This is a guest article by Ray, the owner and primary author of Financial Highway, where he discusses investing, saving and practical money management concepts. You can check subscribe to his RSS feed or follow him on Twitter.
I strongly believe that tracking your financial progress is crucial to reaching your financial goals. If you visit personal finance blogs on regular bases you have already noticed that measuring net worth is very common and many bloggers make it public like Flexo does here. There are a couple of metrics that can help you track your financial progress: Net worth and
Net Investable Assets are two most common and each provides different information. Let=92s take a look at each and determine which of the two measurement methods is better for tracking your financial progress.
Net worth
This is the most common metric you will see around and it’s simple to calculate. Net Worth illustrates how much you are worth after all your assets are sold and all debts have been paid off. The formula is simple:
Net worth = Assets – Liabilities
Debts include your consumer debt (credit cards and loans) as well as your mortgage. Assets include all your investments and savings (including emergency fund and retirement funds) as well as your home, cars and other personal property. You simply add up all your assets and subtract your debts from it and you have your net worth. Although this is often used in determining your financial strength, I do not consider it the best measurement. It assumes that you sell all your assets at the current value; this is not always a practical option.
Net investable assets
This term is often used in the investment industry; we would primarily track our clients’ net investable assets because this would be the amount we could work with. The net investable assets calculation is slightly different than the net worth calculation, and to me it’s somewhat more practical. In calculating your net investable assets you do not include your personal properties such as car, home and cottage. You simply add all your savings and investments and subtract your consumer debt (credit cards and loans). This leaves you with investable assets. This tells you how much money you have available without selling all your personal properties.
We do not subtract your mortgage because you need a place to live and if you do not have a mortgage than you would have rent to pay so it’s a regular expense. The net investable assets calculation gives you a more accurate measure of your financial independence.
Net worth or net investable assets?
How should you calculate your financial progress? Well it’s all up to you and what you feel comfortable with and makes sense to you. Recently Trent Hamm of The Simple Dollar announced that he is not including his home value in his net worth calculation, however he is still continuing to count the mortgage in the formula. Although this method makes sense to some I find it distorts things a little. If you do not count your home in your net worth than the mortgage that goes with it should not be added either, hence you would have your net investable assets.
No matter which way you go, or if you decide to make slight changes to things the important thing is to stay consistent and do what makes sense to you!
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{ 4 comments… read them below or add one }
I think I follow Trent’s approach, basically adding up all assets and debts, but then subtracting out full value of the house. So my number is what I’d have if I paid off the mortgage in full. And this is the important number to me to track progress to retirement. I don’t want to count on the house to pull money out by downsizing or moving, so it’s not part of the retirement planning.
On the other hand, there will be a point, maybe 15 years into retirement when between the downsizing to a smaller home and moving to a less expensive area, there may be a windfall. Just not ‘counting on it.’
That’s an extremely good point – I feel like everyone I talk to figures their house into their wealth. But it’s kind of like a having your cake and eating it too kind of thing. Realistically, you wouldn’t really sell your home without buying another one. The only time factoring in your equity is really applicable when you are shopping around for a new home.
I think both measures are useful for different purposes. The second one takes into consideration the liquidity of your assets. It all links back to your financial goals and which measures are most appropriate to use for measuring your financial goals. I like net worth as it is the most commonly understood measure.
I count 80% of my estimated value of my house as an asset, and the current value of my mortgage as a liability.
IMHO, a house is worth too much to not be considered, vs say your sofa…
Why 80% you might ask… Well, I’d rather understate the value of my house instead of overestimate it. And I figure, 80% is the home owner equity I could get from a bank if the house was paidoff.