It was late 1992, and my family and I just arrived in the US.
We had liquidated pretty much everything of value we owned back home to cover our moving expenses, but that wasn’t enough, so we borrowed $6000 from my parents.
Beyond our clothes, a few books we brought with us, and some toys for the kids, we really didn’t own much. That meant that our net worth, what we owned minus what we owed, was negative.
My new annual salary was $31,000 – not much to support a family of four, even in West Texas.
For years, we had to be very careful with our groceries, and those $0.20 packets of ramen noodles featured far too often as what was for dinner.
We did ultimately pay my parents back, but it took many years, because my salary was so low, our immigration status didn’t allow me to earn anything through side hustles, and my wife wasn’t allowed to work at all.
It’s been a heck of a ride in the nearly 28 years since then, and I'm grateful for the success we've seen. Throughout the years, I always used our net worth to map where we were, to figure out if we’re getting closer to our goal or further away, and to compare different options to make the optimal choice.
I’ll give you some examples below of where I used net worth to make better decision, but first let’s define what we mean by net worth and accessible net worth.
The Classic Definition of Your Net Worth
As mentioned above, your net worth is the difference between what you own and what you owe.
Here are some examples of things you may own:
- Your bank account balances
- Your investment accounts’ current value
- Your cars’ value (use Edmunds.com’s true market value to estimate this)
- Your home’s value, if you own (use Zillow.com to estimate this)
- The estimated value of your business, if you own one (this is harder to estimate, but if you use a consistent measure such as 3x your annual profits, you’ll know your progress)
- The value of your personal property (e.g., jewelry, furniture, clothing, etc.)
- The cash value of life insurance policies, if any
Here are some examples of what you may owe:
- Your mortgage balance (ideally, this should be your payoff amount, but if you use your balance consistently, that’s good enough)
- Your auto loan balance(s), if any
- Your credit card balance(s), if any (even if you pay these at the end of each month, include the snapshot-in-time balances, since you’ll have to pay those back, likely with money that’s currently in your bank accounts)
- Your student loan balance(s) (even if you anticipate having these forgiven due to working or volunteering in eligible positions, you still owe this money until it’s forgiven)
You can use this Bankrate.com net worth calculator to estimate your current net worth.
If you’re happy with this way of estimating things, that’s perfectly fine, and will let you see how you’re doing over time.
However, you can do better if you’re willing to make a few simple changes…
Accessible Net Worth – per Ben Le Fort
Ben Le Fort defines “accessible net worth” as your net worth excluding the value of your primary residence but including your mortgage balance.
Le Fort offers good arguments as to why you may want to exclude your home’s value from your net worth calculations. Specifically, he points out that accessing this value is difficult, and comes with drawbacks and risks. However, Le Fort’s retaining your mortgage debt in his definition leads to some unreasonable side effects.
To see this, let’s say you’re about to buy a $300,000 home using $60,000 from your savings to cover a 20% down payment, and taking out a $240,000 mortgage to finance the rest. You’ll also pay $5000 toward various lender fees and other closing costs.
For simplicity, let’s assume that before the home purchase, your accessible net worth was $165,000. At closing you hand $65,000 to the title agent, who forwards $60,000 to your lender as the down payment.
According to Le Fort’s definition, the instant you bought the house your net worth decreased by the $65,000 of your down payment and closing costs, and by another $240,000 mortgage balance. This means that by signing the (very many) dotted lines, your accessible net worth dropped by $305,000 to a negative $140,000!
You don’t get to count your home equity toward your accessible net worth, which is reasonable since it’s not easily accessible. However, per Le Fort, you must count your total mortgage debt against your accessible net worth, which is not reasonable. If you don’t count the value of your home, you should not count the debt that’s linked to that value.
Since I very much doubt that Le Fort would include in accessible net worth the (multi-million-dollar) capitalized cost of long-term rent payments for someone who rents, it makes no sense to include the mortgage balance, which would be part of the capitalized housing cost for a homeowner.
Another problem is that Le Fort retains in his calculation all non-financial assets, such as furniture, jewelry, etc. These are also hard to access, whether for sentimental or practical reasons. For example, if you had to sell everything in a hurry, would you get the same value for your furniture as what it would cost you to replace them? Hardly!
To sidestep these shortcomings, I define accessible net worth a bit differently.
My Definition of Accessible Net Worth
The way I see it, accessible net worth is the easily accessed value of your assets minus the balances of your non-mortgage debts.
If you own a collection of rare books and want to include its value, estimate how much you could get if you had to liquidate it in a hurry.
Want to include the value of your car? Get an estimate from Carmax of what they’d pay you for it. This is likely far less than you’d get from a private party, but it’s what you could get in a hurry. Also, only include this if you can do without the car. Otherwise, subtract how much you’d need to spend on a less expensive vehicle with which you’d replace it.
I’m with Le Fort in removing the value of your home from the calculation, but unlike him, I remove the balance of your mortgage too. If you had to pay off your mortgage right away for some reason, you’d sell the house, which would actually add the home equity (less the cost of selling the home) into your accessible net worth. If you're concerned about the rent you'd have to start paying, that would be more than offset by not having to make any further mortgage payments.
In my opinion, since valuing non-financial assets' quick liquidation value is difficult and likely to overestimate what you have, it's better to use a more conservative estimate of your accessible net worth by including only financial assets and liabilities. This excludes cars, furniture, jewelry, business, and home equity. Since you could liquidate any life insurance policy cash value(s), I count that as part of accessible net worth.
Why You Should Remove Your Home Equity from Accessible Net Worth
Selling your home at what you think it’s worth can take months, or if the market has gone down, it could take years to recover. A friend of mine had to wait over two years to offload his previous house, to avoid paying more to settle his mortgage than what he’d get for the house in a down market.
There are significant costs too, not least of which is your real estate agent’s commission (up to 6% of the sale price). You could try to sell without a realtor, but unless you’re as savvy as one, you may well end up with a sale price that’s lower by much more than 6%.
You may object that you can access your equity using a home equity loan or line of credit, or that you might be able to take out a reverse mortgage. Both are true (at least in some circumstances), but as Le Fort points out, there are risks and costs involved with either of these options.
Why You Should Remove Your Business Value (if Any) from Accessible Net Worth
If you own a business, selling it will likely take many months, and up to several years, if there’s even anyone willing to buy it. Trying to hurry this process will make it much more difficult to find a serious buyer, let alone one willing to pay what your think it’s worth. Further, selling the source of your income is unlikely to improve your financial situation.
How to Use Net Worth and Accessible Net Worth to Make Better Financial Decisions
In almost all cases, the more you know about your finances, the better. This is why I look at both our “classic” net worth and our accessible net worth when figuring out where we are now, projecting where we may be in the coming years, and making financial decisions. Here are three types of such decisions where I used this tool.
Making a Large Purchase or Not
When considering a large purchase, I don’t look just at whether we can afford the expense. I also look at what impact this purchase has on our projected future accessible net worth by the time we’d want to be able to retire. If the purchase would significantly reduce the amount we could expect to safely draw from our portfolio in retirement, that goes into the “cons” column when making the decision.
Selling a Previous Home vs. Leasing It Out
We moved to a new (for us anyway) home a couple of years ago. Since we had the wherewithal to do this without accessing the equity in our previous home, we had the luxury of choosing whether we wanted to sell our old home or lease it out. To make the best decision, I projected the impact on our net worth and our accessible net worth of both options. The leasing-out option projected to increase (both flavors of) our net worth more, so that’s what we ended up doing. Of course, if we suddenly find that we can’t rent it out at a profit, we’ll reconsider, and may sell the property.
Starting a New Business
Starting a business almost always takes investment.
For some businesses, the investment is mostly your own “sweat equity.” For others, it may be paying for training, education, coaching, equipment, space, tools, etc. For some, it may take a major capital investment, such as purchasing commercial real estate.
When the investment has such a financial component, you want to put together at least a basic business plan, to see how much you’re likely to make, how much you’re likely to spend/invest, and how your taxes will affect things.
I did exactly that when deciding whether we should buy an office suite or continue leasing one from others. Ultimately, seeing that our net worth will likely grow faster if we bought office space, especially when considering the tax benefits of depreciation, I set up a new company to buy the office space, and found tenants to lease space from us.
The Bottom Line
If you’re trying to get someplace, whether a physical location or a financial goal, you’re very likely to fail if you don’t know where you are now, and if you don’t keep track of your progress over time.
Calculating your net worth, both classical and accessible, and using this calculation to project your possible outcomes, lets you make optimal financial and business decisions.
Financial strategy is all about setting financial goals, crafting a plan to reach them, and doing what's needed to start implementing that plan in both your business and personal life. Figuring out how to make the best decisions is an important part of financial strategy. If you'd like to learn what financial strategy can help you accomplish, email me and we'll coordinate a free, no-strings-attached phone call to explore that.
This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.