If you’ve ever read one of Warren Buffet’s famous letters to Berkshire’s shareholders, you know that he starts the letter the same way each. Each letter begins with how the company’s book value changed from the prior year. Here’s how he opened his must recent letter:
The per-share book value of both our Class A and Class B stock increased by 13% in 2010. Over the last 46 years (that is, since present management took over), book value has grown from $19 to $95,453, a rate of 20.2% compounded annually.*
By book value he means the net worth of the company. He doesn’t point to how much money Berkshire Hathaway made last year (although that’s important, too). Why? Because net worth is the clearest picture of the financial value of an entity.
If you think about it, net worth is a result of how much we spend in relation to how much we make. Spend more than you make, and your net worth goes down. Spend less than you make and it goes up. Pretty simple. And that’s why it’s important to track your net worth–it’s the best indicator of your financial progress.
How to Track Your Net Worth
Tracking net worth is easy, but there are a few questions you need to answer. For example, do you include in the calculation absolutely everything you own down to the last piece of flatware? Do you include your house, and if so, at the purchase price or current value? Do you include only your investments? Do you include the value of a business, and if so, how do you value the business? The answers to these questions depend in part on what purpose the net worth calculation serves. We calculate our “net worth” in three different ways, each serving different purposes:
Personal Financial Statement (include everything):: We maintain a Personal Financial Statement that includes everything we own and everything we owe. We update our PFS once a year or more frequently if necessary. The PFS serves several purposes:
- It shows in hard, cold numbers the net result of a lifetime of financial choices (both good and not so good).
- A PFS is required to obtain financing for the rental properties we buy.
- It’s a good reminder that much of what we own (e.g., cars) depreciates each year, and therefore, doesn’t move us closer to Financial Independence.
- It causes us to take stock of what we have, which often results in selling or donating stuff we no longer need.
Net Worth (excluding personal property):: For tracking what I consider to be our true progress toward financial independence, we use a modified version of net worth. Here, we include all investments, cash deposits, rental properties and our home, along with all debt. We exclude our cars (even though they are paid for), furniture, and other personal property that goes down in value over time. It seems that the only potential controversy here is that we include our home (at current value) in our Net Worth calculation, which we do for several reasons:
- The value of our home is a significant asset for us, representing about 50 percent of the total assets in our Net Worth calculation. The equity in our home represents about 40% of our Net Worth. To exclude our home value (and related mortgage), would omit a substantial part of our financial picture. True, we don’t intend to sell our home in the foreseeable future (which is why some exclude it from the net worth calculation), but we don’t intend to sell our mutual fund investments, either.
- Although we don’t have plans to move any time soon, we do expect eventually to down-size and move to a less expensive area. And we intend to use the equity in our home to pay cash for our retirement home. Including our home in the Net Worth calculation helps us keep track of the equity in our home for this purpose.
- It helps us look at our home as an investment. While our home is much more than an investment, including it in our Net Worth calculation helps to remind us that it is a valuable asset in our overall financial picture.
Investments Only:: Finally, we also track our investments (taxable, retirement, 529, cash, etc.) separately from our other assets. A big part of this process is asset allocation of our investments.
Net Worth Tracking Tools
All of this seems like more work than it really is. We track Net Worth and our Investments in Mint, which updates automatically. We’ve even included our home, and Mint updates the value of our home automatically using Zillow. (Incidentally, there are a number of great home value tools worth checking out.) Mint can then produce graphs of your net worth, like this one (I’ve excluded the actual numbers):
We’ve set up a Personal Financial Statement in Excel, which it takes just a few minutes to update. After tracking this information for several years, you can see the progress you’ve made (or not made), which helps to motivate us to make good financial decisions.
Published or updated May 23, 2011.