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.