When reading how others made it to early retirement (and I mean at 30 or 40 years of age) there is usually a post tucked in amongst all the fluffy stuff that joyously outlines their net worth.
Net worth sounds really exciting. If you have a high net worth, it’s like a warm cozy blanket to snuggle in, safe in the knowledge that compared to everyone else, you’re doing great.
Now I know lots of people will chime in here, a little outraged, that it’s not a competition and that it is most definitely not a yardstick to measure yourself against.
Well if that’s truly the case, I ask myself what is Net Worth useful for?
Well first, let’s look at what it is. Google tells me that net worth is the difference between the assets and liabilities of a person. Ok so, assets are things I own that I could liquidate, and the market value of those, while liabilities are my debts, credit etc. All fairly straightforward. Another quick Google tells me that The Central Bank, for example, calculates that each Irish household has a net worth of more than €135,000 making us Irish one of the richer European nations.
In the CITK household, here is our net worth breakdown. For the purposes of simplicity I’m not going to dig out the value of my engagement ring or stuff like that (art, jewellery etc.).
Our Assets (what they are worth not what we paid):
- House – €295,000 (see here for valuation tool)
- Car – €1,800
- Savings – €71,000
- Investments – €4,700
- Our Pensions – € 140,000
Total value at this time of our Assets is: €497,800
WOW. Almost half a mil. Feeling a bit cha-ching looking at that. But just wait a bit.
- House Mortgage – €160, 700 (we bought in 2014 just before ‘the recovery’.
- Credit Cards – €2,500
Total value at this time of our Liabilities is: €171,500
Our Net Worth at this time is €326,500.
Wowsers! But, but, how come I’m still struggling to pay the bills?
Here’s a couple of issues I have with Net Worth Calculations.
- It doesn’t include interest that you pay on the mortgage. The cost of that credit would have our Net Worth in minus, like zippo.
- All that worth is tied up, and you have to make some pretty big life decisions to liquidate it – move house etc.
- We cannot touch our pensions until we are 65. So that’s completely useless to me if I need some cash here and now.
- It doesn’t take into account your day to day bills other than loan repayments/credit cards/mortgage and any other fixed value items.
Everywhere I look it says that it’s important to know your Net Worth so you understand your true financial position. I say this is in theory a good idea, but Net Worth is actually worthless at showing your true financial position. If my kids can’t eat but I’m worth 50K due to a pension that’s off limits until I’m 67, does that really reflect my finance?
Would a bank lend money to me based on that 50K? No, I don’t think so. Banks are the hardest to please because they take a risk based on my present and forecasted financial position. I wasn’t asked the value of my pension when I applied for a mortgage, I was asked to give a year’s bank statements so they could forensically go through my income and expenditure.
Net Worth may be a reflection of your true financial position if you are not lower or middle class. If you have so much income you don’t need life insurance, or to budget or to think about loans, then sure, Net Worth is a valuable calculator. Other than that it’s just a nice snuggly number to give you a false sense of security and make you feel good compared to the national average (if you are above it).
Cash flow it seems to me, is far more important that Net Worth, so I wouldn’t worry too much about Net Worth if you are apparently below it but have good cash flow.