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Net Worth Considerations
Old 07-18-2014, 06:12 PM   #1
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Net Worth Considerations

Easiest way to start a discussion is to try to define Net Worth.

With no agreement on the term, threads often turn into long explanations of how to calculate the number, usually based on the question, "how much is enough?"

Just a few of the differences:
Include the value of the home?
Include social Security?
Expected inheritance?
COLA on Pension?
Effect of age? Expected Future Wages?
Effect of Market, and Charting expectations.
Net Present Value... any estimated values.
Inclusion of Personal Property... Cars, Jewelry, Furniture, Collectibles, Antiques, Tools, 2nd homes, camps, recreational vehicles/property, life insurance,

Some of these items may have substantial net worth value, as in SS, which may have a Present Value of $400,000 or even more. Projecting a COLA'd Pension over a 30 year period could be much more. Annuities are often overlooked as an asset, though again.... Present Value could be a major factor when putting together a long term plan, which uses Net Worth as a base.

Then there are varying reasons for using one or another factor estimate net worth, with regard to age. A $400,000 house that might be considered as necessary at age 50, may make more of a difference in planning for someone who is 75, who is considering to use the cash value and moving to an apartment or a continuing care facility.

A key to making a plan using Net Worth, may be in understanding "Tangible Net Worth", especially in the case of finite planning... ie... using the amounts on the basis of one's expected lifetime, not including leaving an inheritance.

Using any calculator including FireCalc must include a full understanding of all of the above factors. Simple isn't always good.

At this point, I'll put in a disclaimer... Not being rich, I suppose investment ignorance doesn't qualify me to give advice, but a quarter century of living unemployed but above the poverty level has to count for something.
.................................................. ....................................
That said, some more basic points about net worth here:
Calculating Tangible Net Worth
How To Calculate Your Tangible Net Worth
Present Value of SS
What Is The Present Value Of Your Social Security Benefits? - Forbes
Money Scoreboard
Money Scorecard: How Do You Rate? - Forbes
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Old 07-18-2014, 06:14 PM   #2
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If you died today, what would your heirs get less any life insurance. That's your net worth.
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Old 07-19-2014, 09:36 AM   #3
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Well, there is an established definition promulgated by the Financial Accounting Standards Board for personal financial statements, which would include net worth. The standards broadly are similar to the recognition and measurement standards for corporate financial reporting.

See http://www.fasb.org/cs/BlobServer?bl...lication%2Fpdf

Quote:
Include the value of the home? Yes, at fair value
Include social Security? No, because it is life contingent
Expected inheritance? No, it is a contingent asset and is not recognized
COLA on Pension? No, because payments are life contingent
Effect of age? Expected Future Wages? No, ditto
Effect of Market, and Charting expectations. No
Net Present Value... any estimated values. Sometimes utilized in measurement but not recognition
Inclusion of Personal Property... Cars, Jewelry, Furniture, Collectibles, Antiques, Tools, 2nd homes, camps, recreational vehicles/property, life insurance, Generally yes, at fair value
Since I'm sure there will be a rukus as to why SS and pensions are not included, let me explain - since benefits are generally subject to someone being alive at the time the benefit is received (or thereabouts) there is uncertainty as to whether the benefit will be received so life contingent benefits are technically contingent assets and are not recognized. The resolution of the contingency (the beneficiary being alive is an event that results in recognition of the asset - a receivable for that months payment if applicable). OTOH, if you had a payout annuity with guaranteed payments for a period or for life with a certain number of guaranteed payments, then the value of the certain payments would be recognized as an asset because they are not life contingent. While I concede there are merits to recognizing life contingent benefits and for planning and other purposes they are critically important, the standard setters chose to draw the line there with respect to recognition in financial statements.

Also note, that net worth would include an estimate of taxes on tax-deferred accounts aka deferred income taxes.
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Old 07-19-2014, 09:40 AM   #4
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If you died today, what would your heirs get less any life insurance. That's your net worth.
A good high level conceptual definition and part of the reason the standard setters did not include pensions and SS and included deferred income taxes and used fair values.
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Old 07-19-2014, 09:46 AM   #5
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Net worth is a broad term that has different meanings for different applications. Why not just add a little context? Beauty is in the eyes of the beholder, and the definition of net worth is determined by the question being asked.
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Old 07-19-2014, 10:15 AM   #6
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Using the 'real' definition of net worth seems less valuable in retirement planning than some other indicator that includes defined future income streams. You know, the two guys that are completely identical in all financial respects, then one of them buys a life annuity with all his liquid assets.

We need more descriptive ways to describe "net-worth like attributes". After all, Eskimos have 50 words for various kinds of snow*, shouldn't we be able to come up with a few more terms for these various attributes?

*https://www.princeton.edu/~browning/snow.html
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Old 07-19-2014, 10:18 AM   #7
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If there is a concern with inheritance/estate tax, then you would consult your state's tax department for a better understanding of what might get included. This is definitely on the radar of those who live in states where the exclusion has not been raised in quite some time (like NJ).
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Old 07-19-2014, 11:01 AM   #8
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I thought there was a generally accepted definition of net worth: What you own less what you owe.

But that for accounting purposes things like future income streams are hard to value. Likewise some assets, like a personal residence are less relevant for retirement planning for some people, but not for others who perhaps plan to downsize. As a result, people have used variations on "net worth" to mean all kinds of things, and calculated it with different exceptions and exclusions accordingly.

I believe my "net worth" is everything I own, less any debts. I do not count SS, because while that is likely to pay me an income stream, I do not own it and the rules can change (with political process) any time. Court cases affirm that SS is not an asset or even a promise to pay. If I had a pension or annuity, I think I would have to include some idea of present value in the net worth calculation.

For retirement planning purposes, I calculate "retirement assets" which is a modified net worth. I exclude my house, since I plan to live here. I do not include personal property, cars, minor amounts of cash that maintain required minimum balances on accounts. These are the assets that I expect to use in SWR calculations for how much I can draw in income when retired.

I consider SS and the possibility of downsizing my house and renting as contingency plans or margins of safety in my plan. Without SS, my sustained withdrawal rate is above 4%, but with SS it is under 4%. I think I have an acceptable probability of success without SS, but with SS I feel a lot more confident with the higher probability. I don't consider SS an asset for net worth, but do consider it in my retirement planning.
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Old 07-19-2014, 11:20 AM   #9
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Quote:
Include social Security? No, because it is life contingent
Expected inheritance? No, it is a contingent asset and is not recognized
COLA on Pension? No, because payments are life contingent
I guess that's why they are called phantom assets.
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Old 07-19-2014, 11:57 AM   #10
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Like someone mentioned above, net worth calculations are made for a purpose, and what is included often will take that purpose into account.

To get loan, the banker clearly will not be interested in your ss or pension, except as income rather than collateral.

Often net worth is calculated by the owner as an ego massage. Then throw in everything, including your rubber ducky sitting on your bathtub rim.

One's personally used real estate and personal property involves a few caveats. It may cost a lot and there may be a fair amount of slippage in turning this into cash, especially if one needs to hurry. And of course, much owner occupied real estate, as well as personal property presents costs, like insurance, RE taxes, upkeep. A modest house that fits your needs and is where you want to be is an asset. A very deluxe house or more than one house is sliding into liability territory from the pov of an owner, though it will always be listed as an asset on the net worth statement.

From the pov of solvency only, a couple who live in a rental or modest house in Mobile and have an all-in net worth of $5mm is more secure than a couple with the same net worth, but much of it in a house in San Francisco.

Ha
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Old 07-19-2014, 12:05 PM   #11
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For my retirement calculations, I assume that I will live to 100 years. As such, any of my net worth calculations, which are most often in the context of retirement planning, will make that assumption also.

Social Security is included but discounted by ~ 1/3. This is due to the fact that even in if the SS trust fund is exhausted (which by the way did not even exist until the 1980s), the ongoing FICA deductions of subsequent generations will be sufficient to pay about 2/3 of accrued benefits.

Sure there is a chance that the next generation might just decide politically that they just aren't going to pay anymore, but I see that as a low probability event due to the continuing popularity of the program across all demographics.

-gauss
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Old 07-19-2014, 01:52 PM   #12
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Retirement investments are 90% of my net worth so I use them and also future income streams like my pension and SS when assessing my retirement funding adequacy.

Net worth isn't particularly relevant to my retirement planning. In my case my net worth is my retirement investments + bank account - credit card debt + home - mortgage + value of bigger personal property (car, truck, boat, jet ski, snowmobiles). I don't bother with the value of other personal property (furniture, electronics, etc) or deferred taxes because I only calculate net worth for my own purposes. Since I don't plan to sell my home and downsize or sell any of the other personal property, they will not influence my retirement cash flows (other than the cost to maintain and replace them which are in my budgeted living expenses).
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Old 07-19-2014, 01:55 PM   #13
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Quote:
Originally Posted by pb4uski View Post
Well, there is an established definition promulgated by the Financial Accounting Standards Board for personal financial statements, which would include net worth. The standards broadly are similar to the recognition and measurement standards for corporate financial reporting.

See http://www.fasb.org/cs/BlobServer?bl...lication%2Fpdf


Since I'm sure there will be a rukus as to why SS and pensions are not included, let me explain - since benefits are generally subject to someone being alive at the time the benefit is received (or thereabouts) there is uncertainty as to whether the benefit will be received so life contingent benefits are technically contingent assets and are not recognized. The resolution of the contingency (the beneficiary being alive is an event that results in recognition of the asset - a receivable for that months payment if applicable). OTOH, if you had a payout annuity with guaranteed payments for a period or for life with a certain number of guaranteed payments, then the value of the certain payments would be recognized as an asset because they are not life contingent. While I concede there are merits to recognizing life contingent benefits and for planning and other purposes they are critically important, the standard setters chose to draw the line there with respect to recognition in financial statements.

Also note, that net worth would include an estimate of taxes on tax-deferred accounts aka deferred income taxes.
Thank you for the link. I have read through most of the explanation. What I took from it was that the number representing Net Worth as defined, is very much apart from using that number to plan for retirement.

In effect, as I see it, the number represents what we would call collateral, established as the dollar amount of guarantee provided to negotiate a loan. Thus the reason that Present Value is counted in some cases, and not in others.

For that reason, I look at the number as just a part of my financial planning, A guideline to establish:
1. A number to establish an income cash flow on a yearly basis. Essentially, I look at all of my capital asset net worth... including the home(s), automobiles and other personal assets, and the surrender value of annuities. then... a one time calculation of the annual income provided by these assets. Thus... no income from the house, personal belongings and other properties that have no income stream, but tes... income from IRA's Money Markets, Ibonds, Annuit accumulation, and Stocks.

2. The total net worth. the total value worth described above. Essentially that described in the article cited by pb4uski.

3. The next step is to add up all of the other income from outside sources incoming from other sources. In our case, only Social Security, and a tiny bit from a personal loan pay off. For others this other income stream could include pensions, distributions, rental incomes etc.

Next, I add my known income stream from 1. above, plus my Social Security and other known- income... That gives me the BASE number to work with... ASSUMING that I want to keep my Net Worth to the day I die.

So... Here a theoretical example...
#1. $10,000 Plus #3. Social Security $25,000 other $3,000 total $38,000.
THAT would be the simple ongoing income.
__________________________________________________ ______

Now... the final step in planning. $500,000 net worth... as defined in the cited article.
Next... and last... Planning the maximum number of remaining years... In my case, 15... this would allow spending down the capital each year at
$500,000 divided by 15years... or an extra $34,000/year that I could spend... making a total annual income of $72,000.
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That was hypothetical... In my own case, after selling our summer home and the lake camp, our actual expenses will be less than $35,000 in the remaining years of our retirement.
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In several previous posts, I referred to the 2 phase retirement planning program, where situations change as we grow older... This is the way we use "Net Worth" in that planning.
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Old 07-19-2014, 02:02 PM   #14
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....3. The next step is to add up all of the other income from outside sources incoming from other sources. In our case, only Social Security, and a tiny bit from a personal loan pay off.....
I'm not quite sure where you are going with this thread, but... the personal loan would be an asset at the total principal amount due to you and would be included in item 1.
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Old 07-19-2014, 02:53 PM   #15
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There's a difference between net worth and cash flow, and the two are often detached as we all know. Most people have both a stash and SS and/or pension. Nowadays, with pension going away and this forum being about ER, many of us have to rely on the stash to tide over till SS kicks in.

I am living on 3.5% WR or less, and that is supposedly sustainable without other help. But I recently realized that SS for both of us will not be a negligible boost to cash flow. I think I will be quite all right, if not flush when that SS comes in. Heh heh heh...
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Old 07-19-2014, 03:34 PM   #16
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Originally Posted by pb4uski View Post
I'm not quite sure where you are going with this thread, but... the personal loan would be an asset at the total principal amount due to you and would be included in item 1.
: I'm not sure where I'm going either...

The personal loan in this case wouldn't be included in any probate, so more like a temporary income.

In any case, am not suggesting my plan for others... It's just my way of doing very simple one minute calculation of what I could/can spend.
Income from assets
plus
Other income
plus
Total assets divided by life expectancy available if and when needed.

Easier when the horizon is shorter.
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Old 07-19-2014, 03:41 PM   #17
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Net worth is only one component of a persons financial picture. It is easily calculated. Adding sources of income does not change net worth. However, it does have an impact on cash flow and quality of life. Feel free to calculate NW any way you want but you can't take it to the bank. There is no need to mix apples and oranges.
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Old 07-20-2014, 10:59 AM   #18
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Appears we are close to establishing our own definitions. We are certainly unique enough for that. Perhaps type a nw , includes... Type b consists of ..., thats how dictionaries operate.
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Old 07-20-2014, 11:05 AM   #19
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Originally Posted by foxfirev5 View Post
Net worth is only one component of a persons financial picture. It is easily calculated. Adding sources of income does not change net worth. However, it does have an impact on cash flow and quality of life. Feel free to calculate NW any way you want but you can't take it to the bank. There is no need to mix apples and oranges.
+1
You cannot evaluate any financial picture based on one indicator. I wish people would understand that. Net Worth has a very clear and precise definition. It is what it is. Calculate it correctly, or don't call it Net Worth. Cash flow is a different variable. Both are important. But to try to devise some kind of score based on mixing them is simply mental accounting.
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Old 07-20-2014, 11:10 AM   #20
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Appears we are close to establishing our own definitions. We are certainly unique enough for that.
The classic definition of net worth seems useful and should probably be left alone. Perhaps what's needed is a new term that can refer to the modified net worth used to calculate SWR, so that we can stop saying "net worth" when we really mean that other thing.
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