Calculating your net worth

[justin]

I saw a post a few minutes ago inquiring about how to calculate one's net worth and ways to treat different types of assets on your balance sheet. The post went away, but I thought I'd make a new post because I had questions similar to those of the original poster.

I've started preparing a quarterly balance sheet showing my assets and liabilities and net worth. I have been listing the account balance of my taxable accounts and pre-tax accounts without regard to their future tax liabilities. I don't know if this is proper accounting-wise, or that it really matters that much. However, I do know a $100,000 balance in a Roth IRA is worth a lot more today and in the future than $100,000 in a traditional IRA or 401k. 100k in a roth is even worth more than $100k in a taxable account. It seems spending much time computing the potential tax liabilities on your different accounts with varying tax treatments is sort of an overly complicated process. Even your taxable accounts will have built-in capital gains tax liabilities (unless you are doing something wrong...).

I think when ER time gets here, we will have some tax planning flexibility with all our different account types to be able to keep taxes to a minimum.

For pension and accumulated leave, I have been listing my unvested ESOP on my balance sheet, but I tabulate 2 bottom line net worths - one with the unvested ESOP amounts included, and one net worth with unvested balances excluded. I haven't listed my accrued time off, but the value of this is small compared to my total net worth.

Generally speaking, the net worth that I compute is what I could get if I liquidated everything I own over the next few months and got cash for it. I don't include personal property (clothes, electronics, toys, books, furniture, etc.) because the market value for these are small and it would be burdensome to liquidate most of these items.

I also have fairly large student loans with fixed APR's around 1% or so for a 30 year term. The interest payments are also tax deductible and the principal balance is taken care of in the event of my death (so it is like life insurance). I have been toying with listing the amount of these loans as less than the principal balance that I owe, because the loan rate is so low and the other benefits. If I could transfer this liability to someone else like an investor, I'm sure I would be able to pay the transferee significantly less than what the principal balance is. So far I have kept the principal balance as the liability amount because I want to keep a conservative accounting of my net worth.

Do any others have any opinions on the way I have treated my assets or does anyone else do their balance sheet a different way?

 

[Martha]

Justin, you are working at this too hard. But really, if you look at net worth as what you are left after you sell assets and pay debts, you can't discount the debt just because you got a great interest rate.

Especially if you are not going to discount the value of assets by the costs of sale (like real estate commissions) and taxes you will owe on the sale.

 

[justin]

I just started doing the quarterly statement 12/31/04. When I first set up the list of assets and liabilities is when I had all the questions. Since then, I have simply kept the same conventions as those that I used when I started tracking net worth. It usually doesn't take more than 30 minutes to round up the data to get my net worth figure, and I will use an estimate for some amounts if getting the exact amount would not increase accuracy much and is time intensive.

I think tracking net worth is a good way to look at personal finances. I get to see how much I have saved and how much debt I have paid down. It is also motivating to see how saving more money makes my net worth increase.

 

[Martha]

I have tracked net worth off and on for a number of years. It is motivating when it goes up. A bit harder to handle in times of stock market or real estate price declines. It does help in making you think twice about spending money if you have to look at your net worth decline as a result.

I just wouldn't try to make a science out of it.

 

[justin]

I have a lot of small amounts of money here and there that add up. I find that one consolidated statement of what I have and what I owe - a snapshot- helps me make decisions going forward. It also allows me to look at the balance sheet and do what-if calculations. What if I move the trad. IRA into a Roth. What if I sell the rental unit and put the proceeds in the stock market.

I am many years away from retirement, but I know that the amount of net worth I'll need to accumulate before I get there probably has seven figures in it. I can see where my net worth is relative to my long-term goals.

 

[retire@40]

There are 2 kinds of net worth.  There is the classic kind that includes all assets, and there is the kind that only accounts for assets that produce revenue for you.

For ER purposes, my net worth calculation only accounts for assets that will give me a stream of income.  Homes don't count unless you are going to sell it, rent it, do a reverse mortgage, or anything similar.  Same applies to fur coats, diamond rings, and the pencil on your desk.

 

[cute fuzzy bunny]

There are 2 kinds of net worth.

There are 3 billion kinds of net worth.

Some people think owning their own home is worth a million dollars, even though it only cost $200k.

Some people think not working for a living is worth living off half of their prior income.

Some people think you should include the house, not include the house, include the stuff, not include the stuff, include the cars, not include the cars.

I think at the end of the day, net worth is the collective grouping of stuff that matters to you, minus the stuff that doesnt or that you dont like. And thats worthless as any measuring stick except one that has worth to the beholder...

 

[cute fuzzy bunny]

Hey, ya have to come up with something poetic to offset the Klingon and chipped teeth posts...

 

[laurence]

I (sort of )do include my home value, simply because DW and I have agreed that if it came down to going back to work or moving some place cheaper, we'd be packing our bags! Our theory is the house equity is the safety net, which will enable us to be on the high end of what Firecalc says we can spend from our retirement accounts. Company pension and SS is gravy and not counted on for income in our FIRECalculations. The fact that we'll probably see something from one or both of those plus the equity in the house makes me feel like I'd be running more risk of scrimping too much rather than not enough.

Geez, I just can't write right now, so forgive me if I lost ya there.

 

[cute fuzzy bunny]

I just can't write right now

Right now?

 

[justin]

I would say a house is a pretty important asset to have. While I agree it doesn't produce an income stream in the conventional sense, you have to live somewhere. Living rent-free is the benefit of owning a house. I know you still have taxes, insurance, maintenance, etc. But knowing that you won't pay rent that will be subject to inflation is worth something. In addition, most people could rent out a room or two if they got in a pinch financially.

I suppose someone with a lot of time on their hands could figure out the present value of a future stream of rent payments to see what a house is "worth" in terms of not having to pay rent.


For your net worth calculation, you use the definition of asset as being something that will give you a stream of income. Things like a zero coupon bond or growth stocks with no dividends produce no streams of income, yet are almost certainly assets. I guess it all boils down to how you define what your assets are. I know my house is an asset (sometimes it seems like a liability though).

 

[laurence]

Right now?

Have at you, churlish knave!

 

[cute fuzzy bunny]

Ah, your mother was a hampster and your father smelled of elderberries!

 

[retire@40]

...I suppose someone with a lot of time on their hands could figure out the present value of a future stream of rent payments to see what a house is "worth" in terms of not having to pay rent...

First of all, I don't think you figure out the "worth" of a house  by figuring out the present value of a future stream of rent.

Second, just because you live rent free doesn't give any worth to the rent you are not paying.  In other words, a non-expense is not an asset by any definition.

 

[retire@40]

For your net worth calculation, you use the definition of asset as being something that will give you a stream of income.  Things like a zero coupon bond or growth stocks with no dividends produce no streams of income, yet are almost certainly assets.  I guess it all boils down to how you define what your assets are.  I know my house is an asset (sometimes it seems like a liability though). 

I have a hard time following your thinking.  Zero coupon bonds and even growth stocks with no dividends do produce a stream of income when they are sold.

Your house is an asset, I never said it wasn't.

I just said

For ER purposes, my net worth calculation only accounts for assets that will give me a stream of income.  Homes don't count unless you are going to sell it, rent it, do a reverse mortgage, or anything similar.

If your only asset is your home with an equity value of $1 million, you will not be able to use that value for early retirement unless you plan on doing what I said in my quote above.

 

[justin]

I guess I am looking at the house being an asset that will factor in to my retirement plan. Let's say I have my house where I have no mortgage. I pay $300/month in taxes, insurance and maintenance. I could rent a similar place for, say, $900/month. My house saves me $600/month given these assumptions. This is $600 per month that I won't have to get from somewhere. By virtue of owning a house instead of renting, I have reduced my expenses by $600/mo which means I can reduce my retirement income by $600/month. And like I said before, I could always rent out a couple of rooms to make some income from my house.

I guess I should also say that my house is rather modest cost-wise compared to objective measures. Maybe $150k (I think I have it listed on my balance sheet at $140k). Currently I don't have much equity in it. Listing my house in my 'assets' column won't inflate my net worth too much. If I had a $1 million house with no mortgage on it, then my net worth would consist almost exclusively of my house. Of course, if I had an unencumbered $1 million house, I would probably do what you said. Sell it, invest most of the proceeds and buy a reasonable house to live in during ER.

 

[Martha]

In other words, a non-expense is not an asset by any definition.

Love it! This reminds me of my uncle who loved to buy stuff on sale and brag about how much he saved. And then he would take the "savings" and buy something else.

 

[retire@40]

I guess I am looking at the house being an asset that will factor in to my retirement plan.  Let's say I have my house where I have no mortgage.  I pay $300/month in taxes, insurance and maintenance.  I could rent a similar place for, say, $900/month.  My house saves me $600/month given these assumptions.  This is $600 per month that I won't have to get from somewhere.  By virtue of owning a house instead of renting, I have reduced my expenses by $600/mo which means I can reduce my retirement income by $600/month.

Am I being punk'd?

I don't think you understood a word I said.

I know a place that rents for $8,000 a week.  Since I only pay $8,000 a year for my home expenses, I'm living rent-free for 51 weeks a year.  No, No, even better.  I know of a house that sold for $2 mil.  My house is worth $500K.  I don't need any investments since the SWR on the difference of $1.5 mil is $60K and that is more than what I need to retire. 

 

[justin]

Am I being punk'd?

I don't think you understood a word I said.

I know a place that rents for $8,000 a week. Since I only pay $8,000 a year for my home expenses, I'm living rent-free for 51 weeks a year. No, No, even better. I know of a house that sold for $2 mil. My house is worth $500K. I don't need any investments since the SWR on the difference of $1.5 mil is $60K and that is more than what I need to retire.

you've been punk'd.

Let me rephrase what I stated earlier. If I were to rent the same house that I live in now, it would cost $900/month. If I own the same house with no mortgage, just taxes, insurance and maintenance, I would pay $300/month. Having this asset, my own house that I own, would cost me $600/month less than renting the exact same house. Not the house up the road that rents for $8000/week, but rather the same house. I'm comparing apples to apples, not apples to elephants (or whatever that $8000/wk house is!!!).

I don't know if you would call the $600/mo less that I have to pay "income" or "reduced expenses" or "nothing". In my opinion, not paying $600/mo for housing that I have to have is worth something. This is why I would argue a house is an "asset". In any event, I'll do my balance sheet with the house on it. You don't have to do yours the same way.

I would have to have an extra $180,000 in my portfolio to yield $600/month at a SWR of 4%. I'm not saying my house is "worth" $180,000. But from this example, I hope you can see that the house is worth something to a retiree. In this case a very substantial something.

 

[retire@40]

..I don't know if you would call the $600/mo less that I have to pay "income" or "reduced expenses" or "nothing"...

I call it nothing.

 

[justin]

I call it nothing.

I think this is why we disagree. I see owning a house that yields rent-free living as something, you see it as nothing.

Hypothetically speaking, what would you say about a paid in full health insurance contract (sort of like whole life ins. but for health insurance) that doesn't require any additional premiums, but will provide health insurance for the rest of your life. Let's say 100% of all medical expenses. This hypothetical policy would keep you from paying any costs for your own private health insurance, medical care, prescriptions, etc. You would never pay a dime the rest of your life. Would you consider this paid in full health insurance contract to have any value on your balance sheet? What if it retails for $50,000? What if you know it will save you $300/month for the rest of your life?


FYI for others reading this thread, I found this old post on calculating net worth that may be of value.
http://early-retirement.org/forums/index.php?topic=820.0

It looks like there are 2 distinct sides to the "is a house an asset" issue.

 

[Cut-Throat]

I look at my house as kind of an 'ace in the hole'. It's an asset as far as the bank is concerned but I really don't include it in my retirement planning, other than not having to make a mortgage payment. So it does reduce expenses.

On the other hand, I know that it being around $500K, I can easily get a reverse mortage about 20 years from now that should net about $135K in todays dollars. - So, that is my ace in hole.

 

[retire@40]

Hypothetically speaking, what would you say about a paid in full health insurance contract (sort of like whole life ins. but for health insurance) that doesn't require any additional premiums, but will provide health insurance for the rest of your life.  Let's say 100% of all medical expenses.  This hypothetical policy would keep you from paying any costs for your own private health insurance, medical care, prescriptions, etc.  You would never pay a dime the rest of your life.  Would you consider this paid in full health insurance contract to have any value on your balance sheet?  What if it retails for $50,000?  What if you know it will save you $300/month for the rest of your life?

If you don't have to pay for health insurance, it's an expense you don't have, not an asset.

If you paid $50K for health insurance for the rest of your life, it's a pre-paid expense that will be amortized over whatever lifetime expectancy was used. A prepaid expense is an asset, but it just replaces the cash asset that you had before you made the prepayment, so you don't have an increase in your total assets.

You are getting caught up with this "saving is an asset" thing. Not paying for something is just not included in your expense budget, it's not something you add to your assets.

 

[haha]

Second, just because you live rent free doesn't give any worth to the rent you are not paying.  In other words, a non-expense is not an asset by any definition.

Finally someone says something definite enough that it can be tested.

What you said above is interesting, but certainly Justin's house is an asset by most rational tests.  Both accounting and economic sense would classify this as an asset. First accounting. Look at any balance sheet and under assets you will find a category "Prepaid Expenses". These are carried at whatever amount was paid, less amortization over the period of prepayment. A house owned free and clear and that one lives in is also obviously an asset by the same reasoning. Some portion (probably an increasing portion) of ones shelter expense is already paid for. That is what an asset is. An under market apartment lease under rent control is an asset.

Owner-occupied houses also fulfill other definitions of assets- something that can produce cash flows. It can be sold, rented, partially rented, or encumbered... all in various ways producing cash.

Justin mentioned another good way to look at it. You take the value provided (in his example $600/mo.) and capitalize it at some reasonable rate. This can get very complicated, but what I would do is use an "adjusted SWR" of 5%. So if he gets $7200 worth of shelter from his home, multiply that by 20 to give an asset value of $144,000. As his house is burdened by a mortgage, he has to list the value of that note in his liabilities.

Assuming $7200 a year in benefits is very modest and conservative. If in addition he has an attractive, long term fixed mortgage on it, it is hard to see how this could not be a boon to his financial status and security, and thus obviously an asset.

It also requires a bit of care when you decide how much net worth is needed to retire, because since you capitalized a future service, you have to include the offsetting imputed rent in your budget.

The main benefit I can see to doing this is that although it requires some judgment, it won't mislead you into putting too little value on relatively non-liquid fixed assets.

It also allows you to see when the market value of your house is way out of line with its use value, and possibly it should be sold.

\Ha

 

[retire@40]

What you said above is interesting, but certainly Justin's house is an asset by most rational tests.  Both accounting and economic sense would classify this as an asset. First accounting. Look at any balance sheet and under assets you will find a category "Prepaid Expenses". These are carried at whatever amount was paid, less amortization over the period of prepayment. A house owned free and clear and that one lives in is also obviously an asset by the same reasoning. Some portion (probably an increasing portion) of ones shelter expense is already paid for. That is what an asset is.

Show me a balance sheet that has a house listed under "Pre-paid Assets."