Why Net Worth Can Be Misleading

Why Net Worth Can Be Misleading

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.

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8 Comments... Read them below or add one of your own
  • Ree Klein July 26, 2016

    Hi Matt ~

    As usual you deliver excellent information in an easy-to-understand way. I completely agree with you that tracking your net worth is both an incredible tool and potentially misleading.

    I wrote a post some time ago where I discussed “my crazy method for determining property value for net worth calculations.” People think I’m crazy because I carry my home value at it’s lowest estimated value over the last 10 years.

    This makes my net worth look a lot lower but it’s far more realistic in my view. Why? Because I know that if something in my situation should change and I have to sell my home unexpectedly, I will at least be able to get that much out of it regardless of the economic conditions.

    Call me crazy, but I sure sleep better at night!

    • Matt Becker July 26, 2016

      Thanks Ree! I like the idea of estimating conservatively on something like a home, both because that money is not easily accessible and because you never know what you would get on the open market. In the end you just have to do whatever works for you, which is clearly what you’re doing!

  • Daniel July 26, 2016

    Exactly. Net worth is a metric, useful for seeing where you are, where you have been, and where you are on the road to your goal. But there are so many other factors that are based on your personal situation and preferences (Do you hate mortgages? Then Sam, even with the CC debt is your man. Prefer high liquidity? Then Mike is your guy. The thing is that so many people focus on Net Worth as the be and end all as far as a metric goes, but that is just in line with the fact that there is no “one size fits all” solution in personal finance (a good example is the near holy war about whether it is a good idea to pay down your mortgage).

  • Ralph August 12, 2016

    A paid off house does represent a potential monthly payment savings. The mortgage represents a drain and the investments represent a growth on savings. The house also represents a potential gain in value. How much is based on both location and the current state of the economy. Interestingly, Mike is making a rent payment (or living with his parents) which is a risk to inflation and a job loss. A paid off house represents risk reduction against inflation (vs Mike with rent), a sudden loss of income as with both Mike who could be evicted and Jill and loose the house and all the previous mortgage payments. Now if life takes a turn, Sam (and possibly Jill) will have to borrow more money and go deeper into debt. I applaud Mike for his sizable emergency fund. However, the net worth is a great metric to measure your growth But it isn’t the only one to keep up with and neither should be.

    • Matt Becker August 12, 2016

      All good points. I 100% agree that there’s a lot of nuance to measuring stability and progress and that net worth alone isn’t enough. Thanks for pointing out some other things to consider!

  • Ms. Montana August 16, 2016

    Net worth is something we track, but I really only check it about twice a year. While it’s something we can control the direction of in the long run, there isn’t much I can do about it on a daily basis. Although we did have a really fun celebration weekend when we hit a half million! The number that get more attention are our debt (on rental properties), passive income, saving and spending. If I can keep those numbers heading in the right direction, the net worth will go in the right direction too.

    • Matt Becker August 17, 2016

      That’s a great way of putting it. Focusing on all of those smaller categories is how you really make progress, and by doing that your net worth will naturally be increasing as well.

      I like net worth because it’s a good way to see how all of your efforts across all those different areas work together to improve your overall situation, but you’re absolutely right that it’s the daily habits on specific things that’s the key to getting ahead.

      • Ms. Montana August 17, 2016

        I totally agree! Net worth is the final product. We only look at ours twice a year so that we can see actual progress. But we really celebrate that. =)

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