Net Worth in Perspective

“Net Worth” is a key concept in personal finance. From the wikipedia definition:

In personal finance, net worth (or wealth) refers to an individual’s net economic position; similarly, it uses the value of all assets (long term assets) minus the value of all liabilities.

For the layman, “assets” are what you own – your cash on hand, the stock in your account, and any accumulated value in your pension and 401(k). People tend to over-value their personal belongings (collectibles, clothes, jewelry, etc…) – this is worth what someone ELSE would pay for them (think of the pawn shop) not what you paid for them, typically a few cents on the dollar. “Liabilities” are what you owe to someone else – so for your car, if you are paying on payments, typically you are underwater – as soon as you drive it off the lot the value drops by 20%, plus you are paying interest, so you likely have very little value in your car, unless you paid it off already. For your house, it is more complicated, but many people are “under water” where their mortgage is worth more than the current value of the house, or very close.

According to this “Net Worth Calculator” at CNN Money, you can put in your age and income and see how your personal net worth compares against others. For example, a 30 year old making $40,000 / year, on average, would have a net worth of $8,250.

Why is the net worth so low? Because net worth is what is left after EVERYTHING is paid for, including taxes. When you see your paycheck there goes Federal taxes, state taxes, FICA (social security and medicare), plus sales taxes on everything you buy. If you own a home, there are property taxes, and when you rent there are utilities. Don’t forget your house payment, or rent, and your car payment. Plus – you have to eat, you need to pay for that cell phone and data plan, and cable, and then you might want to date, and everything else. After all this is done, whatever you save after taxes, goes into your net worth.

I remember working near the dot-com explosion in 2000-2002 and many of the companies I worked with and for were having hard times. They changed the timing of payments (from bi-weekly to monthly) and many people, even those making over $100,000, were complaining vocally because they were living check-to-check and this 2 week, one time lag, was killing them. Their savings that were accessible to them were almost nil. At least back then real estate was still appreciating – but now even the cash that isn’t immediately accessible (in your home equity) is gone, too.

Why is this significant? Portfolio one, which we have been running for ten years, has accumulated over $16,000. This is more than the net worth of the typical 30 year old making the average salary who has been working for almost a decade out of college. This means that by accumulating $16k-$20k you have the equivalent value in terms of net worth of working for a decade, which does mean something. Of course this analogy is imperfect because working 10 years means that you can earn more going forward, but it is a powerful analogy nonetheless.

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8 thoughts on “Net Worth in Perspective”

  1. Interesting stuff on the site, nice job. I will catch up on reading more of it this weekend. But I will ask a few questions now anyway. I have in front of me the spreadsheet for portfolio one and all of these companies are gigantic. No small/medium cap, no corporate paper, muni bonds, etc. etc. Is it because of the relatively small size of these portfolios that you are just “stock picking” instead of using traditional investment plans of spreading out your risk? I can’t imagine how shabby my portfolios would look if I had no fixed income and/or other instruments in there.

    Oh yea, dump MSFT, you aren’t getting paid enough to wait that one out.

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  2. Thanks for putting up a legit comment! You are the first.

    1) the gains ARE taxable. They are taxable at the kids’ rate, however, and I can offset losses against gains. If the amount of gains and losses was high enough it would go at the parents’ rate but not for a fund this size

    2) for the kids, I am trying to teach some basic concepts, so I am sticking to stocks. Agreed that other components are needed for a balanced portfolio. Since their time horizon is effectively infinite, I figure an all stock allocation isn’t too bad, but then would move to cash if I really thought they were going to use it shortly for college. Agreed that these are pretty large stocks, I try not to just pick giants, but want to pick stocks that I can explain and understand.

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  3. Hmmm. I don’t know. I think it would be great to teach kids about balancing their portfolio. Even if you only have $10k it isn’t smart to have ALL of it in stocks. But it would be difficult to spread it out properly with such small amounts. You can’t exactly go out and buy $100 worth of preferreds, bonds, corporate paper, muni’s, etc without getting killed on fees.

    So I guess this is good for now.

    Are you doing sector weighting or just randomly picking huge stocks, doing research and buying them? In other words, how do you come up with your list of stocks to choose from?

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  4. I talk to them about stocks and investing in general but also kind of want to keep it simple. Most kids don’t learn much of anything about finance – I am trying to teach them something that is digestible. But agreed for my personal finance stocks are just part of my portfolio and I generally go with index funds (ETF’s, actually).

    I don’t do sector weighting – I pick the stocks myself after doing my own research. Then the kids pick from the list. They come up with substantially different portfolios based on their own preferences but that is life – I try not to encourage them to make a particular choice as long as they pick something from the list.

    Part of this is the fact that I am just trying to teach them also about consequences, and that choices in life do result in different financial circumstances.

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  5. Agreed that these kids will be MILES ahead of most their age when they get to college.

    When you say you pick the stocks yourself after doing your own research, do you look at the fortune 500 and throw a dart? What makes you pick the list to start doing your research on?

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  6. Ha ha back to the dartboard.

    No I am a bit more sophisticated than that. There are a bunch of industries that I know and then I look up stock research and am continually tracking these stocks and looking for trends.

    I do try to pick stocks that aren’t subject to huge gyrations (small, penny stocks) or totally “trendy” if possible because I want something that at least theoretically would hold value over a reasonable return period.

    Actually I do look overseas a lot for ADR’s, and try to at least have maybe 50% of the stocks that I recommend in non USD because the dollar has been falling in value forever.

    When the kids see the list they do their own research and their picks are often very different as they come to their own conclusions. That is good because it gets them to think a bit. I don’t want to pick stocks that are so obscure that no one would recognize them or find them online.

    I am not saying that this is an allocation that I’d use solely for my own funds but I have jumped on the international bandwagon a few years ago through ADR’s and it has supplied some balance to the portfolio.

    Frankly once you get 10 or more stocks AS LONG AS THEY AREN’T THE SAME IN CHARACTERISTICS you will have a pretty diversified portfolio. Portfolio 1 has those characteristics, plus I started keeping some of their $ in cash.

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