A few days ago a fellow blogger brip blap posted a well thought out article on his blog called net worth or worthless. Basically the article desribes brip blap's opinion that the personal finance metric, net worth is worthless and 'Net worth is a very difficult number to analyze, and the difficulty in analyzing it makes it a somewhat worthless tool for measuring progress in your financial life.' Having a differing opinion than Mr.blap, I thought I would rebut the idea that net worth is worthless with a rather lengthy post. Please bear with me, because after all, if I thought the metric was worthless I would not bother tracking it bi-monthly.
brip blap laid his argument out in a series of points which he numbered. I'll reiterate Mr.blap's point briefly before I give my case against the point. If you want more detail on brip's points, please visit his blog, which is by the way a good read.
1. You don't know how it's calculated
I feel that not knowing how individuals are calculating a metric, does not in itself make the metric any less useful. It just means the calculation method should be standardized. Let's suppose for a minute that 3 people were asked to determine their body height. The 1st person stood against a wall and awkwardly ran a tape measure up the wall and determined her height in inches. The 2nd person knew that his rug was 5 foot 6 inches across so he laid across the rug and measured the difference, while the 3rd person looked on his drivers license which was listed in centimeters because he was Canadian. So these 3 people used differing methods to determine their own height. Whether any of them arrived at their correct height is unknown. What is surely known is that their height is a relevant metric that can be measured and is certainly useful; just ask Shaq. Perhaps they should all be sent to their doctor to measure their height to the utmost accuracy. This method could be made to be an agreed upon, standardized method by using the same doctor and the same tools.
Also, of course one's home equity is an asset. This argument alone is probably fodder for another post but it seems really simple to me. If I own a $300,000 home outright but have $0 in other assets is my net worth $0? Of course it's not it's $300,000 because today I could sell the home, rent an apartment, fill the bath tub up with my new found cash and jump in....
2. A net worth of $200,000 means different things in a small town in Texas and in La Jolla, California.
I can't say I've ever been to La Jolla California, but it sure sounds nice (I think I've seen it on that show The House Wives of Orange County.) La Jolla sounds especially nice considering that I pumped gas today without gloves on and I couldn't wait for it to be over. I fail to see how where you live makes your net worth irrelevant. If you were able to ante up for a mansion in La Jolla, then good for you. You probably have more financial horsepower (potential earnings) than I do here in lowly old Brantford. Let's say my net worth was $200,000 and my friend Joe who incidentally lived in La Jolla had a net worth of 200K as well. How is this dollar figure any different? Who is better off Joe or me? A net worth of $200,000 can't really generate a substantial income no matter where you live. I might have a $200,000 house with a $100,000 mortgage and $100,000 in the bank while Joe has a $800,000 house with a $600,000 mortgage and $0 in the bank. I'd still say we both had a net worth of $200,000, and it's fair to say that we are on equal footing net worth-wise. Joe might pay more for an oil change than I do, but who cares, he chose to live there, his property value is higher, and he probably has a nice pool....so what? We both have the same opportunity to grow our net worth, and his dollars are worth the same as mine....well maybe his greenbacks are worth slightly less than my loonies but you get my point.
3. Net worth doesn't accurately measure cash flow generation
Correct, it does not, that is why it's called net worth. A compass does not accurately measure velocity either....move on.
The money that is present in net worth always has the potential to generate cash flow. At any time every dollar one owns can be coverted into common shares of General Electric (GE). GE will pay you approximately 3.4% of your money annually in cash.
4. Net worth also doesn't show risk
Again correct, but really why should it? Net worth also does not slice, dice and make julienne fries but it's only a personal finance metric. You could make it show risk by assigning a risk value to each asset and weight it all. Personally I think that is a bad idea because most people can't agree on a good definition of 'risk' anyway....
Overall I do not think net worth is the 'be all and end all', but I do believe it is the best tool we have to measure our financial health and progress. I don't care how you look at it, net worth is always meaningful, and improving one's net worth is always a financially positive action.