If you track only one financial number, it should be your net worth.
Your net worth is the best indicator of both your current financial health and your progress over time, for the simple reason that just about every good financial decision you can make serves to either grow it or protect your it.
No matter where you’re starting from, you can feel good about your financial progress if your net worth is increasing.
But like anything else, it’s not a perfect measurement. It doesn’t tell you everything about your financial situation and in some cases it can even be downright misleading.
In this post we’ll explore some of the reasons why net worth can be misleading so that you can view your own net worth with a more informed eye and get a more accurate picture of your personal financial health.
Net worth’s biggest weakness
Net worth’s biggest weakness is that it’s a single number at a single point in time.
No matter when you measure it, the point in time is going to be fairly arbitrary in the big scheme of things. And all by itself the number you get is just a number without any context to what’s going into it, how you got there, or where you’re going next.
It’s simply impossible for one number at one point in time to accurately reflect your ENTIRE financial life.
That’s a big reason why it’s so important to track it over time. While knowing your net worth today has relatively limited value, understanding how it’s changed over the past year(s) can be incredibly helpful.
So, what are the things that can distort your net worth at any given point in time? Here are some of the major ones.
It doesn’t account for your personal goals
Comparing your net worth to other people can be fun. It can be motivating. And sometimes it can be incredibly helpful to see what goes into someone else’s net worth and what decisions they’ve made along the way that have gotten them where they are today.
But those comparisons can also be destructive.
It’s easy to fall into the trap of comparing your net worth to someone else’s when the reality is that it’s no more relevant to your situation than what that same person is currently binge watching on Netflix.
Depending on what you want out of life, a net worth of $1,000,000 could be exactly what you need to support yourself for the rest of your life, far more than you could ever spend, or a few million dollars short.
It’s just a number. What really matters is whether that number allows YOU to do the things that make you happy.
Ups and downs of the stock market
If any significant amount of your savings is invested, your current net worth will at least partially depend on the current state of the stock market.
If the market is up, your net worth will be higher. If the market is down, your net worth will be lower.
Of course, you have no control over whether the stock market is up or down. So those temporary fluctuations are in no way a reflection of your financial progress. A big stock market drop doesn’t you’re failing and a big stock market gain doesn’t mean you’re suddenly doing great.
This is another reason why it’s important to put the emphasis on tracking your net worth over time. The numbers at any given point may be influenced by external factors like the current state of the stock market, but those fluctuations will smooth out over longer periods.
What life stage are you in?
A new medical resident might have a significantly negative net worth simply because she has med school loans and hasn’t yet earned the income to pay them off and build savings.
A retiree’s net worth might be decreasing because he is spending from his savings rather than adding to it.
The life stage you’re in matters when evaluating both your current net worth and the progress you’re making. What might look “good” or “bad” on the surface may just be the natural consequence of where you are in life.
What are you doing to improve?
You and I could have the exact same net worth, but if you’ve automated your savings each month and I’m spending like crazy, we have very different financial prospects.
Your net worth now matters, but the steps you’re taking to grow it over time will determine your future.
What makes up your net worth?
Here are three pretend people:
- Mike has $25,000 in savings accounts, $125,000 in investment accounts, and no debt.
- Jill has $2,000 in savings accounts, a $400,000 house, and a $252,000 mortgage.
- Sam has $0 in savings accounts, a $200,000 house, no mortgage, and $50,000 in credit card debt.
Each of these people has a net worth of $150,000. But are they in similar financial situations?
Of course not!
Unless Sam can sell his house and downsize, he’s in some trouble. He has $50,000 in credit card debt, plus the interest he’s being charged, and no cash available to pay it off.
Jill is in better shape, but she has only a small cash buffer to guard against unexpected expected expenses and with most of her net worth tied up in her house, it probably isn’t growing very fast.
Mike doesn’t own a home but he DOES have a sizable cash cushion AND he has investments that should grow over time. He also has plenty of money available to take advantage of opportunities that come his way.
The point is that the TYPES of financial assets you own matters a lot, in addition to their value. Depending on your personal goals, certain types of assets may be more helpful than others.
Are you protected?
Growing your net worth is the main goal. But protecting is important too.
No matter how well you plan, life has a way of throwing you nasty curveballs. And while it may not be possible to prevent them from happening, you CAN ensure that your family will always have the financial resources it needs to deal with them.
This is why things like life insurance, disability insurance, and a good estate plan are so valuable. They’re morbid topics, but they ensure that there’s always money available for your family’s basic needs.
And unfortunately they’re not reflected in your net worth. If anything, they may detract from your net worth because of the cost needed to keep them in place.
But if your goal is to grow your net worth no matter what life throws your way, these protections are invaluable.
The right way to view net worth
Net worth is still the most important financial number. It’s the one number that increases with just about every good financial decision you make.
So yes, absolutely start tracking it now and keep tracking it over time. It’s the best way to measure your progress towards your biggest financial goals.
But remember to keep the entire context of your situation in mind. Because no one number can say everything there is to say about your financial situation, and it’s impossible to say whether your net worth is “good” or “bad” based solely on it’s value.
All that matters is whether you’re making the right kind of progress towards the things YOU want to achieve.