Three Important Ways to Calculate Net Worth

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Recently there have been a number of posts in various finance Blogs discussing some important questions about what should and should not be included in calculating net worth. 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? 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 our 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 65 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 (at the moment) our most valuable asset as well.

Investments Only: Finally, we also track our investments (taxable, retirement, 529, cash, etc.) separately from our other assets. From this, we look at three ratios: (1) Investments to non-mortgage debt; (2) Investments to all debt; and (3) Investments to annual earned income. Currently, our ratios for each of these is (1) Investments = 9 times non-mortgage debt; (2) Investments equal .57 of all debt; and Investments equal 1.7 times our annual earned income. Our level of debt and annual earned income change from year to year (hopefully for the better). Using these ratios allows us to track our progress in a more meaningful way.

All of this seems like more work than it really is. We track Net Worth and our Investments in Quicken, which updates automatically. Once you set up a Personal Financial Statement in Excel, 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.

Here are some links to other articles recently posted on this topic:

• Net Worth v. Net Investable Assets
• How to Calculate Your Net Worth
• What is the Worth of “Net Worth” if it is Not Usable?
• Net Worth, Net Investable Assets, And Net Liquid Assets
• Calculating Net Worth: What Should One Do With Their Primary Residence?
• Calculating wealth as you grow financially
• Biggest Net Worth Mistakes: Is Your Net Worth Accurate Or Useful?

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