Measuring Financial Progress: Net Worth vs. Net Investable Assets
I strongly believe that tracking your financial progress is crucial to reaching your financial goals. If you visit personal finance blogs on regular basis you have already noticed that measuring net worth is very common and many bloggers make it public.
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.
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 a 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!
Net worth, as you calculate it is correct. I do not count the value of personal items, like cars and furniture, although the case can be made to count it. You need to live somewhere, but if you sell a paid off $200K home at 65, put it in the bank and rent for $1K a month, you may never outlive the asset.
What about pensions? If a person has a 100K an year pension, with COLA (and I do not), that has a NPV and maybe should be included. They may be dead broke otherwise, but a 100K pension is very good.
I use the house value in my net worth calculation because I’m open to downsizing thus converting equity into investable assets. We are also aggressively paying down our mortgage so a large percentage of our net worth is tied in the house and disregarding that would be silly. However, to make tracking net worth trends easier and independent of the housing market fluctuations I use what we paid for the house as a constant number year-over-year. Whenever I want to run downsizing scenarios I just pull the estimated house value number from Zillow and subtract about 6% for sale transaction costs.
Its true that net worth can fluctuate quite a bit if your house is a large portion of the number. Regardless, all investments can fluctuate widely including stocks and I do not see anyone suggesting pulling out stocks from the mix. Since net worth is a common measure and speaks to true worth at a given time I would not pull out anything, but under the same token I would not over inflate the equity by assuming a high market value, I use taxable value in my calcuation unless a recent market evaluation has been performed. I also do not attribute much value to personal assets unless they are large (RV, car, boat)and then I only subsribe the lowest market value. Net investable assets is kin to working capital and should be even more skinny as most would not use their retirement account (e.g., 401K) as an investment vehicle to create more wealth. Persons prior to retirement would more likely use their home equity for investment purposes (to obtain secured loans) rather than take a loan from their 401K (opportunuty cost of taking value away is too high. That is, low term real estate investments provide smaller return than stocks and bonds). Basically you should treat your net worth as if you came down to the nitty gritty what can you turn into cash within a short period of time (say < 1 year). Investment firms do not count your house equity for good reason (they want to size you up on what is free (cash, stocks) to be transferred to their control. House equity is not a freely transferable asset, but still it is most surely an asset, you would not give it away for free, right. I would suggest that if primary home equity exceeds 50% of your net worth not to take too much comfort in a "high net worth".
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.
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.
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 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.’