Should I Include Known Liabilities in My Net Worth?

Here's a question I recently thought about and would like your feedback: should I include known liabilities in my net worth? Stick with me for a minute and I'll explain what I mean.

Currently, my net worth is a simple calculation of assets minus liabilities. However, in this calculation I have the following assets included:

• Coverdell accounts for my kids
• 529s for my kids
• Amounts for each kid's future wedding costs (saved and invested in an account I control)

Here's the rub: the assets for each of these are included in our net worth, but the future liabilities (the cost of college as well as the wedding costs) are NOT included. This effectively overstates my net worth.

So, I have a few options:

• Ignore the liabilities and just count the assets (after all, maybe the expenses won't occur for some reason -- who can read the future) -- This is what we currently do and, in my view, it's a true reflection of net worth (assets - liabilities.) That said, this means our net worth will take a big hit as our kids enter college.

• Put in some plug figure for the cost of college and the weddings liabilities -- This would offset the amounts in the associated accounts and reflect my (probable) future liabilities, giving me a "true" running net worth.

• Don't count the assets in my net worth calculation -- This is my least favorite option, mainly because it will be a bit more difficult to track my net worth (extra steps requiring me to subtract the value of these accounts.)

I haven't decided what to do yet -- I wanted to hear from all of you first. What's your suggestion for how to handle this?

Comments

[traineeinvestor]

I tend to accrue a liability for some future expenses (such as tax and holidays) on a month to month basis. Longer term liabilities such as future costs of educating our children get ignored until they arise and have to be paid. Perhaps not a consistent approach, but I am comfortable that it gives me a sufficiently useful snapshot of net worth.

Also, if you decide to make provisions for some future expenses, why not all of them? If you create a liability for future cost of children's education etc it would be logical to also recognise a liability for future personal expenses such as the cost of funding your own retirement like companies are supposed to do?

Companies are required to recognise liabilities for the present value of future expenses such as pension plan shortfalls. However the experience has been that they underestimate those future costs creating a misleading impression of the company's state of affairs.

If you are going to estimate the present value of future expenses you risk putting together a balance sheet that is dependent on a subjective judgement as well as an estimate. Whether this is a useful exercise is debatable.

Personally, I would not find it meaningful to recognise the present value of all my future expenses as liabilities.

[Ed]

I say ignore future contingent liabilities. Next thing you know, you are going to be looking for actuaries to assess your valuation of the cost of the kidos going to college.

Keep it simple. At least I do. The only liabilities that have ever hit our person Balance Sheet are items that are fixed and determinable, i.e. any type of third party debt. As individuals, we are not issuing GAAP statements here.

Knowing what I am saving for in my mind and/or on paper is a liability enough for me. We am not going to be spending any money till we have it anyways.

Cheers,

[Mixer]

I count all assets and liabilities I am aware of when calculating my net worth - otherwise, I might spend 10-20 years thinking I'm doing well only to discover (too late) that I have a shortfall I might not be able to recover. YMMV, of course.

My advice to FMF would be to just add another calculation to your net worth totals; one that says "adjusted net worth (less future liabilities)" or something that subtracts the assets currently held for future liabilities. Hardly any change to your system, and you get a chance to see the gap between the two and act on it if necessary. When you realize those libilities, any remainder can be added back in.

[Jane]

If you count as liabilities what happens if a kiddo does not get married or doesn't need the money for college. (And I don't just mean because they don't go, they could get a scholarship or choose a military academy as just 2 examples)

[Mixer]

Jane - It gets added back into total net worth and either you can retire earlier or increase your lifestyle expectations in retirement. Or it becomes a really nice trip to Europe, a nest egg for your kids when they get out of college, an emergency fund... whatever. Having more wealth than you expect is a lot better than having less.

[Mark B.]

I say keep it simple and do not figure your future liabilities into your net worth. Do you reduce your net worth by the amount you have saved for a car replacement? Do you reduce your net worth by the anticipated amount of next months gas bill?

Your net worth is a "current" calculation, a snapshot of your present financial standing.

You are already reducing your net worth in your head when you think about the future liabilites, doing it on paper is not really necessary.

A company will reduce it's net worth for future liabilities because those are legally obligated liabilities. In your case, if a really big catastrophe hit you could technically raid (not that you would) those accounts now for cash, so it is current net worth.

[Benjamin]

You could have two net worths. One the normal way (assets - liabilities), then create another one with estimated future liabilities factored in. This would give you the best of both worlds.

[Mark B.]

Also, think about the flip side. Do you increase your net worth for future income? If you knew you would be inheriting money from a relative when they passed away, would you include that in your net worth?

What I am saying is that a future expense that is not concrete in when or how much it will be should not be reflected in your calculations.

[Traciatim]

Your net worth is a statement of your worth right now, all your assets and all your liabilities as of this moment. It is not a predictor of the future. This means that things like college education for the kids, which is currently in your net worth, will be moved to someone else it will look like you took a hit on your net worth that year. Well guess what, since you gave someone else a pile of money you DID take a hit on your net worth, so the number is only reflecting the reality in that moment, exactly what the tool is designed to do.

[Nathan]

I would take the 529's and Coverdells and include them in your children's assets, since they are strictly for your children. As for the wedding savings, if it's in your name, include it, if you have it set up as a custodial account, don't include it.

[Hal]

I agree with many of the other commenters: if the assets are designated with your children as beneficiaries, they really belong to your children and should not be included in your net worth calc.

However, the wedding funds are really yours until you decide to give them away--I don't see this as any different than another savings account; it's just more specific in terms of its purpose.

[Matt Large]

My opinion is it depends on whether you would be willing to leverage those assets. Would you risk using them now to build them back up later (hopefully in time to excercise them in the way that you originally planned). If not then you should discount them by including the future liabilities.

I've had to think about this too and came to the decision that I only want to see a net worth that reflects the total assets I am willing to leverage into other things for me. Therefore if I am saving for a large holiday next year (something which equally might not happen) I want to discount that asset as I know that I do not want to spend that money in any other way.

But that's just me. I'm sure it's personal preference. Choosing to smooth the Net Worth graph ahead of time.

[Trent Hamm]

Ignore the future liabilities. You do not know what the future holds - all you know are the assets you have on hand right now. If your child gets a four year full scholarship, that 529 money will probably revert to you, for instance.

[No Debt Plan]

I pondered this as well as I looked at my net worth. We're saving money for future car insurance payments, so should we count it?

I agree with Trent... count what you've got right now. Plus, it makes things much easier.

[Beyond Paycheck to Paycheck]

What's the purpose of calculating your net worth? Typically it's to present to yourself (and others) a current financial snapshot. That includes everything you own and borrowed to now, but nothing else. As you said, who knows what the future will bring?

Sure, you expect your kids to go to school and get married (and hopefully in that order). But how much will it cost? You have no idea. When will happen? You really can't be sure. The assumptions you'd have to make on these two items along (when and how much) would drive the amount you'd put on your personal books more than anything else. Say you assume that one kid is going attend a private school, but then winds up going to public. Did your net worth suddenly skyrocket? Of course not.

Taken to it's illogical extreme, you'd have to include your funeral expenses. Now how many years do you want to discount that cashflow? If you knew the answer to that . . .

This is a fascinating question, however. Had you asked does it make sense for companies, I'd say absolutely. But that's because they've already legally committed to their future obligations, which are also reasonably estimated. You have not done so. For you, these expenses reflect only your current intentions and are not those which you can reasonably estimate.

Great post!

[topdog]

Ignore the future liabilities. Do you reduce your net worth by your expected future consumption of food and health care when you retire because you include the value of your retirement accounts? I don't think so...

[Mixer]

I think we're all talking cross-purposes here. I use net worth to track my progress towards a targeted retirement age of 55. I need 4.2 million (a total I came up with using "real" inflation numbers applied to both price inflation and monetary inflation projected out to my expected death while maintaining a slightly lower standard of living I now enjoy.) This equates to a roughly 40% dollar value growth in my estate every year until retirement. If I ignore a future liability, and by this I mean a known large expense tied to a specific incident, I am short-changing my retirement - which means I retire later, or lower my standard of living. Tracking my net worth tells me how much of an estate I have overall, whether or not my growth numbers are on track and whether or not my inflation numbers are on track (I calculate my net worth in dollars, Euros, renminbi, ounces of silver and ounces of gold). As it stands now, I'm looking at a retirement age of 54; I hope to drop that number even lower in the next decade.

But, if you are using net worth just to get an idea of what your wealth totals are, then yeah - ignore the future liabilities and gains and focus on what you have now. But, aside from applying for a loan, what purpose would calculating personal net worth be if not for retirement planning?

[Blaine Moore]

Isn't that the point of having kids, so that they can continually and regularly make huge dents in your net worth?

I wouldn't bother including the "unknown" future liabilities for the reasons stated above, and also because I'm just lazy.

[Dangger]

If it's just a matter of setting up separate reports within a finance software, why not setup up both? I think it would be nice to view both of those numbers. Who says you can only calculate one "net worth"

[Anonymous]

Don't count future liabilities such as kid's college, future car purchases. I have a vacation fund that is $3000 full, and ready to be deployed in Canada this summer. I'm counting that in my net worth, even though we'll blow most of that or more in a 14-day trip.

Bottom line- those talking about Net Worth as a snapshot are correct. Liabilities for which you have not yet entered into an agreement should not be counted against net worth today. Liabilities for which you have an agreement (for me mortgage, student loans) get counted against net worth.

[Todd]

I'd take either of two approaches suggested here, to wit: 1) include the accounts in your net worth and leave it at that or 2) don't include the accounts in your net worth but instead put them aside as your childrens' accounts.

I think trying to determine future liabilities for things such as school and weddings is madness. Will the kid go to a community college? A state school? Harvard? Will he get financial aid? Will he get a scholarship? Will he take out loans? Will he go to college at all? Who knows?

The main thing is that you recognize that at some point your net worth will take a hit and you plan accordingly (i.e., save enough extra money to make up for that hit).

[Matt Large]

I think things like college funds are an interesting emotive item. A lot of people here are arguing for not including anything for which "you have not entered into an agreement", but my muddled point earlier was that these types of items often form an emotional agreement with yourself which is almost as binding as a legal one.

What I was saying was, if you are not willing to spend that money on anything else, therefore putting the thing you are saving for at risk of not being affordable, then it's probably better for your view of net work if you don't count it. It's emotionally inaccessible.

[Michael]

If I have an asset that is earmarked for future spending that I am confident will occur, I generally 'write down' a portion of that on an increasing basis as the expected date of spending draws near. There's no hard and fast rule that I use, but an example might be on saving for a vacation. If I contribute $100 per month for 10 months, I might write down 10% of the total the first month, 20% of the total the second month, and so on. That way, when the vacation occurs, our net worth doesn't take the hit all at once. 'Funds' that I've done this for: Wedding fund, new furniture fund, home repair and renovation fund, replacement vehicle fund, holiday gift saving fund, vacation fund.

This is purely a psychological thing for me. I hate spending large chunks of money because I hate seeing the big effect it can have on my net worth. But, if I've slowly written it off over time, then the effect on my net worth when I write the check is much less severe. Your personality will have a say in this too.

Since this money is eventually going to be your child's and not yours, have you thought about doing a separate 'net worth' caluclation for them? It'd probably be really simple and you would automatically know 'the net worth will most likely go down to zero when they go to college/get married/etc.' but it might be easier to make the distinction.

[JK]

FMF et al.

Did your parents pay for your college and weddings?

How about removing some of those from your "Liability" column by making your children responsible for their own education and future?

You understand personally how important financial responsibility is for your future. Why would you deprive your children of the valuable lessons you have learned by taking responsibility for their futures in these regards?

If you are intent on doing something, why not save the money in an outside account and use it to pay off their monthly student loan payments AFTER graduation. This will give you 4,5,6,? more years of growth while they are in school and their loan interest is deferred (or not in some cases...) Then you can allow that account growth to continue to compound, while paying off the student loans with just the interest from your account, if you plan well. Also you will have no restrictions or penalties on your money this way.

This is my plan for my (unborn) children. So long as children or anyone else is dependent on another for survival they will never truly be "free".

Any thoughts on this?

JK

[Dave]

FMF, don't include future liabilities unless you are also prepare to include future assets. Your measure of net worth is a snapshot of your net worth NOW. If you want an accurate snapshot of what your future net worth WILL be, then you have to account for ALL known, future assets and liabilities.

You are also playing loosey-goosey with the word "known." How do you know your kids will go to college, get married, and that you will pay for the same? Public or private school? Scholarships? Shotgun wedding in Vegas or destination wedding in Fiji?

I think what you can do instead is think about what your future expenses will probably be, and prepare accordingly.

[Rick]

I agree with JK. My parents didn't pay for anything. I bought my own car. Paid for my own insurance. Bought my own house with no outside help. Went to college. All on my own, without a bit of help from my parents. But you know what? It made me a better person. I understand the value of money. Like these PF blogs always talk about, I know how to spend less than I earn, invest in the market, etc.

I don't plan on paying for my kids' education. They can do that themselves. I believe if they have to go through the same trials and tribulations I did, they'll become stronger, smarter, and more responsible yougn adults. That's what my primary goal in raising them is.

[Lord]

What is your criteria for disposition of these funds? Will you bestow them regardless of any changes such as not going to college or not getting married, or if you ran into trouble or the conditions didn't apply would you dip into them? If the former, account for them as both with the liability equal to the asset, or as neither since they are not effectively yours. If the latter, then they are assets but uncertain liabilities and I would only treat them as assets.

[Param]

Option # 2 makes most sense. Add the NPV of expected future contribution as liability to reduce your net worth (caution - it might go -ve!!!) Revise this number yearly as plans change (amount of contribution, discount rate, duration, etc.)
The key question is this - if your investment falls short, will you cover them up with your retirement savings or ask kids to make compromises? Also, if it performs above expectations, will you gift them away or provide your kids with only what they need? If meeting their needs is the objection, #2 makes sense.

[fathersez]

I follow exactly your system. Listing the assets but not the liabilities.

Funny I have not thought about this all these while.

Have to tweak my system a bit perhaps, but NPV's seem a little too complicated.

[SavingDiva]

I would continue calculating the amount saved, and ignore the future liabilities. Who knows when they'll come or if they'll come!?