I’ve been asked this question by a few of the blog readers and thought that I should respond as a post as other people are probably asking themselves the same question.
Question:
“Why do you refer to your portfolio value as your net worth? Or did I read it wrong...”
You didn’t read it wrong...I do refer to my portfolio value as my networth. I know this isn’t the traditional way of calculating networth but for my purposes I feel it’s the most accurate considering my early retirement goal. I’ve done a rough calculation and the cash flow from 1 million dollars is way more than enough for me to retire on…..but I’m pretty conservative and want to have a cushion in case something in my plan goes wrong (plus 1 million is a nice round number – really rolls off the tongue).
I’ll outline the items that a traditional networth calculation includes and try to explain why I don’t.
ASSETS
Cars – I don’t include them because they’re a depreciating asset and for me a necessity. Just an example but if someone had no money in the bank but a paid off $60,000 BMW I wouldn’t say he’s worth $60,000 (if he sold the BMW bought a $15,000 civic and put the rest in the bank I’d say he’s worth $45,000)
Equity in my Primary Residence – This is my thinking (it might be skewed a little) but including your primary residence is pointless, basically because you have to live somewhere (my mortgage is less than rent). I’ll include the equity in my home once I sell it. As an example, if I sell my home for $200,000 and buy another one for $150,000 I’ll invest the extra $50,000 and include it at that point. Just to illustrate this point, if I lived in Vancouver where housing values have sky rocketed and I have a house worth $400,000 to me it’s not worth including in my networth unless I’m planning on moving to a cheaper town, or downsizing to a condo (which are also ridiculously expensive in Vancouver) because as I said you have to live somewhere and I don't ever plan on renting.
Money in Chequing Accounts – I don’t include simply because it’s not large enough to really make a difference (when it does get large enough I transfer it to my investing account)
Work Pension Plan - I’m part of a defined benefit plan (indexed to inflation), so basically when my years of service + age equals 85 I can retire with X amount of my full time wage. I don’t currently count it because it is not that large and hard to calculate on a monthly basis but I will include it when I leave the position.
Any Personal Items or Collectables – Well I don’t really have many and if I did I wouldn’t include them because I won’t ever sell them (I’m keeping my clothes and fishing tackle until they’re worthless)
LIABILITIES
Personal Debt – I don’t have any.
Car Loans - None
Mortgage – (I know people are going to have a problem with this) but I do have a mortgage but don’t count it against my networth. I don’t count it because I have a very modest house that’s 30% paid off and my mortgage payments are less than rent in the city I live in. Additionally, I don’t count the equity in the house toward my networth. (If I did consider mortgage debt I’d have to consider the value of house – which would inflate my networth.) I plan on posting on the topic of mortages in the near future.
If there are any more questions that you have I’d be happy to answer them in the comments section. Cheers.
Monday, April 9, 2007
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7 comments:
I think the traditional definition of net worth calls for adding up all assets and debts regardless of what they are or how big they are.
However I really don't see anything wrong with making up your own definition especially when it's as logical as yours. Not counting cars makes perfect sense to me. If you don't count house equity and house debt then that's fine too.
I guess it might make sense to come up with a different term - it seems that you are basically counting your investments alone as net worth.
I agree that the rationale is logical and the definition fits what you are trying to measure. However, I also agree with the first comment post that redefining terms can be confusing. You could just explain that total net worth is not a relevant measure for you for purposes of tracking your financial progress. What you've defined is usually referred to as "liquid net worth", or perhaps more accurately as "net liquid assets".
I agree that for many aspects of personal financial planning, net liquid assets is a more relevant number than net worth, although no single number of any sort can ever tell the complete picture.
I'm a little confused as to the point of using the term "net worth" when that's not what you're talking about. All you're describing, as far as I can tell, is the size of your investment portfolio - no other assets are included, and no liabilities are included.
Instead of mixing up terminology, why not just talk about the size of your portfolio?
Upon further thought, I agree with you guys (mike, s.b., george). I originally used the term networth because I do eventually plan on buying and then including assets other than my investment portfolio (ie- cottage, investment property) and because of this I didn’t want to use the terms “liquid networth” and “net liquid assets” as they both exclude any real estate investments.
Does the term “Retirement Nest Egg” meet everyone’s approval?
Retirement Nest Egg = Net Liquid Assets + Investment Property
Thanks for your input,
MCM
It has my seal of approval! It's also an Easter-appropriate term :)
Your network calculation looks abtrary. For example:
You have a $200,000 home with a $100,000 mortgage. You also have a $50,000 portfolio. Then your retirement nest egg is $50,000?
Someone else who has an identical home with a mortgage of only $50,000 has less retirement nest egg then you, even though he's further ahead on the amortization?
What happens if this second person borrows $50,000 of HELOC and purchase the identical $50,000 investments as you? His retirement nest egg is still zero, since Investments - HELOC = 0. This gives the impression that the person is trailing you, even though the total networths are the same, but his setup is more tax-efficient than your due to loan interest tax-deductibility.
Hi silverm,
Sorry I took so long to respond to you (I just noticed your comment). I think you ask some great questions and my answer is a little too long winded for the comments section so I will post it on the blog later this week.
Cheers,
MCM
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