What's the Best Way to Calculate Net Worth?

On How's Your Net Worth Stack Up? we've had a mini-discussion that I wanted to bring out in the open for all of us to comment on. It deals with the way net worth is calculated. Currently, I know of two primary ways financial publications, websites, news organizations, authors, etc. calculate net worth. The first is the old-fashioned way:

Net Worth = Assets - Liabilities

The second, which seems to be more popular (quoted more often), is as follows:

Net Worth = Assets - Liabilities - Value of Primary Residence

The theory with calculation #2 is that your home is a place to live and is an illiquid asset that would be the last thing you'd ever part with in case of financial disaster. It provides you a benefit (a place to stay), but isn't part of the true reflection of what you're "able to get your hands on" financially. (By the way, some calculations also take out the value of cars and expensive personal property.) Here's one reader's take on this calculation:

I think the reason some people shy away from including housing in their net worth is to avoid the illusion of being wealthy. Many people in my area are "house rich", with almost no other savings or investments.

On the other hand, your house certainly is an asset. If you had to, you could sell it and get access to the equity. Besides, not to count it seems to distort your true financial situation. Consider this reader's comment:

For what it's worth, I think it's crazy not to count residence in net worth. Is a person with 100k in assets that also has 150k equity in a 250k house in the same financial position as one who owns 100k in assets and rents? I think not.

Maybe the solution is to do both. Another comment:

Personaly, I calculate it both with and without. The one with the home is true net worth, while the other gives be a better idea of liquidity and overall investment performance.

Personally, I calculate my net worth including the value of my house. But I also know that it's not a liquid asset that I could convert to cash quickly if I needed to. That said, I kind of like the idea of calculating it both ways as the reader above suggests.

So, what do you think? Which is better? (If one is.) Which do you use and why?

For more thoughts on net worth, see these posts:

• The Top Five Steps to Grow Your Net Worth

• Five Principles to Increasing Your Net Worth

• Net Worth Explained

Comments

[Lord]

I include it net worth and also compute liquidity but where it really counts is in expenses when you no longer have to make payments. That knocks a good 25% off what you need to live on and eliminates one of the largest inflation sources.

[cory]

This really gets down to the issue of why a net worth calculation is important, doesn't it? Is your net worth really "how much cash can I get at a moments notice?" No, it isn't, that's wealth.

Judging by the comments on this post-- http://www.freemoneyfinance.com/2007/05/hows_your_net_w.html , it's pretty clear that net worth as an instantaneous calculation is meaningless. Person A can say, "my net worth is $5,000" Person B can say, "my net worth is $15,000" Who is better off? You have no idea, person A may be posting $3,000 gains every month while person B is gaining $50 a month, but has quite a few more years under his or her belt.

Net worth is a TREND, wealth is a value. If you're calculating wealth, then you shouldn't include any asset that is not feasibly liquid. If you're calculating net worth, then you should absolutely include the your house because it is an asset with a non-constant value.

[Scott Kustes]

I have a single Net Worth sheet that I use to calculate several things. I have my assets broken into Liquid, Retirement, and Non-liquid. In Liquid, I keep the value of checking, savings, stocks, etc. Retirement is obviously 401k and IRAs. Non-liquid is house value (based on the appraisal value...I don't include our improvements like new windows, fresh exterior paint, and landscaping as I would just be guessing) and a conservative value for our two cars. I pulled the Kelley Blue Book for the cars, then knocked off 8-10% as the only reason I'd be getting rid of them would be a quick sell to erase the bank note on one of them or liquidate the cash value from the other. I then have Immediate and Long-Term Liabilities. Immediate is car loan, credit cards ($0!!!), and no interest loans...basically anything 2 years or less. Long-term gets the house loan and my school loans.

I calculate my Emergency Reserve based only on Liquid Assets minus Immediate Liabilities. This lets me know my easily available capital were I in dire need. Total Net Worth is based on all values, including home and car. I feel that listing the house value and car values are especially important if you're carrying a loan on either as a counterbalancing asset. I don't just have a loan for a house (which drags down Net Worth); I have an asset that I could sell to clear the debt from my life were that needed.

[Brad]

I like your thoughts on this. They simply measure different things. I put a post up about the 3 different measures, as I saw them, and the advantages of each . . . I wasn't sure if you saw it when the discussion was going on at FiveCentNickel. If I want to know how much wealth I am accumulating, I'll look at Net Worth. If I want to know how much is available to me for investing and shuffling around, I'll use Net Investable Assets. If I want to know how much cash I can get my hands on without selling my possessions or tapping into retirement, I'll look at Net Liquid Assets. They're all useful.

[EMF]

I break down my net worth into categories that reflect their relative liquidity.

One thing I do that most people don't when calculating net worth is to discount values.

My property value is the tax appraisal which is reasonably accurate, but then I discount it by 25% because there will be costs to make the sale such as realtor commisions, fix-up costs, and a generous fudge factor in case the appraisal isn't that accurate.

Similarly, I discount my tax-deferred savings by my current marginal combined federal & state income tax. I don't know what my actual tax rate will be in retirement -- it could actually be higher. Use of current tax rate is intended to make decisions on whether to place retirement savings into tax-deferred or Roth accounts neutral when calculating effect on current net worth. Then today's allocation strategy is based on my best guess as to future tax rates (which I expect to be higher).

[MrAtoZ]

The other point to remember about including your house's value in a net worth assessment is that it is hard to measure (unlike most financial assets, where you can measure the value of stocks and ETFs on a moment by moment basis). County real estate valuations are often innacurate, and even services like Zillow.com are guesstimates at best. So, while I agree that equity in a home is a form of worth, exactly the form it takes is only resolved when you have a valid real estate contract in hand from someone willing to purchase your domicile. Absent that, it's a SWAG as to your house's value.

[Punny Money]

If the question of whether or not to include housing ever comes up in a discussion of net worth, then you are likely no longer talking about just net worth. Instead, you are referring to wealth, and net worth is most certainly not the same thing as wealth.

Net worth, by itself, is a relatively meaningless figure for determining your total wealth status. And you've gotta throw a lot more than the value of your house into the mix if you want it to be an accurate picture of your wealth.

[Punny Money]

If the question of whether or not to include housing ever comes up in a discussion of net worth, then you are likely no longer talking about just net worth. Instead, you are referring to wealth, and net worth is most certainly not the same thing as wealth.

Net worth, by itself, is a relatively meaningless figure for determining your total wealth status. And you've gotta throw a lot more than the value of your house into the mix if you want it to be an accurate picture of your wealth.

[Brad]

AtoZ, I agree that this is a problem for most people. For me it's not too hard-- all the houses in my neighborhood are roughly the same size, layout, etc., so I can have a good idea of what it's worth by looking at the recent sale prices in the county's records. As for tax appraisals . . . ours are WAY off. Tax appraisals in our county are around 30% lower than what the houses actually sell for, a nice fact when the tax bill rolls around. Same goes for Zillow . . . I have found the house details to be woefully inaccurate, and the estimates vary wildly even among similar houses. I don't find much use for it except as a quick way to look at sales and tax info.

Still, having even a rough estimate of home value allows you to paint a more accurate financial picture, in my opinion.

[Lord]

As net worth I still use historic book value, but as wealth, I use market value. This prevents me from confusing appreciation with income. I don't consider myself any better off because my house appreciated because I consider this as an increase in equivalent rent. I am not planning on downsizing or moving out. Anything I would likely buy would be as much or more and I plan on owning the rest of my life. Appreciation would only have meaning for me if I wanted a reverse mortgage which I am not planning on anytime soon.

[Terry]

Good comments! I do as Scott suggests and break my net worth down into categories. Let's face it - Net Worth is a tool that YOU use to track your financial progress. As long as you understand what is behind it, use what works best for YOU. I do not remember the last time someone asked me for my net worth, as it is very personal.

I best 90% of folks I know would be shocked to know my net worth as I live below my means. On the other hand, some of my friends "live it up" as they have a high net worth - have nothing saved and virtually no net worth.

[Big Cheese]

Hi FMF,

Since you blog about finances would you mind if I asked you if your savings / stocks / assets is in the 7 figure range? You don't need to be specific but can you give a rough estimate?

Thanks,

Big Cheese

[mbhunter]

I like not counting the value of my house in my net worth but counting the mortgage against it. Keeps me humble.

[FMF]

Big Cheese --

I've talked a bit about my net worth before. See these posts for details:

http://www.freemoneyfinance.com/2007/05/hows_your_net_w.html

http://www.freemoneyfinance.com/2007/04/what_people_in_.html

http://www.freemoneyfinance.com/2007/03/net_worths_and_.html

Let's just say I'm doing fine financially and that the principles I talk about here at FMF are ones I know will work based on my personal experience. ;-)

[Big Cheese]

Thanks for sharing and being open FMF. Can you comment on how much of your portfolio is in the stock market vs bonds and cash? I know you are a big advocate for investing in the market.

I am saving a lot of money and tend to keep all the savings in cash for the time being. I used to invest in the market and since 2002 - 2003 lost some money so while I keep a modest portfolio I tend to accumulate the rest in cash. Perhaps this is a big flaw since I am still young (in my 30's) but the upside is I paid for my residence recently 100% in cash (it is a modest place not a McMansion).

Thanks for the advice!

-Big Cheese

[FMF]

I'm roughly:

75% in stocks (I have a LONG time horizon)

5% in bonds

20% in cash (includes emergency fund, planned purchases of larger items, and potential downpayment on new house)

[Anthony]

The problem with including a house as a measure of net worth is that nobody really knows how much the house is worth...and people almost ubiquitously think they're home is worth more than it is.

Especially if you live in places like California or Florida, where in many portions of that state, residential real estate is dropping in value by around 1 percent per month. If you own your house as a place to live (not a flipper or speculator), then by factoring in that loss (which you probably wouldn't want to admit to, anyway) would give a faulty impression of your other investment performance.

[Ryan]

I also do not include the value of my house in my net worth, but I do include my mortgage as a liability. My take is that if I do decide to move to another house, the equity contained from my house gaining value will be more than offset by the increased price of the house I plan to buy.

[Griffin]

A couple of thoughts:

1. The formulas given are: NW = A-L or NW = A-L-V of PR. In either case, your mortgage (if you have one) is a liablility. You can't very well include your mortgage (liability) without including the primary residence (asset). And it would be unrealistic to not include your mortgage on your balance sheet since this is a very real liability.

2. Traditional accounting practice would dictate that your house, if you include it, should be included on your balance sheet at the lower of cost or market. This is accounting conservatism and means that you aren't assigning your house a wildly overstated value that might disappear if the market tanks. Nobody knows for sure what their house is worth until they actually sell it. If you book a gain at sale, then this will show up on your balance sheet after the sale. On the other hand, if you know your house is worth less than you paid for it, then it should be included at that value -- again, by doing this you are not living in a dream world pretending that you really haven't lost money.

3. If you don't have a mortgage (kudos to you), then the house should still be included on the balance sheet at the lower of cost or market.

4. As some readers have already said, categorizing the asset section of your balance sheet provides you with a convenient means of seeing how much of your net worth is "financial" -- stocks, bonds, cash, etc. -- how much is "retirement" -- IRAs, 401(k)s, etc. -- how much is investment real estate, how much is the equity in businesses, how much is collectibles, how much is your primary residence, and so on. As some have said, if the bulk of your assets is your house, it's probably a good idea to work toward changing this.

5. By the same token, the liability section should also be broken out -- mortgage debt (primary mortgage, home equity lines, etc.), consumer debt (credit cards), commercial debt (business), investment real estate debt, and so on. Biz and investment debt match with their counterparts on the asset side of the ledger -- the difference is net worth (or owner's equity).

6. The point to "not including" your house is to make sure you see the value of your financial assets. As many have said, the value of your house is not available unless you sell it. A lot of people think they're "rich" or "well off" or "wealthy" because they have a house that's worth a lot of money -- or a lot more than they paid for it. But you can't get at this value without selling or borrowing against it (which is what many have done, leaving them with little or no equity). It's great to have a house with no mortgage and/or a lot of equity -- but it's even better to have a lot of financial assets on your balance sheet to go with the house. As the financial assets grow -- and the mortgage balance decreases -- the house will become a smaller and smaller percentage of net worth.

Great site.

[SUSAN]

Hmmm - interesting post. I include the current assessed value amount for my house as an asset (which is pretty far under the realtor's estimate of my home value), then I list the remaining mortgage amount as a liability.

I tend to look at my net worth picture as a "what would I leave to my children if I died tomorrow" - they'd sell the house, pay off the mortgage and get the remaining money, so I count that as an asset.

Granted, it's not money I could get my hands tomorrow, but it exists, and therefore should be counted - in my very humble opinion.

My IRA money is included as an asset too - but I have no intention of getting my hands on that money for some time.

I do not include term life insurance benefits payable on my death though - which, based on what I said at the start of my note, you'd think I would. But I don't see that as ever being "my" money.

I think whatever method people use, if they stay consistent to their method, they can still determine if their net worth is going up or down.

[Todd]

I don't even understand why there's a debate on this issue. A home is an asset and therefore part of one's net worth. Indeed, arguing otherwise is illogical.

For example, if I have $200,000 in the bank (savings, CDs, stocks, whatever) and I take $100,000 to put down on a house, my net worth didn't suddenly decline by 50%. Rather, my net worth stayed the same ($100,000 in the bank and $100,000 equity in my home) while its composition changed. But according to the "logic" of the "home isn't part of one's net worth" crowd, I just saw a $100,000 decline in my net worth. Complete nonsense.

Is a home as liquid as cash? No. But neither are a lot of things. For example, if you own 3 or 4 original Rembrandts, you have a very high net worth, but you can't "spend" a Rembrandt at the corner store. But it can be converted to cash - in time.

Similarly, with a home one can sell it, take out a home equity loan or obtain a reverse mortgage on it. And the latter two options can be done quickly.

[TLL]

Initially, I calculated our net worth by including our house. To determine our equity, I used the previous years tax assessment as the current value. As I tried to explain this to my wife, she didn't like the idea of having the house in the calculation since we suffered a large loss on our previous move. Gotta keep the boss happy so now I calculate net worth both ways....with and without our house. Since I track our accounts in Excel, it's very simple to do both.

[JD]

I agree that a net worth calculation that includes your house is very misleading for most uses. Its easy to calculate net worth in both ways and that is what I do, but the main number I focus on is my LIQUID NET WORTH. Even in total net worth where I include my home equity I do not include other possessions - doing that just borders on insanity unless you have very high priced possessions like expensive art or jewelry. The problem with the net worth calculation that includes your house is ---- what use is it? Sure if all hell breaks loose and you need to sell everything you have than it makes sense, but barring anything drastic you're not going to sell your house just to get your hands on some cash (if you do than you have bigger problems). For me the only number I care about is my liquid net worth because that is the only number of any real use. If I owned a business though I might include that even though that is illiquid, however I would in all likelihood be holding it as an investment pure and simple. Same with investment properties, I would include them even though they are not liquid. But including your primary residence just reeks of desperation to inflate your net worth figure. Keep that number in the back of your mind if you want, but the real number to focus on is your net worth minus your primary residence.

[traineeinvestor]

I agree with Susan (and the comment in the original post). Not including your home in your net worth calculation is either wrong or a calculation of something other than net worth. At the end of the day the house is an asset just as much as shares, funds, bullion, bank deposits, business equity and many other things. The only arguement I have seen for not including your home in your net worth which appears to have any validity is the psychological motivation that comes from understating your net worth.

To address the point about valuation uncertainty, this is correct but you have the same issue with investment properties and any other assets which do not have a stated redemtion value or a mark to market value. Including the house may lead to uncertainty over the result of the net worth calculation but the result will still be a better indication of net worth than a calculation done without including the home.

[Todd]

In my experience, those who advocate not including their home in a net worth calculation usually don't have any equity in their home (or they rent) and thus are trying to skirt the issue. But since net worth is simply assets - liabilities, one can't exclude home value any more than he can exclude a CD or a mutual fund.

Of course, one can separate his net worth into categories such as so-called "liquid net worth" and "illiquid net worth." But those are just components of net worth and not substitutes for it.

In addition, a home is an investment and has a significant growth component to it, as homes have appreciated on average by about 6% nationally since 1963.

One final point is that if you own a home outright, your cost of living is much lower (and thus the amount of liquid net worth you require) than if you are making payments on a mortgage or for rent.