Your net worth can be calculated in many different ways. Let's explore how your net worth is calculated according to wealth managers and socialists. After all, with Joe Biden as President, there's more hyperbole talk about socialism coming back to America.
One of the common beliefs I'd like to overturn is the idea that one shouldn't count their primary residence as part of their net worth. This belief is propagated by some in the wealth management industry because wealth managers only earn fees based on your liquid net worth.
Ideally, some wealth managers would also like you to believe that your 401k, IRA, and any tax advantageous retirement account are not part of your net worth either. The reason why is because these retirement accounts cannot be managed by wealth managers so that hey can earn a fee.
Interestingly, the other group of people that believes a primary residence shouldn't be included in one's net worth is the socialist who looks to protect the feelings of renters who don't own any property.
Their logic is: if renters can't include their place as part of their net worth, neither should anyone who perhaps saved for years to come up with a down payment and took some risk to buy. In the socialist's mind, it's OK to discount completely a $200,000 down payment or a 100% increase in home equity.
Let's analyze a simple example to illustrate my contention that all savings and equity you've accumulated in your lifetime should count towards your net worth.
Your Primary Residence As Part Of Your Net Worth
Let's say you own three, paid off properties worth $200,000, $500,000, and $1,000,000. You also have $300,000 worth of stock.
You have no liabilities, no savings and no other assets to keep things simple. Your net worth is clearly $2,000,000. According to the wealth manager and the socialist, however, it is not.
Wealth Manager's Point Of View
If you live in the $1,000,000 property, the wealth manager will say your net worth is only $1,000,000 ($200,000 property + $500,000 property + $300,000 stocks).
But practically speaking from the wealth manager's point of view, your net worth is really only $300,000 because that's the figure used to calculate fees. Even if you decide to rent out your $1,000,000 property and live humbly in your $200,000 property, the wealth manager's business eyes still only sees you as being worth $300,000.
From the wealth manager's perspective, one way to increase your net worth is to sell one of your properties and decide to keep the proceeds in cash or buy liquid investments such as publicly traded stocks or bonds.
Although I eliminated property taxes, insurance fees, maintenance fees, and freed up time by selling my rental house in mid-2017, I exposed myself to venture debt, real estate crowdfunding, and transaction fees through my reinvestments. Alas, there is no escaping investment fees. At least my reinvestments are 100% passive now.
Robo-advisors like Personal Capital have drastically lowered management fees from 1% – 2% to less than 0.9%. However, the problem with robo-advisors is that unless you tell them what percentage of your net worth they are managing, they will automatically assume they are managing your entire net worth. Therefore, it's up to you to make sure their asset allocation corresponds with your risk tolerance.
Socialist's Point Of View
If you decide to live in your $1,000,000 property, the socialist will also say that your net worth is only $1,000,000. But if instead you decide to move into your $200,000 property, it's unclear whether the socialist will agree that your net worth is now $1,800,000. After all, the wealthier you are, the more concerned the socialist is.
In the spirit of equality, if socialists assign no value to the equity in your primary residence, then they should also assign a negative value to your net worth for renting.
After all, the return on rent is always -100%. Therefore, the negative value assigned can simply equate to the cumulative cost of rent over time. The longer a person rents, the higher the negative value assigned to the renter's net worth e.g. -$240,000 value to net worth after 10 years of spending $2,000 a month on rent.
In other words, renting will always be a drag on your net worth if the socialist is fair, no matter how much you use your disposable income to invest in other risk assets like stocks. At some point, the cost of renting might even outstrip your investment returns as you reduce risk in retirement and receive lower returns.
Now That's Not Fair For Renters!
Since most of you are not wealth managers, most of you will agree how inaccurate the wealth manager's assessment of net worth is.
But given that roughly 37% of the US population rents, I can already hear a huge cacophony of complaints that it's wrong to assign a negative value to rent, but okay for the socialist to completely negate all the home equity built up in your primary residence. After all, it is human nature to be completely inconsistent in thought.
One of the common arguments socialists make is, “You've got to live somewhere!” True, but after living somewhere for 30 years, who has the ability to live rent free, earn rental income, sell their property tax free up to $250,000 / $500,000, or pass on their property to their children at market value to avoid paying any capital gains tax? Only the homeowner.
Another argument socialists make is, “The return on rent is not negative! I get a place to live!” So does the homeowner, but with the added optionality of making a potential profit in the future.
It's a tough pill to swallow that each rent check paid is never coming back, but acceptance is important for moving forward.
Let me be clear that I don’t believe renting is for losers. Renting is a fine choice for many people, especially people who are not yet sure of where they want to establish roots.
I just want to challenge the double standard where some people believe the equity value of a primary residence must be completely expunged from a net worth calculation whereas there is no negative value assigned to a renter’s net worth calculation. You can’t have without doing the other, unless you're delusional.
Think Clearly With Minimal Bias
In order to build wealth, you must be rational in your thinking. Liquidating your entire retirement portfolio because you find Donald Trump to be a vile man is not rational since he is pro-business.
Expecting to go straight to the corner office because you've been working a couple years is not rational since you have colleagues who've worked for decades and are still not there yet.
I know none of you are socialists reading Financial Samurai, so please don't think like one. It's understandable to be biased towards stocks and against homeownership as a renter.
The same goes for the 30% of homeowners in America who have no wealth besides their primary residence.
Just realize that in 30 years you will kick yourself for not owning a primary residence just like you will kick yourself in 30 years if you don't own stocks. Think about your children's point of view when it comes time for them to invest in order to recognize the power of inflation and compounded returns.
If you would like to include your primary residence as part of your net worth, feel free to do so. Being able to rent out my old home after buying a fixer upper in 2014 was a fantastic way of monetizing the value of my primary residence. So was selling.
If you don't want to include your primary residence as part of your net worth, that's fine as well. Conservatively valuing your net worth might lead to greater wealth as you spend more time hustling. Just know that when you die, the government will include your primary residence in their estate tax calculations.
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Invest More In Real Estate
Now that we agree we can include the equity in our primary residence as part of our net worth, let's really invest in real estate. You're only really long real estate if you invest in real estate in addition to your primary residence.
My favorite way to invest in real estate with lower volatility, but also with a more surgical approach is through real estate crowdfunding. Given interest rates have come way down, the value of rental income has gone way up.
Take a look at my two favorite real estate crowdfunding platforms that are also free to sig up and explore:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.
A primary residence is clearly part of your net worth. Here’s our example. We bought a home in Southern California in 1994 and sold in 2004. The value of the home increased just over 300% over that 10 period (yay!). After selling, we moved to a lower cost state and bought a new home for less than half the cost. We invested the remaining proceeds into a start-up business, a rental home and stock market investments. Each of those new assets have grown over the past 13 years.
The sale of the California home was simply a conversion/diversification of one asset class into a several others. How could that occur, if the original asset was not part of our net worth?
The wealth management formula is essentially a scam pure and simple. Citizen A owns a home in SF worth $4M free and clear and has $500,000 in stocks. Citizen B rents and has $1,000,000 in stock. Who would you rather be? Seriously. According to that formula, Citizen B is a “millionaire” and A is not. Ridiculous.
Also, the “renter versus homeowner who is better off” debate nearly always fails to account for the value of what I like to call the “landlord put.” In essence, the renter must bargain for a lease term and once outside of it could be compelled to leave the property regardless of how much hassle/inconvenience/cost may be entailed in a forcible move. The cost of that “put” needs to be included into the renter’s cost structure but never is. Rent control attempts to transfer the value of that put to the renter from the landlord – a “takings” in the classic sense but one that is never compensated under our laws regardless of how baldly unconstitutional these laws are.
How do you value this put??
Consider maybe liquidation value? It’s how I do it. I look at my liquidation value in a week to cash as my actual net worth. I would say a month is probably more fair. A week makes it either investment grade cost for your house or a very hot market, but is the actual value of your house if you needed the money. My current primary residence area has a very soft market with houses taking 8 months-1.5 years to sell on average, and often for well below list price. My county property tax estimates my house as almost 50% higher than I paid for it a year ago, because I paid short sale price and they seem to judge by market listings. The real problem with property in net worth is everyone OVERESTIMATES when calculating their home value and forget transaction costs. It’s why I use liquidation value, to include fees for my retirement accounts (not really in a position to use 72(t) yet).
My real difficulty if I’m lucky is how I will count the *possible* double pension with healthcare for me and my husband in hopefully 15 years. The total net worth is always post tax (to include brokerage accounts) because that is really what I have to use if say, I needed to post bail for the unlikely scenario my husband is arrested for murder and there was no bail bondsman, favors I could call in, or access to credit. Some people like to calculate one way or another to feel better about themselves — but I think a low net worth motivates me more. Those in hot real estate markets love including their house, but rarely include the refinancing costs if they wanted to tap into their value (assuming they have at least 20% equity) or transaction costs in selling. I think liquidation is fair — a hot market will account for the ability to quickly sell and multiple bids, and a colder market will prevent those from over-valuing their house as it languishes.
Very true in your perspective. Unfortunately these socialists ideas are also spreading into the business world. I work for a quite large tech company and they are now implementing socialism in to our corporation thru our pay scales. As a 13 year employee I have been dedicated and hard working and have earned small incremental raises over the years. Now my company has a new policy where they are paying everyone the same regardless of work experience or tenure. What this means is if you happen to be a new employee you were given an instant 25% increase in your hourly rate regardless of knowledge or skills. If you are a very tenured employee you get 0-5%. A complete slap in the face for hard work and dedication.
Take you history of hard work and your hard-earned skills elsewhere, where they will be better appreciated.
Buy one share of stock in your corporation, then go to the stockholders’ meeting and complain from the floor about current managements’ morale-sapping policies.
Get together with similarly situated and discuss joint action of some kind, whether it be to form a united front in order to get a better deal from current management or be to leave your company en mass to form a competitor company.
“Expecting to go straight to the corner office because you’ve been working a couple years is not rational since you have colleagues who’ve worked for decades and are still not there yet.” – Can’t agree more! I had a new hire ask for a promotion only six months into his job lol. Our rockstar associates (rare, and he wasn’t one) would get promoted in 1.5-2 years, with the average taking 3+. Clueless
Home value should be included in net worth calculations, as well as the loan(s). Just my $.02
I purchased my primary residence during the absolute bottom of the last housing crisis as an investment because I understand my local market. I don’t plan on living there forever, and until the recent run up in the equity market it, the appreciation was way better…now only slightly better. Now if I had only levered up my purchase instead of paying cash for my house, wow that would have been a good one! LOL, actually there are zero regrets about having no debt. What I think is an important distinction though is that people should consider what the actual cash in hand number is net of fees and capital gains taxes…not just was Zillow says you could sell it for.
Now if you are calculating you safe withdraw rate from your investments and plan on living in your current residence forever, of course you don’t include it.
I believe the GAAP treatment on this would be yes include the property in net worth but value at the lower of cost or book value. So don’t inllude unrealized gains until the property is actually sold but do include expected selling costs to get a realistic value.
I factor in home equity as a component of net worth, but it is not the same quality as other net worth assets.
First, the primary reason I own my home is a place to live. I am not in the business of speculating on the value of the asset at some hypothetical point when it is to be sold – notwithstanding that I did try to get a good deal when I bought. Second, it does not generate income like other investments (stocks (dividends), bonds, rental real estate, cash (interest)). Third, it is not liquid. Fourth, it is not a diversified investment. I view my home as a (nice) necessity that ties up money that could otherwise be more productively used (or at least more wisely risked). As a result, my home equity is a relatively small component of overall net worth and something I tend to exclude from investment decisions and analysis.
My view on whether to own versus rent is to own (for the long term) because independently of its inferiority as an asset class, owning a residence with a mortgage requires forced equity savings and involves expenses (property taxes, maintenance, insurance and mortgage interest) that are cost competitive in my market as compared to rent of equivalent property. I suspect that this analysis would not work in all markets. And there is the intangible benefit of ownership that doesn’t have a number associated with it but does have value.
Do you include a car as part of your net worth as many people do?
I don’t include it as part of my calculations as my definition of an asset is something that appreciates in value over the long term or at least maintains it’s value with cash being the only exception.
Ask the IRS whether your primary home is part of your net worth. From an estate tax perspective such as filing a form 706, I think the answer is clear that the home is in one’s net worth.
I agree… What about 529 accounts? I’m annoyed that some savvy personal finance people exclude it from their net worth calculation when it’s clearly their property. Yes, it’s for the child’s tuition headed for college, but so is part of the money that they will spend on groceries.
The socialists can go to heck! Feelings…who gives a shoot about feelings? Of course net home value is included in net worth.
I think you can include your home in your net worth if you plan to sell it one day and liquidate it as an investable asset and perhaps rent!
I like to include the home in the net worth calculations but I know this is not the calculation I will use for retirement nest egg.
BTW, I think that the main reason socialists -liberals do not readily include primary residence in net worth is that they’d also have to include their own homes in their own net worth. And since most socialists live along the hyperinflated housing coasts (it is their enviro-nimby lobbying that has restricted housing supply and driven home prices through the roof after all) including their home equity in their net worth would place them in the nation’s most top 5%, which would undermine their socialism as they compete virtue signaling with other leftists. Any chance they may put their money where their mouth is and voluntarily share some of that wealth? Perhaps since they have so much home equity they can spare some of their remaining liquid wealth? I’m not holding my breath…
I manage wealth for select few members of my family, on a no-fee basis, and I always include all assets including primary home in net worth. For home, I include only equity net of mortgage and subtract an estimated figure that covers transaction costs of sale and potential taxes under a separate line item called “selling costs”.
I am a CPA and a wealth manager. I don’t care if people include there gold fish collection and put a super high value. Net worth means NOTHING.!!
Cash flow and ROI is what you retire on.
If I make 100k return a year on 1mm investable assets it’s 10%. Or
100k on 2mm net worth because I include my paid off house. It’s 5%.
All that matters is cash flow
Agree, although a home paid off reduces future cash flow.
I’ll play.
I’m a renter (aka sinner, as per this site, Sam pleasure spare us ‘the renters are not losers’ consolation, we know your strong bias!) who is 40 with kids and never owned a home. I have nothing against real estate as an asset class. I have nothing against any asset class for that matter. I believe in appropriate asset allocation that is continually monitored and rebalanced based on risk tolerance and market dynamics. I can confidently say that my mix of public equities, reits, commodities, currencies, credit, bonds, cash, hedge funds has far outperformed putting any money put into a primary home in my market (Manhattan) when you consider liquidity, co-ops, maintenance, etc. Not to mention the headache of owning and being locked down, at any give time you may be living in a home too large or too small. Meanwhile I was able to rent exactly what I want (no compromise on space, commute, amenities, views) at least 20% under the market (no special deals or help from anyone, just prudent searching and negotiating with landlord) the whole time, and was able to move apartments as my needs and tastes changed and my family grew (didn’t move many times). Now of course if I had bought a place in an outer borough (long crappy sweaty commute and lower quality of life for my family) at the right time with a lot of leverage, I could have made a lot of my money, but still lower than my levered investments (hedge funds). I could have also super leveraged my assets and bought investment property in the right place at the right time (just like you Sam! But alas we are not all property shark geniuses) but it as outside of my risk tolerance (when you’ve almost won the game, it’s better to play it safer IMO). Overall, I’ve been financially better off not owning, and I now have liquidity to walk into a house and buy whatever I want in cash. This doesn’t mean I don’t mean to buy anything in the future or include physical real estate in my asset allocation, like I said I have no bias toward any asset class. Every asset class should be looked at in terms of the entire portfolio without regard to emotion. Thank you for reading!
And yes, of course your home should be included in your net worth!! Net worth is a simple calculation, net worth = total assets minus liabilities minus estimated costs of liquidation.
I own my home, but I do not think that renting is for losers.
In addition to the mobility and flexibility advantages you mentioned, purely from a financial standpoint, owning is not a clear winner over renting, especially in speculative markets (i.e. the hyperinflated coasts).
More specifically, ROE (return on equity) in places like San Francisco is dismal. Capitalization ratios for owners are around 40! So what’s happening? Are all home buyers delusional?
No. The only reason these capitalization ratios are sustainable is if there is a lot of home value appreciation expectation, appreciation above and beyond inflation that is. Even people who do not fully rationalize it are basing their home purchase decisions in these expensive areas on the expectation of great home price appreciation. Otherwise they would rent instead of buying, or other more financially savvy people would tell them to.
If you buy a house in San Francisco to rent it out, even if you put 30% down, your cash flow will be negative because the cap ratio is so low, and the little your mortgage payment contributes towards principal no way makes up for it. So it all hinges on significant home value appreciation above and beyond inflation (inflation only appreciation is no appreciation, that is for losers).
So far home appreciation in San Francisco and other expensive west coast areas has indeed far outpaced inflation, and kept up with speculative expectations, primarily due to an enviro-nimby coalition that chokes off new housing supply (an environmentalist renter, now that is a financial shoot-yourself-in-the-foot looser in my financial book). But the moment this strong appreciation expectation fades away, these markets will collapse, since it makes no sense whatsoever to buy at these cap ratios if there’s no appreciation. People will stop buying and a vicious cycle of price declines will bring prices back to earth.
It has not happened yet, of course. But can prices (and wages) keep exponentially diverging between the coasts and the rest of the country? It’s very hard to answer a perpetual “yes”.
Remember, there are short term bubbles that burst (two to five years) and then heal, but there are bubbles that burst and never recover. After all, in the fifties and sixties Detroit was the dynamic industrial activity center everyone wanted to be in. Today?
Will high tax enviro-nimby California always be able to extract ever larger sums for housing just because it’s the electronics capital? In perpetuity? Without any other area worldwide been able to break the inefficient high tax nimby cartel and undercut California productivity, wages, and home prices? In perpetuity with ever higher capitalization ratios diverging into infinity?
As the pace of everything human keeps irreversibly accelerating many things that we never thought possible will happen. Which ones, remains to be seen. The investor who has even slightly better intuition than random will come out ahead.
I’ve worked for several wealth management firms and private banks, and I’ve never heard of a wealth manager not taking a home into account on a net worth statement. Our financial statements always include line items for real estate as well as automobiles and even jewelry, art and furniture. Those are certainly part of net worth and are important to understand in order to advise properly, especially with regard to cash flow needs, insurance and estate planning.
But they are USE assets, not INVESTIBLE assets. They can’t be rebalanced, nor to they provide income. Many fail to appreciate over time as well and may even be impossible to sell in any reasonable length of time (even real estate, especially when you get into super high end homes). So naturally investment managers ignore them for purposes of portfolio management and asset allocation/rebalancing. They are not considered “assets under management” for fee purposes either, as you note (at least in most cases – when trusts are involved that can change).
The vast majority of all clients with enough money to have a wealth manager have a small portion of their assets under management, for the record. We do not ignore those assets obstinately because we can’t charge fees on them, as you suggest. There are often huge business or real estate interests, stock options or RSUs, private equity holdings, personal loans and even sometimes large 401k assets that cannot or will not be directly managed by a wealth advisor.
I own two homes and I don’t live in either of them. I rent a two-bed in a metropolitan city. One of my homes is already paid off whereas the other is carrying a mortgage but only has a few years to run. Of course they are part of my total wealth as well as net-wealth. They are not providing extra cash to me at the moment which is fine because I want to motivate myself to earn more cash through work and business. I know it’s nice to generate enough passive incomes but it is certainly not fun to leave a workplace and stopped interacting with the world on a face-to-face basis when you are still young. Working is learning and growing. Wealth advisors from a wealth management company always carry an agenda. They advise you but really serve their employers. If I had sold my US property and bought stocks perhaps I have doubled my wealth today. But I don’t regret as my home has emotional value to me. I wish I had bought my third property in the city where I live as real estate prices had quadrupled in the last ten years. Being a home owner also gives you a sense of pride where renters are hard to feel.
Enjoy reading your posts Sam.
Since this is a financial website.
The socialist may regard affordable renting or government housing as a form of subsidy as it clearly has value.
The future value of those cash flows could be discounted into a NPV and subtracted from the net worth of the individual who has a house.
It get more complex from here as your article pertains to rentals which are fixed assets and depreciate over time.
Liquid assets are easily valued where illiquid ones less so. That’s probably another reason why wealth mangers struggle with the net worth calculation. Ever asked a RE agent about stocks?
Agreed, the value of the different properties including the main one should be part of the total wealth. Specially as you can rent a part of your main home and also as you can sell it.
I can sell my $750k Home and rent for 20 years at $3k/mo, so yes, it’s part of my Networth.
I only consider home equity as part of my net worth in so much as it saves me $3000 per month in rent since it is paid off; just like any other asset providing 6% cash-on-cash return with a potential equity upside.
Stay focused on building a solid passive cashflow, and just factor your house into the calculation.
Of course it is part of your net worth, it is just generally speaking a pretty lousy investment and more illiquid than most anything else you have. To me it is like your cars or your toys or any other possession except it is slightly better than a depreciating asset. It is worth what you can sell it for but except for some freak time periods it will barely keep pace with inflation.