Basic NW and Accounting Question.

[Jerry1]

This is something I always struggled with at work. Take a hypothetical question like “what’s my net worth”. Of course at work that was never an actual question. My answer always started with - “what are you going to use it for?”

In business, Net Worth is defined by general accepted accounting principles and its overriding purpose is standardization so that financial statements of different companies can be compared or utilize for analysis.

At a personal level, GAAP isn’t really relevant. If you want to plan your income stream, your net worth is irrelevant. If you go to a bank for a mortgage, your NW is almost irrelevant. They want to know your income stream.

In estate planning, your NW is more relevant but as described above by OldShooter, you need to make adjustments based on your intended use of the information.

Personally, my focus is on my investable assets when I’m thinking about how much I’m worth or how much I have to handle things like long term care. I don’t really worry about my estate planning because it’s simple - whatever is left my DD’s split 50/50.

When I budget, my main focus is on my SS (including DW’s) and my pension. They cover all my necessary spending and most of my discretionary spending.

I’m a CPA and while I have a spreadsheet that totals down to something I have labeled NW, it wouldn’t pass an audit and that’s fine. It doesn’t need to.

 

[ShokWaveRider]

We all add up our NW in different ways. Personally, we will deduct any SPIAs we choose to buy in the future. The one's I find most ridiculous are:

1) Car Value unless it is a collectable and has a true Auction Value. Daily drivers are typically not.
2) Any Jewelry that has not been values at true Auction Value. We all know most jewelry is only worth around 25% of its purchase price. In the case of gold, it is melt value at spot.
3) Furniture unless it is again antique and has a true Auction Value.
4) Tools
5) Electronics
6) SS & pension estimated values

I do believe a home should be added to NW at FMV. minus any mortgage or lien obligations. In our case we still use our 20 years ago purchase value. Our home has almost tripled in value but we still do not recognize it as such.

Again, we all do it differently and justify the math in our own way. But as someone mentioned earlier in NW is only valid in the eye of the beholder.

 

[RetiredHappy]

7 years ago I used all of my IRA to purchase 2 term deferred income annuities, 10-year, followed by a 15-year. I took the amount off my net worth immediately. However, they show up as my income stream for my age of 60-85.

My first annuity has since started paying out benefits. If I die before my 2nd annuity starts, my beneficiary gets back the lump sum that I paid in. So it does move back into "net worth" bucket for my beneficiary. However, if it starts paying, then my beneficiary will get the remainder term monthly payout.

 

[DrRoy]

I don't count my small pension.

 

[old medic]

Seems the more I learn, or try to learn, the more confusing it can be. NW seems to mostly an arbitrary number that depending what, where your assets are, and when in time.

 

[pb4uski]

I don't see it as arbitrary at all. IF you are adhering to GAAP, what should or should not be included is pretty clear, it is just that some people don't like or agree with where the standard setters drew the line.

But the reality is that unless you are a HNW person preparing personal financial statements for a creditor, there is no real use for net worth or personal financial statements and if you are doing it for your own entertainment and enjoyment then you can do whatever you want.

 

[Koolau]

Someone already suggested it depends on how you are going to use the NW number. I calc. NW once a year just to compare it to the previous year(s) to see if it's going up or down. That gives me some comfort (or potentially discomfort) regarding my spending and yearly investment results. Realistically, NW for me has no practical meaning, but it's a benchmark I follow - sort of like taking my temperature or heart rate.

 

[OldShooter]

Someone already suggested it depends on how you are going to use the NW number. I calc. NW once a year just to compare it to the previous year(s) to see if it's going up or down. That gives me some comfort (or potentially discomfort) regarding my spending and yearly investment results. Realistically, NW for me has no practical meaning, but it's a benchmark I follow - sort of like taking my temperature or heart rate.

Yeah. That's where the GAAP argument gets sticky. I wouldn't say that my NW went down significantly if I moved a chunk of change from MM into buying an annuity asset. If you don't recognize the annuity as an asset, your year-to-year comparisons go out out the window.

So we are back to "it depends."

 

[Jerry1]

Yeah. That's where the GAAP argument gets sticky. I wouldn't say that my NW went down significantly if I moved a chunk of change from MM into buying an annuity asset. If you don't recognize the annuity as an asset, your year-to-year comparisons go out out the window.

So we are back to "it depends."

Totally disagree. If you DO recognize the annuity your year-to-year comparison ignores the fact that you completely changed the asset from a liquid and relatively risk free asset (a MM fund) to an asset that has the potential entail to be worthless (which it will upon you death). Recognizing the annuity in your NW totally glosses over that significant change in your financial situation.

 

[OldShooter]

Totally disagree. If you DO recognize the annuity your year-to-year comparison ignores the fact that you completely changed the asset from a liquid and relatively risk free asset (a MM fund) to an asset that has the potential entail to be worthless (which it will upon you death). Recognizing the annuity in your NW totally glosses over that significant change in your financial situation.

How is that different from using the MM cash to buy a junk corporate bond, which I assume you would include in your balance sheet? Or maybe the MM money is used to buy a commodity option? Still on the balance sheet despite its inevitable expiration, right?

The potential for the annuity to become worthless can IMO be accounted for in what parameters you use in an PV calculation.

But back to "it depends." Do what you like with your NW calculation and I will do what I like with mine. Like what Allen Weisselberg said to Trump: "What number do you want it to be?"

 

[old medic]

I don't see it as arbitrary at all. IF you are adhering to GAAP, what should or should not be included is pretty clear, .

But the reality is that unless you are a HNW person preparing personal financial statements for a creditor, there is no real use for net worth or personal financial statements.

I had to look up GAAP, and it even stated its the simple "assets minus liabilities" on a "given date". Got a paid off million dollar house, Pig farmer moves in next door. Next day its worth half. Even if its
I agree with you on the reality of it on a personal level, Its more usable in a business/ company aspect.

As an example, our house... We paid $6500 cash 4 years ago...thats not a typo. We have done tons of work and spent thousands in improvements. Currently owe $5400 on different accounts at 0%. Checking on insurance, they put a value of $175-208K for coverage, Tax records value at $28K.
And haven't found a bank to loan us ant money on it because of their perceived loan to value.

 

[RunningBum]

Totally disagree. If you DO recognize the annuity your year-to-year comparison ignores the fact that you completely changed the asset from a liquid and relatively risk free asset (a MM fund) to an asset that has the potential entail to be worthless (which it will upon you death). Recognizing the annuity in your NW totally glosses over that significant change in your financial situation.

No, it really does depend on what you are using it for. When I die, it is no longer my financial situation. If you are calculating for your estate, of course you wouldn't include it. But if you are using it to calculate your AA, you might.

If you don't want to change how you invest, when you annuitize you either have to include the annuity as an asset, or change your AA ratio, unless you happened to pay for the annuity by drawing from your assets by that same ratio.

 

[pb4uski]

How is that different from using the MM cash to buy a junk corporate bond, which I assume you would include in your balance sheet? Or maybe the MM money is used to buy a commodity option? Still on the balance sheet despite its inevitable expiration, right?

The potential for the annuity to become worthless can IMO be accounted for in what parameters you use in an PV calculation.

But back to "it depends." Do what you like with your NW calculation and I will do what I like with mine. Like what Allen Weisselberg said to Trump: "What number do you want it to be?"

It is different from a junk bond because if you die, the junk bond still has value, whereas if you own a life annuity and you die then the annuity is worthless. The option would be carried at fair value and the value will reflect the likelihood that it may expire worthless.

While the annuity could be valued using a mortality table and the time value of money, it really isn't valid to use mortality tables for a single life. Way back when, the standard setters decided that it was too dicey to include as an asset so a life-contingent annuity would be not recognized until you have the legal right to the benefit (you live another month). Of course, it should be disclosed in the footnotes so the reader, like a banor other creditor, can include that fact in making their credit decision if they wish to.

If you don't like that answer, write to Financial Accounting Standards Board, 801 Main Avenue, P.O. Box 5116, Norwalk, Connecticut 06856-5116

 

[MarieIG]

From time to time I do a "back of the envelope" calculation of NW. Assets minus liabilities. IMHO, NW is different from portfolio - and while, for example, I am aware of the (approximate) value of my house, I would not include that in a portfolio or consider it for withdrawal purposes. I would not include a SPIA but I would include a MYGA. (Yes, I agree that payments certain would have a current value but, for my own purposes, I'm not going to calculate that.)

DH's pension has payments certain for 10 years if we both bite the dust early, and while I looked at what it would have cost to buy a similar income stream, I did not add that to our portfolio. (It cost precisely nothing to add the payment certain feature, so I did.) Full disclosure - when doing my back of the envelope calculation, I completely forgot about the current "value" of my variable annuity - which in any event I will "remove" when I annuitize it.

 

[Jerry1]

How is that different from using the MM cash to buy a junk corporate bond, which I assume you would include in your balance sheet? Or maybe the MM money is used to buy a commodity option? Still on the balance sheet despite its inevitable expiration, right?

Let’s stick to your example - a year to year comparison. Would you revalue the bond or the option? Yes - a bond or option would have its value stated on your year end statement. So, you would recognize the new situation that your purchase put you in. But now you don’t want to consider that with the annuity? You bought an income stream. You need to recognize that.

 

[OldShooter]

... If you don't like that answer, write to Financial Accounting Standards Board, 801 Main Avenue, P.O. Box 5116, Norwalk, Connecticut 06856-5116

I don't like or dislike the GAAP answer. It is irrelevant to my purpose. Actually, GAAP has lots of problems that can make the asset side of the balance sheet a poor representation of reality. Among the many: goodwill, values of purchased real estate, values of depreciable assets. But I don't care. And I guess it's good in the sense that it provides employment to analysts trying (a la Ben Graham) to figure out the real value of an enterprise.

... You need to recognize that.

No I don't. It's my personal NW balance sheet and my goal is to have it be a reasonably accurate representation of my reality. Pretending that an annuity has no value does not contribute to my goal.

Sheesh. I don't know why you guys are so testy about this.

 

[Dash man]

My view in retirement is if an asset will be included in our estate value when each of us passes. Not a big deal now, but possibly in 2026 or later, especially if we have a couple more years like this.

 

[pb4uski]

I don't like or dislike the GAAP answer. It is irrelevant to my purpose. Actually, GAAP has lots of problems that can make the asset side of the balance sheet a poor representation of reality. Among the many: goodwill, values of purchased real estate, values of depreciable assets. But I don't care. And I guess it's good in the sense that it provides employment to analysts trying (a la Ben Graham) to figure out the real value of an enterprise.

No I don't. It's my personal NW balance sheet and my goal is to have it be a reasonably accurate representation of my reality. Pretending that an annuity has no value does not contribute to my goal.

Sheesh. I don't know why you guys are so testy about this.

You're the one that's testy. We've already conceded that you can do whatever makes you happy since the view you are creating is for your own use. You just can't call it GAAP, that's all.

 

[Jerry1]

Sheesh. I don't know why you guys are so testy about this.

The written word does not convey emotion very well. I'm not testy at all. Imagine standing at the water cooler with a co-worker and go back and read my responses to yours. It's all good. I'm just conveying some of the subtleties of the premise you presented.

 

[Koolau]

Yeah. That's where the GAAP argument gets sticky. I wouldn't say that my NW went down significantly if I moved a chunk of change from MM into buying an annuity asset. If you don't recognize the annuity as an asset, your year-to-year comparisons go out out the window.

So we are back to "it depends."

From time to time I do a "back of the envelope" calculation of NW. Assets minus liabilities. IMHO, NW is different from portfolio - and while, for example, I am aware of the (approximate) value of my house, I would not include that in a portfolio or consider it for withdrawal purposes. I would not include a SPIA but I would include a MYGA. (Yes, I agree that payments certain would have a current value but, for my own purposes, I'm not going to calculate that.)

DH's pension has payments certain for 10 years if we both bite the dust early, and while I looked at what it would have cost to buy a similar income stream, I did not add that to our portfolio. (It cost precisely nothing to add the payment certain feature, so I did.) Full disclosure - when doing my back of the envelope calculation, I completely forgot about the current "value" of my variable annuity - which in any event I will "remove" when I annuitize it.

I occasionally do a back-of-the-envelope (BOE) of NW (including home value) just for "funzies." But my "thing" is to at least "think" of NW as my portfolio which includes virtually every invested asset (but no real estate or cars, belongings, jewelry, etc.)

With that in mind, here is a classic example of how that can vary in a somewhat bizarre fashion:

Before retirement, I had a condo in Hawaii that I called an invested asset. IIRC I valued it at about $250K at the time. I had a home I lived in which I valued at about $150K. The $250 was part of my BOE NW while the $150 was not part of NW.

When I moved to my Condo and sold my house, NW changed by (plus) $150K (proceeds of my personal residence - then invested in a short term CD) but (minus) $250K due to my condo moving from an investment to a personal residence. NW went DOWN by $100K and all I did was move.

So, it's complicated and we each set up our own rules for determining NW. Nothing right or wrong as long as the "rules" are stated. Anyone can disagree with the rules and set their own rules. I love to be able to set my own rules. It's part of the FIRE experience but YMMV.

 

[Finance Dave]

For many years I've calculated our NW annually and we had a "goal" in mind. Included in our NW at the time was a lump-sum pension at MegaCorp that included an option to turn into an annuity at any time prior to distribution (and prior to age 65). Last year we decided to do the annuity...so for a year now I've been getting a direct deposit for about $1,400/mo. But when I sat down with DW to discuss our financial position (which we do every year for about an hour while sitting in our home office), she asked why our net worth went down so much. Well, part of it was that we spent money for the year, but also part of it was that our lump-sum pension no longer existed, it was now an annuity. Not saying either way is right or wrong...just need a broader understanding of our finances so that it makes sense. As I said earlier...there's nothing wrong with having a $0 NW if you used all your money to buy a COLA'd annuity that pays you $200k/year for life.

 

[ShokWaveRider]

We do not need to Calculate it, our MoneyDance Software automatically does it for us.

 

[Cobra9777]

OK... I'll jump into the fray.

For me, NW is a more comprehensive and consistent way to track changes in wealth over time, compared to the portfolio alone. I include an estimate of the FMV of our home because we can easily convert it to cash and become renters. Or more likely, convert part of it to cash, and part of it to a significantly smaller home. Maybe the smaller home will have a mortgage, maybe it won't.

I also include the estimated FMV of our recently-purchased Class B camper van. It's a significant value and will also be converted back to cash at some point in the future. In any case, NW is a useful mechanism to keep these asset transfers on the balance sheet, if they are material enough to track as such.

I also had the same scenario that Finance Dave described. While working, I always included the vested lump sum value of my pension as part of NW. That's the amount I would have received had I left employment, or elected the lump sum option at retirement. But at retirement, I decided to take the annuity instead. So our NW suddenly declined by the amount of the lump sum. Or did it? I think compelling arguments can be made either way, as far as how to handle that situation. But just to keep it simple, I removed the lump sum values from all my historical tracking so that I have an apples-to-apples trend line moving forward.

Again, my intent is just a consistent and comprehensive tracking of changes in wealth over time. I see nothing conceptually wrong with counting the pension NPV going forward. I just thought it was simpler to recalibrate to a lower baseline, and move on.

 

[brett]

I would view my net worth in terms of total current realizable value of all assets.

If I die, the only realizable value that will be derived from my DB for my estate is the $15K life insurance policy that is part of of the DB benefit.

Since it is not a realizable asset, other than the $15K, I would not include the DB it in my net worth.

Even if I was so inclined to focus so intently on my net worth. I really do not see the point in such an exercise other than perhaps ego.

 

[sengsational]

NW went DOWN by $100K and all I did was move.

That should indicate you did something wrong


The tendency here is to be conservative, and that often means leaving primary residence out of the net worth calculation. I know if I ran out of portfolio money and owned my house, I'd sell it, or effectively sell part of it (get a loan on it) rather than eat cat food. It's not a liquid asset, but I think it belongs on the balance sheet. The fact that you're "never going to sell it", is irrelevant.