Net Worth Part Two

by Ron DuBois on June 10, 2011

Figuring your Net Worth using the traditional methodology of Assets – Debts creates a financial starting point that gives you an idea of how healthy your situation is or isn’t. But, as I alluded to earlier, relying too much on this number without considering all the dynamics surrounding it could leave you feeling more secure than you actually are.

Your Home

If you are fortunate enough to still have equity in your home, what percentage of your Net Worth does it represent? For many Americans the home was, until the last few years, their largest asset — and the made up the greater part of their net worth. As the housing market dissolved so did their net worth. Now I don’t even think it is realist to think of a home as a liquid asset with home sales near all time lows and property values continuing to fall in many parts of the country.

The Value of Knowing Your Net Worth

While it’s not a good idea to completely turn your back on the importance of knowing your net worth, it is important to understand its limitations. Net worth will provide you with a snap shot of your debt to asset ratio. By looking at the debt you carry versus the current value of your assets, you can see how much getting out of debt will improve your situation. Another benefit of the net worth calculation is that it will bring into focus percentage of your assets that are liquid and those that are illiquid.

What is Liquidity and Why Should You Care?

Liquid assets are assets that can quickly and easily be converted into cash. Obviously cash and cash equivalents qualify. Stocks, bonds, and mutual fund shares can also qualify, but is important to keep in mind that the value of these items often fluctuates considerably. Precious metals, jewelry and other physical items can be counted as well.

For our purposes here we are concerned with net worth for one reason only. That is to determine how many months you could sustain your current lifestyle if you became unemployed, unable to work, or wanted to take an extended vacation.

I’ll write more about this when I get to the section about budgeting. In the meantime I want to write about the second definition of net worth I wrote about earlier. Robert Kiyosaki’s definition of net worth is the one we want to aim for. A positive net worth under his definition would provide us with positive income flow whether we’re working or not. Sure makes that extended vacation sound even more relaxing – no need to sell the house, the cars, or the heirlooms.

Leave a Comment

Previous post:

Next post: