Your net worth is an illusion. Unless your house is fully paid for, and unless you can access your retirement accounts and liquidate your business today, your net worth is not real.
Although we've recovered quite a long way since the 2008-2009 financial crisis, we can never fully count on the full value of any of our assets. This is especially true for less liquid assets like real estate and private equity investments. You just don't really know the truly value until you try to sell.
The only thing we can really count on is cold, hard cash and the cash flow your investments generate. It is a little disingenuous to say you are worth $1,000,000, when 70% of your net worth is tied up in illiquid assets.
Your home is only worth as much as someone is willing to pay for it. And you just don't know how much someone is willing to pay for it unless you try to sell.
In 2017, I thought I got a great deal selling my rental house for $2,745,000. In 2H2020, a random realtor believes I left $655,000 on the table! Go figure. Everybody has got an opinion.
Even your 401K and IRA are suspect because those accounts can easily collapse. When it's time to withdraw, you don't know exactly what the government tax laws will be.
Your Net Worth Is An Illusion: The Asset Side Of The Equation
Here are all the assets that may be included in your net worth calculation.
Cash
Stocks
IRA
Private Investments
Primary Residence
Valuables (Jewelry, Collectibles)
Pet Bunny
For retirement purposes, your assets should equate to CASH + liquid securities you can sell today + MORE CASH. With stocks at all-time highs, it's good to have a cash buffer.
Calculate Your Net Worth Conservatively
The way to look at net worth is consistent with my “Going Broke To Win Big” methodology. In uncertain times, like we are experiencing during the coronavirus pandemic, you want to operate life as if none of your assets except for your cash is dependable.
Perhaps your retirement goal shouldn't be a net worth goal, but a cash or savings goal if you want to be really conservative. If your home equity, 401k, IRA, private equity investments so happen to be there when you retire, great! If not, no big deal because you never counted on it anyway.
Unfortunately, our government is printing cash like it's no tomorrow to bail us out from this coronavirus devastation. Hence, even our cash is suspect in value. You may want to buy real assets outside the country with stronger physical systems.
If you can't do that, I'd diversify your cash into as highest possible yielding rental property as you can. Rental property is a very powerful asset to make money and hedge during inflationary periods.
As you age, feel free to regularly convert your investments into cash or more risk-free assets like U.S. Treasury bonds or AA-rated municipal bonds for that bankable guaranteed interest income. The wealthier you are, the more you need to focus on capital preservation.
Net worth is more important than cash flow before you retire. But after you retire, cash flow is more important than net worth.
Your Net Worth Is An Illusion: The Liabilities Side
The liability side of the equation on the other hand is very straight forward. Your liabilities are all your debt. Debt includes credit card debt, student loans, auto loans, mortgages, personal loans, IOUs, and more.
In order for your net worth to be properly calculated, you seriously need to make sure you account for all your liabilities.
To better protect your net worth, you should view your net worth like it's an illusion. It's not real, so don't count on most of it.
By risking all your retirement savings in the stock market, you're doing yourself a disservice. I'm not saying don't continue maxing out your 401K and IRA accounts every year. That is a given. I'm just saying one should think twice before adding MORE of your cash into the stock market.
One of the easiest allocation rules can simply be your age. A 40 year old should think about allocating 40% of their liquid assets into cash or stable bond funds, a 50 year old should allocate 50% to cash and so forth.
If you insist on including the value of your illiquid investments into your net worth calculation, then take at least a 50% haircut to the value. Have a cash retirement goal and not a net worth goal. You'll be happy you did.
Related: The Average Net Worth For The Above Average Person
Track Your Wealth For Free
Although your net worth is an illusion, you still need to track it. I recommend signing up for Empower's free financial tools so you can track your net worth, analyze your investment portfolios for excessive fees, and run your financials through their fantastic Retirement Planning Calculator.
Those who are on top of their finances build much greater wealth longer term than those who don't. I've used Empower since 2012. It's the best free financial app out there to manage your money.
Your Net Worth Is An Illusion was originally written on 9/18/2009. Time flies when you're having fun! The bull market really made so many things better. However, tough times came back and there's a lot of uncertainty in 2024. Make sure you convert some of your net worth into more freedom and a better life. The YOLO economy is here to stay!
Related posts to your net worth is an illusion:
Your Risk Tolerance Is An Illusion As Well!
Net Worth Benchmarks To Ensure Proper Growth Over Time
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As many of us learned over the past couple of years our home equity can change drastically! I agree that your home value shouldn’t be counted towards your net worth until after you sell it and pocket the money!
Yep! How did you find this post btw? Google?
Sam,
I’m a new reader and love this site. So many interesting points of view.
So for you and all the readers any thoughts on this allocation?
650k SF apartment – own 100% equity and net yielding about 4% in rental income
700k cash – crappy yield of .25%
400k in vanguard bond fund – about 2.75% yield
400k in stock mutual funds – about 2% yield
Is this too conservative? Any thoughts on what to do with the cash?
I’m 41, currently not working, and, as you did, trying to find my “next” career.
Thanks,
Marcel
Of course, on the other side of the coin, a band called Styx once wrote a song called “Grand Illusion” that fits pretty well with the entire idea of networth. :-)
Well I disagree that any investment aside from one’s principle residence should not be counted as part of their net worth. I see net worth as changing over time, and as long as it is in the positive direction, then I am better off. If it went down, I could analyze and see if it was due to stocks and adjust accordingly.
Likewise, this is also age dependent as well. For instance, someone who is relatively close to retirement age (say 59 1/2 because that’s where one can draw down their 401k/IRA), then it becomes more valid to include investments as part of one’s net worth.
After all, if one is nearing “traditional” retirement age, and they have the investments to sustain their livelihood after retiring, they have just achieved the same as anyone who retires earlier.
In the past, I would count housing (both mortgage & valuation) into my net worth. I don’t see that as being realistic, since I have to live someplace. If I were to sell the place maybe it doesn’t sell as quickly as I like, or sells significantly below what I thought it would, etc. I also don’t want to pay for an evaluation of my home every year or so, just for the sake of updating my net worth.
With all the above being said, it is very quick and easy using a tool such as Quicken or YNAB to provide different reports that either include investments and/or housing into one’s networth calculations.
And as you and another user posted, it is a great feeling to have a zero net worth, and then to look to the other side where you’re in a positive net worth is even that much more enjoyable.
There is a somewhat well written book by Ralph E Warner titled: “Get a Life: You Don’t Need a Million to Retire Well”
Now, if one has a million, then they are that much more comfortable in retirement or semi-retirement.
My point is for people not to be deceived and think they have more than they really have come liquidation/draw down time. It’s too dangerous to get comfortable. The economic Armageddon of 2008-2010 should be a great wake up call.
People laugh that I have a million bucks in CDs averaging 3.5%-4% for the past 4-5 years. I don’t care. That’s $35,000-$40,000 a year in stress free, guaranteed income spread across three banks. I’ll take it!
Some people may call your 4.5 to 5% CD rates fictitious. I don’t blame them.
That was back in 2012. Today, the rates are under 1%. See the dates.
Hey Sam! I came to see your mid-year update! ;) I’ll check back tomorrow!
Lol, I was going to publish it today, but then I read over the weekend another bailout offers mortgage payments for one year and had to write the Free $50,000 post! Will go up Wed prolly.
While I don’t disagree with you on the volatility risk faced by those who have to sell assets to meet living costs (and may be forced to sell in a downturn), I very strongly dislike cash as an asset class for the longer term – unless you believe in a return to deflation (very unlikely), it offers negative real retruns. The USD has lost most of its value since the Fed was created in 1913 – it would be a very brave investor who would gamble their financial life on that trend not continuing.
For a retiree who does not have the benefit of a taxpayer funded pension, a portfolio of assets offering negative real returns requires either accepting declining living standards as one ages or a significantly higher amount of accumulated savings (which will at least delay or, at worst, frustrate, the timing of your retirement).
I’m happy to go with 2-3 years worth of living expenses in cash/near cash and take the real loss on that investment so that I don’t end up being forced to liquidate assets at unfavourable prices, but everything else is going into higher yielding risk assets – real estate and equities which have at least the potential to grow over time. The emphasis is on yield (without making the mistake of reaching for it). If the cash flow is good enough, what the assets are worth on any give day is irrelevant. In the context of a 40+ year retirement, I’ll sleep a lot easier at night holding mostly equities and real estate than I will if I have my life savings in assets which I know will lose a little bit of their real value each and every year.
Interesting that you will sleep better holding equities and real estate. Sounds good to me.
Around how old are you?
In terms of identifying wealth, I primarily focus on cash flow.
Stock prices and home prices are subject to the opinion of the market. So while a “net worth” calculation is good to know, it’s not too meaningful. Having an expensive home and other expensive assets doesn’t work out so well if there isn’t cash flow to keep the game going.
Cash is good, but subject to risk as well. As you’ve pointed out, federal and state mismanagement has led to printing of cash, plus there are deficits, etc. Having too much worth in cash makes inflation risk the largest risk to a portfolio. Plus, perhaps the biggest risk for the average person is that they are unable to save enough for retirement- so having too low of a rate of return is a risk in and of itself. Cash is just a promise that is only as good as the organization making the promise- the US federal government (or other countries).
Buying assets and products that generate cash flow, to me, is the most “real” sort of value. Dividend paying stocks, interest paying bonds, distribution paying partnerships, ownership stakes in private companies, and rental property, are assets that produce cash on an ongoing basis. Diversifying into numerous sorts of asset classes reduces total risk- stocks, partnerships, and rental property hedge against inflation risk, while bonds help smooth out volatility and act as a cushion during recession. Most corporations today are in better financial shape than countries are, and large stock price drops don’t affect the ability to pay dividends and distributions- only the success or failure of those companies’ fundamental operations determine that.
What does everyone think the recent effects deficit/debt talks at the highest levels of government will be? Is there room for compromise when one side refuses to raise taxes and the other refuses to cut services? I do like the pressure this puts on simplifying the tax code, but can there be meaningful debt reduction in the coming days/months? How important is it to get this one right over and above the usual partisan politics, because I honestly feel like this could be a bit of a turning point for the States. If the USA continues down the path of non-cooperation where one side cuts taxes when they are in power, and the other adds services when they are in power, yet all sides borrow to fund these projects, is there any doubt China will look at not recognizing the USD as the reserve currency for the world?
My only problem with money is that it’s paper and backed by government sensibility. If we keep printing money like it’s wallpaper, inflation will eventually rise (no skyrocket) and the dollar today will be work 5 cents tomorrow. So even though there is some value in money, it’s still at the mercy of an intelligent responsible government.
Note, I’m not predicting that the us dollar is going to be work 5 cents in the future, it was just an example. For a great example consider Zimbabwe’s 100 billion dollar that’s worth USD $80 (that was back in 2008, it might be worth less now). Sad huh…
Very true in deed Don. Which is why we really aren’t worth anything! :) Best to buy some real assets in an appreciating currency country and kick back instead.
people like to feel good – it’s partially psychological, an illusion nonetheless
by cash goal, do you mean a target cash flow?
Yes, target cash flow generation based on the cash one has been able to accumulate.
I agree that it is folly to include your primary residence in your net worth calculations, Sam. I never did understand that line of thinking. I would include equity in second homes in my net worth calculations though.
Best,
Len
Len Penzo dot Com
I wouldn’t. No equity or perceived equity allowed in your net worth calculation! The idea is to not rely on anything! That way, you will have upside, and live your life with measured prudence.
I agree. I don’t understand why people will put every dime they have into the market, and just “hope” for the best, and rely on these numbers to calculate their net worth. Myself, I have a lot of money in a permanent life insurance vehicle from an extremely strong mutual company, and my cash reserves grow every year. Of course, that will bring out the “you don’t get the cash when you die! and the “you only gain 2%” and the “your rep was just trying to make money!” comments, which I will gladly debate each and every argument. However, I put as much money as I can into my IRA every year, and I also have a pension. But what I’m looking for is access to cash, which is what my permanent life insurance provides to me. I don’t want to have to miss opportunities because I’ve locked up my all my cash in a vehicle that has no access or guarantees. Every year, my net worth actually increases with my cash values, and that is a number I can count on.
Great post.
Hi Jon, thanks for sharing your thoughts, and good to see you see the light as well!
I like the idea of a permanent life insurance vehicle from a good, little chance of going bankrupt company. USAA is one of those.
Liquidity, and a REAL guaranteed return is key. Furthermore, in an environment where there is no inflation, or frankly, deflation, 2-4% returns or just fine thank you very much!
you make some great points the market is down even just this last week it has got down a lot. the numbers for unemployed and the status of the global economy might make the rest of this year an up hill climb for the stock market
This post is a sign we are near the bottom. Bloggers in 1999 would have been saying to go 100% in stocks. Markets make opinions, opinions don’t make markets.
Young people should be dollar cost averaging in at today’s prices.
If you can get the kind of retirement you want with returns on CDs etc. then go for it. Most people I know can’t.
I hope you’re right that this post is a sign we’re near the bottom! I’m all about asset allocation frankly, and not so much stock picking.
I’ve believed in a heavy cash earning 4-5% return allocation for about 7 years now. I continue to believe in cash and stable investments.
I agree that asset allocation is the most important thing. It is also important
to have a plan which you obviously have. The thing to avoid, as Dalbar
points out every year, is for investors to get caught up in emotions. They
tend to sell at the bottom and buy at the top.
As this market moves lower keep in mind Rothschild’s maxim to buy when
there’s blood in the streets.
Don’t think it’s quite too blood yet. In fact, I think things feel down right chipper in the real world! Gonna put up a post sometime soon to share.
I don’t agree with you, Sam.
When you say that only cash counts, what you are really saying is that only stable asset classes possess a real value. Because the nominal values of things like stocks changes so much, they are said not to possess a real value.
Stocks possess a real value. All that you need to do to know the real value is to determine the amount of overvaluation and then do the necessary math. Stocks were priced at three times fair value in 2000. Those who had portfolios with a nominal value of $300,000 certainly did not possess $300,000 of real wealth. But the entire $300,000 was not illusory wealth. $200,000 of that total amount was illusory wealth. $100,000 was real.
Stock wealth is every bit as real as cash wealth. It’s just that you need to factor in the amount of overvaluation present to know how much wealth is actually present in your stock portfolio at any given time.
Rob
Once you get to a certain level of cash accumulation, I start NOT wanting to take too much risk anymore. If you have $1mil cash earning $40,000 a year in interest, that’s good enough. It’s not worth it to me to potentially win or lose 20% or $100,000 in the markets.
I see what you’re saying, but I’m happy to have a minority of my net worth in the markets.
I am 42, and probably too heavily invested in the stock market. It’s difficult to know what to do, because I was ‘raised’ to believe that stocks were the best investment overall. However, I think rules are being broken all over the place these days, going back to the tech bubble. Our economy is definitely changing with all the global competition and I think new rules may need to be written. I just don’t know what they are yet.
At least I am buying at perceived low prices! :)
What would you estimate your net worth percentage is allocated in stocks? Have you always been a stock investor?
I’ve had good and bad experiences with the market, which is reflective of the past 10 years performance.
I believe in 4-5% guaranteed returns for the big portion of my cash/liquid investments i.e. 80% of it. I’m happy to punt around the remaining 20% of my liquidity in the market, but not more.
I am probably 65-70 percent in stock right now. Too much I am sure, but I am not ready to make adjustments at these prices. I am in no hurry, but I do plan on switching out of some of my stock funds once prices recover some.
Gotcha. I admire your guts. Hopefully you were able to stay the course last year and ride up the recovery!
@JoeTaxpayer
Haha, nice. I couldn’t see the dang dolphins for the longest time myself!
@Financial Samurai
My comment was “With 7 or so years to go, we’re more heavily into stocks than we plan to be at retirement” as in we need to shift from the current ‘too heavy’ weighting to a retirement mix. Moving away, not toward.
Sam – If I squint just right, I can see a naked woman in damn near anything.
.-= JoeTaxpayer´s last blog ..A Real Disaster =-.
I’m sure Argentinians would consider cash an illusion as well. (Venezuela just devalued and froze their exchange rates: one for the government and one for everybody else.) Or consider the recent history of Iceland with bank debt of a few banks exceeding GDP. Since the budget of the US resembles that of a banana republic, maybe we go the same way. Being in my position cash flow is my only valuable metric. However, it is only valuable to an extent as money is only a medium of exchange and you never know. What is truly valuable is clean water and air, a dependable food supply and shelter. Tools and the skills to use them could also quickly turn out to be more valuable than $200 to buy a DVD player. I do not consider it completely unlikely that in the future I would only take someone’s money if I needed wall paper. People are already using pennies for flooring. (It’s durable, looks pretty good, and surprisingly not that expensive.)
@ ERE – Sounds good man. Good thing the USD is the reserve currency of the world, and I’m bullish on the USD at this level!
Cash flow is key, and the ability for cashflow to buy necessities.
I think part of the question is “for what purpose”? With an eye toward the day we can retire, I don’t include the full vale of the house in my math. In other words, I subtract the mortgage balance from assets and ignore the house value completely.
As far as the retirement accounts go, I need to reallocate so at retirement, we have the mix we’re comfortable with. With 7 or so years to go, we’re more heavily into stocks than we plan to be at retirement.
I don’t know how well I agree with the Age=Cash% rule, curious what others think about that.
Thought provoking article.
Joe
@ Joe – I’m surprised with only 7 years to go, you are moving “heavily” into stocks. What is your rational?
My other question is, do you see a naked woman or something else in the last picture?
I for one have no problem with the age = cash rule as a starting point. With 7 years to go I assume you’re around 58. You need a portion of your assets to last at least 30 to 35 years from now. We’ll likely go through a virulent inflation, see incredible changes in 3rd world countries, and unbelievable advances in bio tech over the next 30 years. With 42% in equities you’ll be able to weather the down turns and participate in the advances. In fact, with nasty downturns like we are experiencing now (ex. if market drops 15% from here) I would add to equities – at least 5%.
Having said all this, I would suggest starting backward. Figure out your income need and income sources. If you need $20,000/year from your nest egg then divide $20,000 by .03. This tells you how big your nest egg has to be. This works out to approximately $667,000. If you’re there or close you don’t have to take as much risk.
Finally, don’t retire at the top ofthe market,i.e.like 2000 or 2007.
There’s no inflation that’s why rates are so low. Everything is rational.
Also, why do you assume people retire at 65? That’s a fallacy.
I really think most people, with their head on straight can retire after 20 years of work i.e. 42-45 years old.
If you can retire at 42-45 go for it. I’m not sure 65 is a fallacy though for
most people. I would think 55 is doable.
If you have kids, want to live in a school district with good schools, take nice
family vacations etc. it costs a lot.
The .03 is the 3% safe withdrawal rate. I’m not sure if that’s what you were
referring to in terms of interest rates being low.
OH boy . You clearly a are a victim of financial illiteracy propagated by the Elite finance managers of the ruling class.
Do not feel too bad though since approx 99 percent of the population are financially illiterate when it comes to the subject of money and inflation.Most have no idea how the central banks of the world have made billions off the stupidity and ignorance of the masses.
Respectfully take some time to reeducate yourself.Failure to do so could deep six your financial future and those of you kids if you have any.
@Financial Samurai
Ok, yes, but CD’s aren’t immediately liquid without paying a penalty. 4% isn’t bad, but I’d hate to be locked into that for 7 years if interest rates and inflation rise. But your blended return isn’t too shabby, I’ll take a look into the DVD Method.
I think you are overstating the returns on cash. Where exactly can you get 4% return on cash right now (besides reward checking accounts that have max balance limits)? 20-30yr Treasuries, yes, but then you are locked in for that long.
Jason – You can call USAA for a 7 yr CD at 4%. Take a look at “The DVD Method to CD Investing”. My blended return for all my cash right now is around 5.2%.
@Financial Samurai
And if you asked how risky they were two years ago, they’d likely say, ‘what risk?’ Most people have the bad tendency of assuming that the immediate past will dictate how the future proceeds. (And you’ll note I also allowed that you could even be underestimating the risk in investing; I’m far from an expert in gauging investment risk.) I still intend to include my IRA value in my net worth calculations, but I fully understand that when it comes time for me to retire, the value may be significantly lower than I was assuming.
I do like your last comment; I do intend to rely on myself and my earning power rather than investing. Although, if my investments pay off and help to boost the money I can put into my savings, who am I to look a gift horse in the mouth? ;)
.-= Roger´s last blog ..Small Business 101: Funding =-.
Roger – That’s exactly it. ONLY until you convert your investments into cash, can you really bank on that asset for your retirement. Everything is an illusion, and I mean EVERYTHING!
If you have the mindset to just focus on the cash and the cash conversion, you will be surprised on the UPSIDE when you call it quits, rather than be surprised on the downside.
@Financial Samurai
Well, how boring would it be if I agreed with everything you write? ;) I do tend to agree more with what you say than disagree, but it’s more constructive (and fun) to point out the areas where I disagree, and try to argue my case.
And don’t get me wrong, there is risk in most types of investment, I just think you were overstating HOW risky said investments tend to be. Of course, that’s just my opinion; it’s possible that you are completely correct, or even understating how much of a haircut to give your stocks in order to come up with their ‘real’ value. I just wanted to put my thoughts out there.
.-= Roger´s last blog ..The Flaws of the Self-Made Man =-.
Roger – I overstate how risky investments are? I bet if you ask 100 people how risky investments are over the past 18 months, they’ll say “OMG, SO RISKY!” :)
Don’t rely on your investments to make you money Rog. Rely on yourself.
Hey FS,
I also posted a blog entry, similar to this but discusses the importance of cash flow.
Having just cold hard cash, I consider bad as it’s not generating any income.
Though we both agree looking at just net worth is bad.
.-= Investor Junkie´s last blog ..Does Net Worth Matter? =-.
Definitely agree, cash is not as good a holding as a Cash-PRODUCING asset.