Don’t Focus on Net Worth

As part of personal development and financial education, one of my long term goals is to learn constantly and make better decisions as I mature. As investors, we all strive to take emotion out of our decisions, yet most of us fail and panic when there is a market crash eroding our wealth. Over the course of last six years, we have had an amazing bull market run and it has been extremely easy to make great investment returns. While this is all well and good, we need to take a pause from patting ourselves on the back and prepare for the next downturn.

The Net Worth

The market always moves in cycles. A downturn is around the corner and sooner or later, we will hit a new recession and the economic cycle will have come a full circle since the financial crisis of 2008/09. Preparing emotionally and financially are key to surviving the market turmoils. One key area that I have been thinking more about is the total net worth. My total net worth is something that I have never shared on this blog, and dont intend to – as it changes on a day to day basis considering most of my wealth is tied to the stock, bond, commodity, forex and housing markets. I do share a breakdown of how my net worth is divided and is represented in the chart below.

Net Worth - Oct 2015

Before I get into a rant, I want to preface by saying that: Keeping an eye on net worth is still a good idea to keep track of overall progress and checking up on it from time to time. However, getting obsessed with net worth numbers and getting into the mindset that your overall worth is high is something you should avoid.

Wealth Effect

The wealth effect is defined as:

The wealth effect is the change in spending that accompanies a change in perceived wealth.

The keywords are “perceived wealth”. Our perception of wealth gets skewed when the markets are at all-time highs. Unless we sell our assets and lock in those profits, that wealth is not ours and is simply just a number that should be taken with a grain of salt. This is not only true for stock markets, but also other markets – housing market, bond market, forex market or commodity markets.

Home prices have seen an unrelenting rise over the past decade in Canada (Americans saw a similar market a decade ago) and have reached insane levels where dilapidated shacks sell for $1M in Toronto and $2M in Vancouver. This, coupled with stagnant wages result in homeowners (an incorrect term really, but should really be called ‘mortgage owners’) left with massive debts that some will never be able to pay off in their lifetime. New homeowners are simply looking to ride the wave with no intention of paying off the mortgage. The debt-to-income ratio for an average Canadian is now at 164.6%, according to Statistics Canada. This has pushed Canadians to borrow more and an average Canadian consumer debt (non-mortgage debt) stands at $21,028!

Those numbers listed above should raise eyebrows and seem massive to most folks (unless you belong to the 1%) but lenders have been happy to push consumers more into debt at the record-low interest rates and this euphoria can only end in one way. In fact, thanks to successful marketing, I am reminded of Scotiabank’s (BNS) marketing catchphrase “You are richer than you think”. Repeat it enough times, and its ingrained in your brain that it really is true.

Don’t Focus on Net Worth

I believe this mindset stems from us focusing too much on the net worth numbers. With most of our fortune tied to stock market (we are at all-time highs), bond markets (interest rates are at record low, and remember bond fund prices drop when interest rates rise) and housing markets (Canadian housing market is in bubble territory, and same goes for a handful US cities). We tend to think that we are richer than we are, but this is due to perceived wealth. This increased perceived wealth is what gives us the confidence that we have money to spend on non-essential luxuries. But if our wealth is tied to the markets, volatility will eventually bring us back to reality.

What are your thoughts on net worth? Does the perceived wealth cause you to take financial and investment decisions that you wouldn’t take if your net worth wasnt as high? Share your thoughts below.

 

41 thoughts on “Don’t Focus on Net Worth

  1. R2R,

    I agree with you 100%. My approach has been to focus on building up a portfolio of income producing assets to generate a passive income stream. The net worth part will take care of itself. As you said, paper profits aren’t real until you cash out the underlying investment. You can’t buy a cup of coffee with paper profits, but you can live on the cold hard cash produced by passive income investments.

    Thanks,

    Deets

    • I approach my investing and path to financial freedom in a similar way – focusing on building my portfolio to increase my passive income. The actual net worth will simply increase as I accumulate more assets over time – and will take a hit when we eventually hit a recession…so, one thing that I can control and work on consistently is to invest at regular basis and increase my passive income and save that/reinvest it to compound growth.

      Thanks for stopping by and sharing, Deets.
      R2R

  2. You are absolutely right. While Mr. and I probably have similar net worth, because my assets are producing income vs. his not producing cash flow. net worth doesn’t mean much then.

  3. R2R,
    I agree with you, but the net worth is useful (like you say) to see where you are heading and also as a rough guideline of the efficiency of your investments when you compare your income over your assets.
    D4s

    • Hi Div4Son, I think keeping an eye on the overall net worth is still a good idea – as you suggest – “as a rough guideline” – just to make sure that you arent spending more than your overall earnings and savings rate. My argument here is to remind readers not to get obsessed with the net-worth numbers.

      R2R

  4. Carmen says:

    Monthly net worth is just one tool in my financial kit. For my bottom line, I look closely at dividends received monthly in my RRSP and TFSA index fund portfolios. Further, I watch the payout yield of my dividend stocks (and DRIPs) in my non-registered accounts. Second, I monitor my savings rate. I aim for 50 % of net salary, monitor coupon usage and live within my fixed expenses, grocery, transportation and entertainment/alcohol budget. I budget for splurges. With an aggressive saving plan, a full-time well paid career and a part time job, I was able to pay off my mortgage in about four years and top up the annual RRSP and TFSA. Did I go out for lattes? Never. But I bought an expresso machine(4 years ago) that has paid for itself many times over. And I bake a great lemon loaf..take that Starbuck$.

    • Wow! Sounds like you have a great handle on your finances. Two jobs, mortgage free in four years AND topped up RRSP and TFSA. Thats absolutely fantastic, Carmen. I wish I could achieve that kind of saving rate – maybe one day I will be able to get there. Lately, we’ve been somewhere ~35% savings rate. But there plenty of room to fix our finances. Cutting back on splurges like daily lattes etc is key. It was one of the first lessons I learned when I started off my financial independence journey.

      Thanks for stopping by and sharing
      R2R

  5. Thanks for the article R2R. Networth is important to keep track so that you know where you stand on a bi yearly and yearly timeline. To spend based on a increase in networth is just silly. True investors know it fluctuates wildly so stick with the plan and that’s staying consistent and living below your means.
    The income produced from our assets is my real source of measuring wealth. To me, a safe 3 percent yield is reasonable and so cash flow is king.
    Thanks for the reminder Sabeel and keep up the good work.
    Cheers and take care my friend.

    • I hear you on checking up on net worth on a biannual or annual basis – just to see how things are going. Even checking up quarterly might not be such a bad idea. But checking on it time and again will probably be more detrimental to people.

      Best
      R2R

  6. R2R,
    You make some valid points, though I still view net worth as being a valid gauge of financial success. I like to keep half an eye on that number because it may alert me to financial behavior that we should be avoiding (like overspending).

    On the other side of the coin, anyone who owns investments has to be cognizant of their effect on net worth. The ebbs and flows are inevitable. When our net worth drops, I usually look for a reason. If we are overspending, that’s one thing. If it’s because the NAV of our investments is contracting, I can console myself as long as the dividends continue to roll in. Income is my first priority, because I’m an old retired guy.

    • Oh yes, of course – knowing what your net worth is definitely has a place in everyones finances. Its good to keep, as you say, half an eye on it – to know how things are progressing, but what I wanted to illustrate with this was for people to not get too caught up in the numbers and let that dictate how overall spending takes place. Or raising more debt for that matter.

      R2R

  7. I track our net worth monthly but I’ve never once felt compelled to spend more or increase our debt just because our net worth is rising. It’s a moving number anyways and once you get to a net worth above $100-200k most people have very little impact on the changes in net worth from savings alone. The markets, especially when volatile, can wipe out $20k+ in an instant so saving say $1,500 per month doesn’t really soften the blow. Plus if your net worth is primarily tied up in non-accessible assets (401k or other tax deferred accounts that can have penalties tied to early access) or your home which is generally a non-income producing asset the net worth does’t really tell you anything about where you stand. You know if you can cover all the debts that you owe but that’s about it. Net worth for us has always been a secondary goal, yes we want to see it grow each month/year but the cash flow is what tells us how close we are to our goal of reaching FI. We don’t include any cash flow from our retirement/tax deferred accounts so it’s all dividends, interest, and blogging/writing. Once that covers our expenses we’re golden.

    • Hi JC.
      Good points – that you want to make sure that your net worth is heading in the right direction and if it comes down to it, you are able to cover all your debts. Like you said, having it tied up in inaccessible assets doesnt really help in any way. I have seen some people borrow more knowing that their net worth is heavy and I thought that it was a bad decision overall – as the overall markets simply mean that the wealth is just perceived. Of course, I agree with your pointview of cash flow and accumulating income producing assets to fund our retirement. I am on the same path with you there 🙂

      cheers
      R2R

  8. I use net worth as a gauge to make sure I’m on the right track with my financial goals. I don’t find a lot of benefit from looking at it often, however.

    I currently only review it on a quarterly basis as I think it gives a slightly better picture since you can have wild swings from month to month.

  9. DA says:

    I just make sure net worth is heading in the right direction, otherwise it gets mostly ignored. Especially with the ridiculous real estate valuations – everything looks amazing on paper until it doesn’t.

    • Agreed, DA. My net worth is definitely bloated right now with the real estate market at its peak. This party cannot continue forever and when it ends, the home prices and with that, our net worth will come down.

      R2R

  10. Yup, Net Worth is nice to have, especially when its positive and hopefully slowly growing.

    But, when it comes to my stock portfolio, I focus more on quality and dividends and dividend growth. Although I would like to see my portfolio value hit 30k for the first time by the end of the year.

    And net worth like you mentioned certainly doesn’t necessarily equate to wealth. Its, income that really lets you buy more if you want it. Simply having a lot of wealth on ‘paper’ doesn’t make you rich till you cash out, just like at a casino.

    Thanks for the post!

    • You got it, DW. I am in the same boat – just looking to accumulate quality assets to boost my passive income. Wealth on paper doesnt really mean anything. Wish you the best in hitting your $30K goal by end of year.

      Best
      R2R

  11. R2R,

    I pay no attention to my net worth. I like to say that I can’t spend my net worth down at the net worth store. It’s just a number that’s out there fluctuating all the time. The income that my investments provide on a regular basis and the growth of that income is really what matters to me. That’s real cash flow that can be measured against real expenses. Better yet, that income tends to move in just one direction: up! 🙂

    Cheers.

    • Thats the attitude, Jason. I like the way you put it – that there is no net-worth-store to spend that on. Focusing on cash flow and looking to accumulate appreciating assets is the way to go to achieve financial freedom.

      Thanks for stopping by
      R2R

  12. I think the overall trend of your net worth is more important than the day-to-day net worth. Things are pretty fluid as you mentioned so your net worth can go up and down quite a bit if you track it day-to-day or even month-to-month. I think what’s more important for all of us is self worth. You can have very high net worth but if your self worth is very low, then you’re probably not having a good time in life.

  13. Great article. I can totally relate to this. I don’t even calculate a total net worth in my dividend tracking spreadsheet, primarily concerned with growing dividend income each and every month…

  14. I used to calculate our net worth once a year when doing taxes. I no longer do that. Knowing our net worth did not influence our budget or lifestyle. We’re continuing to be as frugal as possible.

    We did, however, buy a new house and decided to hold on to our previous house as a rental property. The rental income just about covers the mortgage payments and property taxes. Any maintenance will push us into the red. I feel thats OK though, as property in the Bay Area continues to rise in value.

    Even if I continued to calculate our net worth, I’ll never feel comfortable sharing that publicly. I don’t mind if others do, but that’s just not part of my personality.

    Thanks for a thought-provoking article!

    • I hear you, FerdiS. I didnt track my net worth for a very long time, but have started to do that now…however that doesnt seem to have any effect on how I spend or do anything else with my finances. It is however good to observe for fun’s sake that it is heading up regularly.
      Bay Area housing market seems to be crazier than what we are seeing here in Canada. I have a sibling who lives there – so I hear some crazy stories about the housing market not covered in the media.

      cheers
      R2R

  15. Great article and I agree focusing on constantly fluctuating net worth can be problematic for some investors and can influence decision making and even spending habits. Unrealized gains can give investors a false sense of security, your housing market example is spot on too. Within the US, California in particular saw ridiculous price appreciation in the housing market, people thought they had money they really didn’t have from ridiculous appraisals and many homeowners tapped their “equity” which really wasn’t there and paid the price for it when the market prices dropped.

    • Hi Devin,
      I am seeing the same behavior here in Canada. With the inflated home prices, homeowners are tapping into their equity and spending like crazy. I met ppl lately who seemed extremely confident in their decisions of borrowing money against the house and raised my curiosity. We might heading down the same road that the US market saw last decade.

      Thanks for stopping by
      R2R

  16. R2R,

    I think I put even less emphasis on net worth than you.

    To me, net worth is just a bragging number. “Look at me, I’m worth $1,000,000.”

    That’s nice, but that doesn’t mean you can actually spend $1,000,000. You don’t actually have that money.

    To me, cash flow is a much more important measure. Access to self-replicating liquid capital is more important to me than a dollar amount that I don’t actually have, or paper wealth that fluctuates daily.

    No one ever retired early on their net worth. They did so on their passive income cash flow.

    This article hits the nail on the head.

    Sincerely,
    ARB–Angry Retail Banker

    • Thanks for the support and the words of affirmation, ARB.
      You are rights – its the cash flow that matters and looking at net worth doesnt do much rather than giving you false confidence and bragging rights.

      R2R

  17. Nice article R2R! While the general direction of portfolio value is good to know, however, keeping a constant hawkish eye on the absolute value is not. For DGI bloggers like our self, the passive income generated by that portfolio is critical. Keep racing towards FI!

  18. R2R,

    Thanks for the inspiring post. It is great to be reminded to keep things in perspective. Investors should not get to be too confident with their net worth, as you said, because that is always in a constant state of flux. Personally, my only goal is to increase my net worth as fast as I can so that even with market fluctuations and investment mistakes, I am able to subsidize living expenses. I am looking forward to reading more posts! Thanks!

    Jim

    • Thats the idea, Jim. Keep working away at it and increase the net worth – but avoid taking risks and investment or debt decisions based on it..that I feel is the way to go.

      Thanks for stopping by
      R2R

  19. An interesting thought. I particularly like the perceived wealth phrase. I personally love the idea of tracking net worth, but like you said it can easily go up or down as the various assets change in value. The reason I like tracking it over time is that it forces learning (or possibly allows it). If I had not been watching my net worth over the GFC I would probably not have learnt as much about the importance of diversification, defensive assets, cashflow and the housing market in Australia.

    I think Tawcan said it best “the overall trend of your net worth is more important than the day-to-day”. That is why I ret and keep records every 6 months (sometimes more if something “interesting” happens (e.g. purchase a property).

    • Thats the essence of what I was trying to convey with this post, Tom. I find a lot of folks too obsessed with their net worth numbers and that turns out to be just a perceived wealth and nothing else. That shouldnt change how we live our day to day life and just because the stock market market is up – we shouldnt go out and buy a new car for instance.
      I agree that tracking net worth is an important part of personal finance – I track my net worth too — and funnily enough, I use the semi-annual results to watch for overall trends – as I find that monthly and quarterly tend to vary a lot.

      Thanks for stopping by and sharing your thoughts

      Best wishes
      R2R

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