Our culture values wealth in a somewhat disturbing way. We idolize millionaires and billionaires, but we don’t really take the time to think about what a millionaire or billionaire really is. So much of what we hear reported in the news stratifies individuals based on their net worth. It’s an easy measure to help quantify economic markers, but is it really a good measure of your wealth and financial health?
How Net Worth is Calculated
Net worth is simply the sum of all of your assets and liabilities (or debts). For instance it would add any cash, investments including retirement accounts, property (i.e. houses and automobiles), and subtracts from that any debt such as a mortgage, car loan, or credit card debt. The result is a number representing your “net worth”. In other words, it’s the amount of cash you would have if you sold all of your assets and paid off all of your debt at a specific point in time.
What’s Wrong with Knowing Your Net Worth?
There’s nothing wrong with knowing your net worth. In fact, I recommend that all of my clients complete this calculation because it helps us to see what assets and debts are in their portfolio and gives us the opportunity to develop a solution to their financial quandaries based on a holistic view of their financial picture. The problem is when you rely on your net worth as a measure of your financial security, especially when it relates to retirement.
Let’s talk about owning a house as an example. For most Americans this is the biggest contributor to our net worth. Our home offset by our mortgage is probably worth more than our retirement savings and other investments combined. This can severely distort our assessment of our financial security when we’re looking at how much money we have and when we can retire. When it comes to your house, the only way you really get that money in hand is to sell your home, but for a lot of us we’re looking to stay in that home and unless we sell it, the “worth” of that home is tied up. Sure you could take out a home equity loan if you had to, but that’s no way to finance your retirement.
Additionally, your net worth is constantly fluctuating. That’s not necessarily a bad thing. In fact, you want to have the majority of your money in accounts where they can potentially bring you dividends and gains on your investment. This helps to stave off the effects of inflation, but it also means you are exposed to the ebbs and flows of the public markets. Ideally, you are in a place where you can hold onto your investments until they recover from a downturn, but sometimes that’s just not the case. In those situations, your net worth from a month ago may have no bearing on reality. As many of us learned the hard way during the Great Recession, our investments are never a sure thing.
Your net worth also neglects to factor in taxes. That's a pretty big oversight when you're looking to calculate how much money you have available for your financial goals. Depending on the type of tax you could owe over 30% of those gains to the IRS.
The Bottom Line
At the end of the day, I absolutely encourage you to take stock of your debts and assets in a net worth calculation. That being said, keep in mind that your net worth should be taken with a grain of salt. Until you have cash in hand that number really means very little. As far as retirement goes, it makes sense to talk to a professional to determine if you’re on the right path or what you can do to better secure your financial future. Please don’t use your net worth as the prime indicator of your financial security.
Written By: Lindsay Dell Cook
Lindsay Dell Cook is a CPA, finance writer, and founder of Budget Babble. She lives in Philadelphia with her uber supportive husband and adorable daughter. When she's not working, she enjoys spending time with her family, taking their lovable mutt for walks, or reading a good book while buried under a pile of cats.