot Com
Seems to me that net worth is overrated. Whats more important to me is simply its vector of change. If its not increasing I need to do something. If its not increasing fast enough I need to do more of something.
@LenAn annual basis…yikes! I do check mine monthly still. It's not a real big deal though, but I like to see that it's moving in the appropriate direction. There have been some times when we have loss our focus or had big lifetime changes, and seeing the impact reflected in our financial statements give me perspective. However, if once a year works, that's cool.@LeanLifeCoachI agree with the vector of change statement. I have a row in my adjusted monthly income statement for net worth increase. To me, this is infinitely more meaningful at this stage of the game. Perhaps when I have a net worth of $15,000,000, I will not be as concerned by what it increases by.Friendly Regards,Shawn
Excellent article as usual.
Thanks so much Anja!
I track my net worth on mint.com, which has been acquired by Intuit and in my online banking account. I know my net worth and minimized spending on frivolous things. The next step is to find out where to educate myself on investing the money I'm saving, do you have any recommendations?
@Cheryl Marquez,Thanks so much for visiting my blog. I do have recommendations for learning about investments.I actually learn about investments from the Motley fool (great podcast), Seeking Alpha (frequent updates), and Blogging Stock websites.I also subscribed to a newletter: indexinvesting.com. I no longer have a subscription with them, but I used their newletter to get solid recommendations for asset allocation.I believe in long-term (>5 year) index investing with Exchange Traded Funds (or index funds). In other words, I follow the market and don't try to beat the market, and I do this investing myself with Sharebuilder. Sharebuilder is a discount brokerage firm. There are many others such as Scottrade, Etrade, Fidelity. I invest for myself because commission fees can erode the return tremendously and rarely outperform an index fund.I also recommendThe Intelligent Investor, by Benjamin Graham.I hope this helps you get started, and let me know if you have additional questions.
I check my net worth every few days. I have an excel spreadsheet that I use to keep track of stock investments and it also shows my net worth. It's fun to look at in good years, not so much during bad years. It also helps me keep track of my asset allocation so I can adjust new contribution accordingly.I don't track my cash flow that closely, it doesn't change much from month to month. I do need to work on increasing the cash flow. 🙂
I have a spreadsheet and will update it once every 3 months.I want to check out Mint.com.What happened to your commenting system? Got to go through 3 steps to comment now (word verification, URL, name). Kinda tough mate.
I currently track my net worth each month! It helps to keep me accountable in order to maintain the correct asset allocation percentages.
I have a Google Docs spreadsheet that I use to track my net worth once per month. It helps to keep me accountable to keep up the proper asset allocation percentages.
Great post, Shawn. Seems to be one of those personal decisions, like keeping a monthly budget. I think we've tracked our net worth only a few times in the last ten years, maybe more so in the last couple. Since our only large debt is our primary home mortgage, I have a rough idea of what our NW is any one time.
I don't really focus too much on net worth because I know it can all change in the blink of an eye. Stock market crash, housing market crash, you name it. (Wait, those things already happened.)I put about 27,000 miles/year on my car, so my vehicle depreciates even quicker than most, so I don't even include my cars in my net worth at all.Sometimes I will go through and look at our net worth, but I tend to do it on 'up months'. Isn't that funny? I only want to see good news.
Very interesting article re: the pros and cons of net worth calculation. I'm going to try to find a site that shows the Canadian stats re: median networth like you have linked to for the U.S.A.
What do you think are the biggest advantages of your tracking your net worth?I love feedback! Decent Feedback is like a warm comfy blanket to me! So I loosely track my net worth!What do you think are the biggest disadvantages of your tracking your net worth?Time wasted on such activities. When I was younger I had more time to think about such things! But now with kids…Would you or do you track your net worth?Yep, with a spreadsheet!Would you post your net worth on a public forum (i.e. Net Worth IQ)?Maybe, but time is too limited right now…
Tracking net worth can help with better decision making, but it is only one metric among many. At the same time, you need to be ensuring that you're not taking unnecessary risks, that you have an adequate safety buffer both in terms of an an emergency fund as well as a healthy gap between income and expenses.I would probably not publish absolute figures in public, but I don't mind publishing percentages. Maybe I'll do so on my blog at some point, though I feel no compelling reason to do so at this point. ;)Great comprehensive post, Roshawn!
P.S. You got rid of Disqus? Or Intense Debate… whichever it was.
Shawn, I have been tracking my net worth for decades, and use it as the main barometer of our family financial health. I agree with Len, less is definitely better.
Retire By 40,Although I do track my net worth, I try not to look at it more than once per month. You definitely have me beat there since you track every few days. I guess if your income remains stable, then you have less incentive to track it but more incentive to shake things up as you suggested!
Sam,Every three months (quarterly) doesn't seem too bad and provides a more long-term perspective instead of the more tumultuous ups and downs of weekly or monthly updates.This post is old and already had comments using my old commenting system. That's why you don't see my new comment interface.
Jacob,Once a month is what I typically do as well. The accountability factor is huge for me!
Google Docs works just fine. I used that at one point. However, I personally I prefer Excel, but you have the advantage of being able to update it as long as you are online!
Andrew, I can definitely understand not tracking it as much if your net worth is relatively stable. Like you said, you know what it is.
Kris,I completely understand your inclination to only look at net worth during up months. In terms of how it could all go away in the blink of an eye, you are right anything is possible. I try to think of it also though in terms of plausibility. If I continue XYZ behavior, what is the likely outcome? It's hard for some people to do that kind of planning without using the net worth or some other metrics as a barometer.
Sustainable PF,Yes that would be an interesting read indeed!
Money Reasons,Yes it is a huge time burden (perhaps not the net worth) but other financial statements. I am contemplating at what point I will hire a professional bookkeeper. For right now, I don't find this practical.I use a spreadsheet as well. We just think alike. I don't think I would ever post my personal net worth with my name on a public forum.
Kevin,I agree, tracking one's net worth can definitely lead to better decision-making, especially as part of a plan.In terms of posting absolute figures, I get it. I'm not inclined to do so either. This is more my nature though. I'm pretty private overall.
Kevin,I did not get rid of my new commenting system. This post is recycled and already had comments using the old commenting system, so that's why you don't see my new commenting interface. Subsequent posts will have the new interface.
Barb,As far as using net worth as the main financial barometer, I can see why some people do it. To me, it is just a measure of financial health. I guess it all depends on your goals. Thanks for your comment!!!
What do you think are the biggest advantages of your tracking your net worth?I know whether I am progressing.What do you think are the biggest disadvantages of your tracking your net worth?Time consuming, sometimes discouraging because it isn't just savings but your investments too that fluctuate.Would you or do you track your net worth?I do. Fabulously Broke in the City.Would you post your net worth on a public forum (i.e. Net Worth IQ)?I do. brokeinthecity