For example, “Janey” owns a home, has a 401(k) account, a car and some cash worth $236,000. They also have debts of $195,500. If Janey paid off all her debts, she would have $40,500.
This is Janey’s net worth – what you own after paying what you owe to others. Net worth can vary widely. It can even be negative, and often is, especially for younger people just starting and those with student loans, like “Jason.” These are not real people, by the way.
Net worth is a metric for progress
Net worth is a yardstick for measuring progress. This is, where are you today versus where you were a year ago? Did yours go up or down?
Let’s look at Jason’s year-over-year comparison:
Jason’s net worth is negative in 2023, but he has made great progress in the last year, by paying down his credit card, student loans, and car loan by a total of $7,000 and adding another $500 to his bank account. As a result, Jason’s net worth went up by $7,500!
Net worth is a yardstick for measuring progress. This is, where are you today versus where you were a year ago? Did your net worth go up or down?
Let’s look at Jason’s year-over-year comparison:
Jason’s net worth is negative in 2023, but he has made great progress in the last year, by paying down his credit card, student loans, and car loan by a total of $7,000 and adding another $500 to his bank account.As a result, Jason’s net worth went up by $7,500!
The art and science of net worth
We often think about accounting and finance as black-and-white, concrete issues. When we start to dive deeper into net worth, however, we see that things are often not quite so absolute. In the Steven Soderbergh classic film Ocean’s Eleven, there is a wonderful exchange about this topic:
Ilayer: “Why were you in prison?”
Danny: “I stole things”
Player: “You stole things. Like jewels?”
Danny: “Incan Matrimonial Head Masks”
Player: “Any money in those?”
Rusty: “Boatloads. If you can move them. But you can’t.”
Danny: “My fence seemed confident enough”
Rusty: “If you deal in cash, you don’t need a fence.”
Danny: “Some people lack vision.”
The point is that some assets have values that can vary widely, depending on who is valuing those assets and their circumstances. Other assets have a very stable and predictable value. How you think about your assets is very important when you consider your net worth.
Not all net worth factors are equal
Let’s go back to Jason and Janey. Jason and Janey appear to have a net worth of $139,000.
But let’s look closer. Some assets are easy to value. Cash is cash, so $10,000 is worth $10,000. Similarly, mutual funds are an investment that can be easily bought and sold. If those mutual funds are listed at their current market value, then that’s what they are worth. In the case of their other assets, the value greatly depends on the market conditions.
Intangible values are variable
Jason owns a car that he values at $15,000. Most people value their possessions based on what they paid for them. More important than the purchase price in thinking about net worth is what would someone else pay for those assets? In the case of Jason’s car, it’s probably a lot less than $15,000 if Jason wants to trade it in on a new vehicle. Often, the trade-in value is one half or less what the owner paid. It’s also often less than the amount of an associated car loan. So, if Jason’s car is only worth $8,000, for example, and he still owes $14,000 on his car loan, his more realistic net worth is $7,000 lower, bringing his adjusted net worth down to $132,000.
Looking at Janey’s financial situation, we see some big differences from Jason’s. Janey doesn’t have a car, but she did fill her new house with furniture costing $15,000, which she put on her credit card. She also has a vintage collection of Beanie Babies, and based on listings she saw on eBay, she values those at $100,000. While Janey bought good quality furniture, it can be very difficult to sell used furniture, and buyers rarely pay more than 20% of the cost of that furniture. So, while Janey paid $15,000 for the furniture, it’s probably worth no more than $3,000 to a buyer. This reduces Janey’s net worth by $12,000, and she must still pay off the credit card! Ouch.
What’s the value of a Beanie Baby?
Looking at Janey’s Beanie Baby collection, we see that it’s valued at what Janey thinks it is worth based on those eBay listings. While some opportunistic sellersmay list their Beanie Babies on eBay for very high prices, that doesn’t mean anyone will pay those prices. While Janey cherishes her collection, and it gives her great joy, the value of those Beanie Babies if she tried to sell them is likely lower. Much lower.
So, while Jason and Janey appear to have equal net worth, when you look at the market value of the assets, they are quite different, as much as $100,000 different. This is where art trumps the science. When considering yours, it’s fine to consider how much you paid for something, or how much value you place in those assets. But in thinking about your actual wealth, it’s much more important to consider what a third party would pay you for your assets.
Don’t forget about liquidity
This example also highlights another key consideration – liquidity. Both Jason and Janey have $50,000 in equity in their real estate ($300,000 value less $250,000 mortgage). But they can’t easily spend that $50,000 since it is part of their home. While real estate is valuable, it is not easily converted to cash and is considered illiquid.
Julep is not a financial institution, financial advisor, or credit repair company, and does not provide credit repair services of any kind. The information provided is for general educational and reference purposes only. The information is not intended to provide legal, tax, or financial advice. We do not propose any guarantee that the information provided will repair or improve your financial profile. Consult the services of a competent licensed professional when You need financial assistance.