Million Dollar Journey posted in December of last year a comparison of the listed net worths of bloggers and it is still generating comments! If nothing else, it shows our natural curiosity (or our innate sense of nosiness) on how much people make or are worth. But, as is often commented on by others, net worth does not give a true indication of wealth in and of itself. It is merely a balance sheet value which is only really worth something if you liquidated all your assets. Many American found this out the hard way recently; as paper millionaires, their net worth was dependent largely on paper gains on their real estate holdings. Once that valuation collapsed so did their net worth (assuming they valued net worth of real estate at market value and not price of acquisition).
What, then, is a true determination of wealth? The “get rich quick” industry, for lack of a better term, certainly presents a viable measure of wealth: true wealth is determined by how long you can survive without any employment income. In other words, how long can you live on your investments? This concept of wealth has certainly been seized upon by Robert Kiyosaki, author of the Rich Dad Poor Dad series of books, as the true indicator of wealth and used as a selling tool into why people should invest in real estate (although one suspects he’s backed away from such naked support of real estate investing in this day and age).
It certainly makes sense to me from a business perspective. Business need assets to survive just like we do but businesses who do well generate the most of amount of cash from the money invested. This is typically business activities which require the least amount of effort. That is why businesses are moving away from labor intensive ventures (such as retail banking for financial institutions or traditional manufacturing for industrials) to ventures which can make money with smaller amount of employees or employs technology for operational efficiency (hence, explaining the rush for financial institutions be deal- making investment bankers). No one would argue that Bear Stearns was asset rich; its undoing was that it didn’t have enough short-term cash to get through the crisis.
On the personal finance level, and to extend this analogy, the business of “you inc.” requires more focus on activities that make you money with smaller effort than the traditional job. This would involve investing money into dividend yielding stocks, stocks that pay interest or return on capital, cash flow from real estate or returns on investments on private business.
Anyone have any other definitions of financial wealth?
April 28th, 2008 at 7:52 am
Thanks for the mention. That’s the tricky thing about net worth, people can include and valuate their assets at what they “think” it is worth. I like using net worth as a financial gauge as it shows the financial big picture and it’s progress over time.
April 28th, 2008 at 8:42 am
After reading your post, I’m not sure if you are validating the ‘how long can you survive without employment income’ concept as a good measure of wealth. Personally I believe net worth is still a better measure. The fact that investments, whether they be real estate or equities, can decline in value drastically over short periods of time, does not take away from net worth as a snapshot of wealth at one point in time. Earning money from investments when one is without employment is great, but that alone certainly does not define wealth. Many people can live for years without realy employment which I would not consider wealthy. By that definition Derek Foster, or an indivdual collecting welfare are the wealthiest people around. Garnering income from investments matters, however the actual value of assets is more meaningful. Assets that can be liquated and turned into income in various forms is the real deal. Assets-liabilities will always be the best measure of true wealth. I’ll take a million dollar net worth and my own business or a steady job anyday before I’ll take $20,000 in dividends for the rest of my life and an exit from the workforce. What you want to do to grow or derive the capital regularly is the key.
April 28th, 2008 at 8:52 am
I agree the net worth statement in the form purported by many bloggers and financial planners has many short comings that traditional accounting suffers. Typical net worth statements measure historical cost and market-to-market value of invested capital.
In the investment industry the value placed on the stock of a company should reflect the present value of its future income stream and to some extent we can see that this may hold some truth.
This is the true value of ones net worth the present value of the income stream of their investments? If so do we measure in perpetuity or should we limit our lives to the remaining life expectancy? How does the average person measure the present value of their non-dividend equity holdings.
I just posted a basic overview of preparing a net worth statement last week and your post draws some interesting questions.
The Personal Money Tips Blogger
April 28th, 2008 at 1:42 pm
One of the oft-forgotten investments in “YOU Inc.”, at least from a retirement perspective, is money “invested” into the CPP or private pension plans. For most retirees, this forms the core of their income at retirement, yet it’s rarely quantified as part of a net worth calculation.
Net worth is simply a snapshot - it’s a useful metric to determine if you are moving towards, or away from, financial independence.
As to the comment about real estate values and rapid fluctuations, I’ve tempered those problems somewhat on my personal net worth calculation by using the municipality’s valuation of my property (the one created for property tax purposes) rather than a true “market value”. I’ve found that this number is quite conservative, and avoids the large spikes and dips that can occur.
April 28th, 2008 at 3:02 pm
Net worth measurements have some advantages - for example, showing the difference between someone who makes $300,000 and spends it all and someone with a much smaller salary who saves regularly - but I agree that on the whole it leaves out a lot of information. If you count the value of the house you live in in your net worth that can make it look good, but you can’t actually sell it without making other significant financial commitments.
The real measure of your wealth depends on what you want. Your goals might include a large home for your family or one with a nice view; that’s something that has a certain value and isn’t as easy to put in cashflow terms. The best measure would be to look at what things you want to own that really make you happy and the cashflow you need afterwards for regular spending. You can convert between them - using cashflow to pay off large expenses or selling something for cash - but there’s really two separate parts. By that measure someone who owns a small home with no mortgate and lives off 20,000 in dividends might be wealthy in their terms, while a pf blogger with over $1m in assets might have a long way to go.
April 29th, 2008 at 12:17 am
…and then there’s the ’survivor’ factor. OK, this is a bit off topic, but I’m making my way through past episodes of LOST. One character, named Sawyer, doesn’t have much going for him and didn’t do any of the ‘right’ things, but he sure knows how to fend for himself when the going gets rough. Could another measure of financial wealth be: what is your cunning and crafty and gutsy quotient, as it pertains to managing money through good times and bad?