Tuesday, October 31, 2006

How Much Are You Worth?

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Series: Beginning Investing (2nd post)
Section: Set Your Goals
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Now that you're sufficiently pumped up to start on your own journey to wealth, here's a fun task for you - calculating how much you are worth today!

In performing this calculation, we will use a very strict and narrow definition of assets, considering only those of your things that hold or appreciate in value over time rather than the accounting definition which assigns a value to everything you own. The reason for this is that we're trying to arrive at the most conservative and true assessment of your net worth rather than a value that will reduce over time due to depreciation.

[You could add in the value of your goods to make you feel better if you like, but do remember that these will reduce in value over time and will not contribute to your financial goals. After all your surround system will not really fetch much ten years from now if you want to sell it to meet your financial goals! And, what the heck, your net worth is for your eyes only so where's the point in inflating it?]

The calculation is fairly easy:

  • First, work out the total value of your assets (things you own that meet the definition above). This would include cash in bank accounts, stocks, mutual funds, property, gold, fine art, jewellery, foreign exchange, antiques and other valuables (and even the spare change in your drawer if you're sufficiently desperate!). To be really conservative, take a reduced value for the more volatile assets like stocks and equity funds to account for a possible fall in value. You could discount them by, say, 20-30%.
  • Then total up your liabilities (what you owe to others). This would essentially include all kinds of loans like your car loan, housing loan, personal loans, credit card outstandings etc. Be true to yourself and count everything you can think of.
  • Subtract your liabilities from your assets to get your net worth

The above ignores the value of your car and other worldly goods and it paints a very stark, but true, picture of your financial health.

All too often, we feel well-off because we have nice things, a rockin' night-life and a cool car but in reality, we're just a mis-step away from trouble. And like the picture of Dorian Gray, this 'net worth' calculation presents us with what the ugly truth really is!!

If you find you have a healthy positive balance from the above calculation, pat yourself on the back. You're already well down the path to financial freedom.

And, if you find you're in the red, don't despair. A bit of discipline and you'll soon be in positive territory, after which it's just a matter of time before you're watching your moolah grow before your very eyes!

Next Post on Beginning Investing: How Much Do You Spend?

4 comments:

Prasanth said...

Amit,

Some points:

1. I do not include the value of my primary residence to calculate my net worth - argument being that I'm not likely to sell it off as I need a place to stay. I agree that we should include any other real estate that we own (with a 20 % markdown from it's current market value). What are your views on this?

2. I include the surrender value of my insurance policies (money back, ULIP - yes, unfortunately, i do have these - the ones I bought when I was young and gullible ;) )

3. For all long term debt like housing loans, I calculate the amount I need to retire the loan as my liability.

4. Lots of people miss including accumulated EPF in their calculations - they just do not think about it as it is not part of their "take home" pay.


Since I include the housing loan as a liability and not the value of my house as an asset in calculating net worth, my net worth figures are not great - though I'm happy to say that it is a positive number !!

Regards,

Prasanth

Amit said...

Hey Prasanth,

Thanks for your comment. I agree with points 2 and 4 (in fact thanks for pointing this out - even I missed it)

On point 1, would prefer to take the value of primary residence as it is among the things you own. After all you could rent instead of own your apartment...

On point 3, I meant one should take principal outstanding only, not including discounted value of future interest or EMI as the EMI payments should get considered as monthly outgo when you calculate your monthly spends (check the next post in the series).

And, boy, if every one were as conservative as you, we'd all be in the red!! :) Congratulations!

Prasanth said...

Amit,
One Point 1, i have had the same argument (you can always rent) thrown back at me whenever i discussed this. My contention is as follows:
a) Here in US, where i'm now, it's very easy to get a Home Equity Line of Credit (HELOC) or a reverse mortgage with the result that too many people have already used such money to finance their lifestyles and finding themselves suddenly in too much debt. The house on which they were counting on is not an "asset" anymore. I have started seeing similar "reverse mortgage" loans being offered in India and eventually similar stuff will happen in India too.
b) One thing that i have noticed is that when people calculate their networth, because of the huge amount houses or property are worth these days, they get a nice positive number and are re-assured by it while the actual amount of wealth they have generated is quite small (this is especially true if you inherit property).
c) My motto is "be ultra conservative when calculating your assets and be ultra liberal when calculating your liabilities and you will not go wrong!!".

Amit said...

Aha, but if you reverse mortgage your property you have to count the additional debt as a liability as well, right? That would reduce your net worth even if you are counting on property as an asset.

Having said that, I completely agree on your ultra-conservative approach being the best thing to do but I'd be OK with someone throwing in their house into the assets side. If one has bought property they've earned the right to calling it an asset and gaining from the appreciation in its value (I would do so)

At the end of the day, the net worth calculation is just supposed to indicate how far you are from your goals so it's really a personal choice as to how one works it out - if one cheats, it's just cheating oneself...

On your point (b) I believe again that it's a very good point. Should you consider wealth you have generated yourself or should you include your share in your grandfather's prime-location house? I'm inclined to ignore inheritance - after all, not only should you become wealthy, you should be building on what your forefathers have left you, not living off it! Otherwise you're just an idle rich kid. What's the difference between you and, say, Paris Hilton?