Why You Shouldn’t Obsess Over Your Net Worth

Dancing At Dundas Square

Yay! We’re out of debt!

“Cure for an obsession: get another one.”
–Mason Cooley

There are few things about which I am obsessive. One of them is toothpaste on the rim of the tube. For whatever reason, if the top doesn’t smoothly twist onto the tube, it drives me nuts. Yes, I know…squeeze toothpaste. Even though I am a generally Type B personality – which caused no end to consternation to my bosses in the Army – I do occasionally get my knickers in a twist over a few things.

One of them was looking at my net worth after I graduated from business school. Probably because it was quite a significant negative number.

Really big.

So, seemingly every day, I’d fire up Microsoft Money, download statements, and see if we were making any progress. I did the happy dance when we finally got to a net worth of zero.

Then, slowly, over time, we got above zero.

Eventually, though, I started wondering what the world would look like when I retired. I harbor ambitious plans of early retirement, so I started trying to determine what I would need to retire.

That’s when I had the “a-ha” moment about what I really needed.


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What I needed was the ability to pay for expenses. I wanted to be able to cover a certain amount every month through a variety of sources – to pay for food, electricity, etc.

It wasn’t my asset base that I was necessarily concerned about; it was the income and purchasing power that the asset base could create that I needed to focus on.

In 1920, a couple of Yale professors, Irving Fisher and Harry Brown, came to a similar conclusion in their book The Purchasing Power of Money. People who save, invest, and borrow money are concerned with its actual purchasing power. Inflation and prices rise and fall; yet, we generally consider money as something stable. Furthermore, we don’t really consider what a certain amount of money can yield in future income. Instead, we think in terms of either present income or present purchases.

Now, before you dismiss everything I have to say out of hand, I’m not saying that net worth isn’t important. Yes, you need to get your personal balance sheet positive, where assets are more than liabilities, and, better yet, get liabilities to zero. It’s much more fun to live life without debt! But, the focus on a “Number” – the magic point where once you reach it, you’re done – is probably overstated.

Here’s what you should be looking at:

  • You can’t really change your net worth on a day to day basis. When I was in my obsession period (right after my Blue period and before my Orange period…thanks Picasso!), my wife and I were getting paid twice a month. So, for two days a month, our net worth went up. Whee! Yet, we spent money the other days of the month too. So, for 28 or 29 days a month, our net worth went down. Boo! Instead of seeing and appreciating the overall progress that we were making, my Monkey Brain was focused on 2 wins and 28 losses each month.
  • It’s what you get in return for the assets that matters. As Ludwig von Mises postulated, money is simply a proxy for exchanging goods and services because there is no more efficient mechanism for doing so. If you were a shoemaker and needed bread, but the breadmaker didn’t need shoes, you’d have to find a third party to intermediate. That’s what money does. It’s why inflation is important. The purchasing power of a million dollars is less today than it was fifty years ago and will be less still in fifty more years. Over time, money sitting in cash loses its ability to buy things for you.
  • Income provides you with security. This study shows that people who have sources of income feel more security. I believe that this is because people are more concerned with their purchasing power, and they’re more concerned about today than they are about the future.

Once you understand that it’s not net worth, but, rather, your potential purchasing power with future income that is important in retirement planning, you can take an additional step. Research from Boston College’s Center for Retirement Research shows that people who factor in how retirement investments can translate into future income save more than people who simply think about an amount to save. When presented with information about how much income they could get if they made additional contributions to a retirement plan, people saved 29% more than those who were not presented with that information.

If you’re sitting in your next HR presentation about 401k plans, or you’re deciding how much to contribute to your IRA, you might not have a calculator handy to tell you how much your contributions could actually affect your retirement income. What do you do then? An imperfect but effective way to estimate retirement income is to multiply your contribution by 0.03. The result you get is roughly how much annual income the contribution you make in one year would get you thirty years later. It’s an imperfect heuristic, admittedly, combining SAFEMIN and recent research challenging the 4% safe withdrawal rate for retirement, but it’s the process of thinking about future income which is important.

So, while net worth is important, it’s really just a proxy measurement for the things which matter – what can you purchase now and in the future, and how much security can that bring you. Furthermore, if you obsess over your net worth on a regular basis, you’re going to remember the losing days more than the winning days, which will cause you to take unnecessary risks to try to have more winning days – counter to the strategy that you really need to be following.

If you’re going to obsess about something, make sure it’s insignificant, such as how many times Snooki will say “um” in the next Jersey Shore episode.

This article appeared in the Carnival of Wealth, where they don’t baby you. If Control Your Cash isn’t on your shortlist of personal finance reads, you’re missing out.

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About Jason Hull

Jason Hull is a Fort Worth financial advisor. Before becoming a Fort Worth financial planner, Jason co-founded, built, and sold a software development company. He is a CFP candidate, has a MBA from the University of Virginia, and a BS from the United States Military Academy at West Point. He is the owner of Fort Worth financial advisor Hull Financial Planning.

Comments

  1. Well said, it really is just a number that is potential purchasing power and used in retirement planning. We don’t focus so much on the numbers as opposed to whether or not we are on track and we are not going down as opposed to up. You are right, we can’t change the numbers unless we are spending more than we earn, then we have all the power to make changes but that still only leaves us with a number. Cheers

    • Hi! Thanks for dropping by, CBB! I’m going to show my geekery, but I think more of the first derivative of “The Number” – are we accelerating towards the goal or slowing down. There are also multiple approaches to figuring out when you’ve reached financial independence; using a Bengen-based 60/40 split with a 4% safe withdrawal rate is only one (and probably inaccurate) approach to marking the financial independence goal.

  2. Good post, Jason.
    This became a reality for me when I looked at what our military retirement benefits will be. Thanks to our long, dedicated service to our nation, our ‘number’ is less than it might have been. In fact we may be able to live comfortably, yet frugally, without ever accumulating an epic net worth.
    The real shame is the number of Americans with negative net worth. That is when net worth needs to be a priority IMO. One way to think of it is this: Imagine a homeless man on a street corner. He has no money, no assets, and no debt. A passing stranger drops a quarter in his cup. He now has a higher net worth than about 30% of American households COMBINED.

    • Rob–

      You’re a case in point. Since you’re a retired Marine, your net worth could be zero, and, ostensibly, you’d be fine, since you’d still have retirement income.

      I agree about the issue that we face with people saddled with debt.

      However, I disagree about the effective net worth of the homeless guy on the street corner with a tin cup rattling around due to his shiny new quarter. His prospects of a lifetime of good income are pretty slim. Even people with a negative net worth have a reasonable expectation of a lifetime of income earning potential (subject, of course, to the vagaries of life like being hit by the beer truck). Tomorrow’s article deals with matching two different curves: a neverending lifetime of expenses compared to a (for most people) terminal point of income.

      • I think we still agree. Regarding income potential, I just gave an unrealistic example.
        But I like my example because I think it is more consciousness-raising a la ‘The Millionaire Next Door.’ If you drop your kid off at Little League while driving a Maserati, but have law school debt greater than you assets, how much better off are you than the homeless guy? Some, a little, a lot? You may never be on the street (it’s happened – I gotta find that link!) but I think it’s time to radically change course before bad gets worse.
        Mr Money Mustache does a great job on frugality. You are right to address income potential. I’m saying too many Americans — the ones with the boat, the trailer, the BMW or F-450 — have their heads in the sand when it comes to net worth.

        • Yes. People get on the hedonic treadmill long before their income can actually justify the expenses. They use hyperbolic discounting to justify spending now and assuming they can pay for it.

          Even though I proudly drive a beater, I’m not against people enjoying the fruits of their labors, but only after the labor and the harvest. I’m quite aware of MMM, and while he and people like Jacob of Early Retirement Extreme can live a quite frugal life, I think that the reality is that they serve a truly small niche. That’s the great thing about financial security and a financial plan which aligns with priorities in life. You choose the tradeoffs intentionally when you’re in that situation. Frugality isn’t the solution to every financial problem, although certainly, for people who are in debt, driving the Maserati (undoubtedly tied with an appurtenant car payment) while swimming in debt, reining in the spending is the first step.

          As a broad brush statement, people are too caught up in conspicuous consumer consumption and spend far too much money on items which provide no return rather than purchasing assets which will then subsequently throw off income to fund future expenses (and, if desired, increased consumption!).

          The equation isn’t all that difficult. Adjust two of three variables:

          • How much you spend
          • How long you work
          • How much you save

          People like MMM optimize for working fewer years and spending less, but that’s not the only solution.

          The problem, as you’re pointing out, is that people don’t even optimize the equation. They expect their future selves to figure it all out, buoyed by the expected pay raise which they’ll get every year, convincing themselves that this time, it’ll be different, while making no behavioral changes. That’s where it all falls apart.

          Focusing on an outcome rather than a number is one step in the long series of behavioral changes which can help people escape the consumption trap.

          • Amen, brother.
            btw here’s why I don’t drive a beater and why MMM probably thinks I’m insane.:
            http://www.robaeschbach.com/why-i-keep-buying-brand-new-cars/
            I think the 3 of us may be pointing in 3 different directions but ultimately get to the same place: “Spend less than you earn”.
            But I am definitely bringing up my ‘homeless guy’ when a client wants to buy a boat but has no savings!

          • I have to admit, I’m at the point where I’m wondering if I’m sinking unnecessary money into the next repair on the beater – will it extend the life of said hoopty long enough to justify the incremental spending. Of course, car owners will face that decision, regardless of whether the purchase was originally new or used. Hey, if cars are important and you can afford it (both criteria you clearly meet), then go for it! It’s all about intentional and conscientious spending, regardless of where the money goes.

            Here’s the boat I suggest, since it might become a home!

          • LMAO.
            I had the same problem, more or less on two cars: new model-itis, in my case. New cars, new problems, should I keep them?
            The better example is the 2005 F-250, widely derided for its diesel engine. Thanks to the used-car market you wouldn’t believe what the dealer gave me for it. I bought the same truck, in a newer more reliable model year for the same price as the old one. Way happy.
            It’s funny to think my kids will learn to drive in it year from now.

  3. Jason,

    I thought I’d write because it is pretty hard to convey my viewpoint in 140 characters.

    I don’t have any major issues with any of your points, but I do think I have a somewhat different point of view. First, I feel as if you’re setting up “Net Worth” for failure by associating it with the word obsession. A philosopher might refer to such an approach as appealing to emotion; associating an action that is always bad (obsessing) with a quite useful benchmark which leaves no financial stones unturned, otherwise known as Net Worth.

    Case and point Jason, I have personally used Quicken to track my own personal financial picture. Quicken has 3 mail categories 1. Investing (liquid monies) 2. Property and Debt and 3. Banking. If one were to value, say, only the liquid portion (the part that can always generate income), and ignore, or devalue, the other two (by choosing a more narrow metric than net worth), then you could potentially end up with a very distorted picture of where one really stands, financially.

    Case-and-point, take a hypothetical individual who has 400K in investments, but say they live in Phoenix and bought a home at the top of the market for 1 Million (financed) and it’s currently only worth 300K. Say they only have 200K in the house (due to a hypothetical multiple refinances) so they still owe 800K. Then they have 400K minus 800K for a NET WORTH of negative 400K. These people are beyond broke. And what one number really mattered? Net Worth. I suspect it is also why Quicken opted to list it at the bottom. It is the sum total, and you cannot create a distorted picture with it. With any of the individual numbers that are part of the Net Worth, you can mislead until your heart is content.

    Another reverse example; say you have a PAID FOR 1.5 million dollar home (true market value) in downtown NY, but only 150K in liquid investments, and you’re wondering if you can retire if you’re willing to make concessions? Absolutely. You sell the home for what it’s worth (1.5 Million) move to where I live (Arkansas) and buy a home for 100K. That leaves you with 1.65 million x 3-4%/year for the rest of your life. You’re done, stick a fork in it.

    I’ll stop here and just end with a brief closure; One shouldn’t “obsess” over anything because that’s downright unhealthy, but one could do much worse than choosing Net Worth as a singular measure of one’s current financial progress, especially where it applies to middle-aged or older individuals. Obviously, for younger 20 somethings, net worth isn’t really that relevant …. yet.

    One other thing, if you don’t use net worth to measure progress (in a healthy fashion, say quarterly or yearly), then what else would you use?!?

    v/r
    Bradley

    • Hey, Bradley–

      Thanks for the well-thought out response.

      I think in the cases you’ve articulated, net worth is a necessary, but insufficient step. When you’re in retirement, the name of the game is producing enough income to live on without running out of money before you run out of heartbeats. It’s the end game of the life cycle savings and investing approach. That’s why the number one question that clients who are approaching retirement want to answer is “do I have enough to retire?” They know their net worth. What they do not know is how the net worth translates into spending.

      Whether using a blunt instrument like the 4% withdrawal rate or a more nuanced approach, at some point, if they want to feel more secure about retiring and, thus, ending income as a result of labor, they need to make that conversion from net worth to a stream of income.

      I have an article coming out the week of November 11 about the measurement we’re using in lieu of net worth. It might not be right for everyone, but it’s what we’re doing.

      I also agree; it’s not healthy to obsess about anything!

      Thanks again for the articulate and well-reasoned response!