Net Worth

If you decided to "cash in your chips" by selling everything you own for as much as you can and then paying off all of your debts, the amount of money left over would be your Net Worth. Naturally people don't usually sell everything they own but, that does not mean they don't calculate their Net Worth. What they do is make a Balance Sheet that lists the value of all their assets and subtracts all of their liabilities. The difference is their Net Worth.

So, lets do an example.

For Assets you might have

Cash in Bank Accounts $3,000
RRSP Savings $50,000
Appraised House Value $450,000
Vehicles $10,000

So that would be a total of $513,000. Notice how all the money spent on travel, eating out, cloths, entertainment, bank charges, bank interest, taxes and most other day to day expenses do not appear on the Balance Sheet as Assets.

Now let's say that you have consumer debt of $13,000 and a mortgage of $250,000. So, your liabilities are $263,000.

The difference between your total assets and total liabilities would be your net worth, in this example, $250,000.

Now this is an extremely simple Balance Sheet however, just having it and knowing what your Net Worth is, is huge. You see, to achieve a work optional status, you will typically draw down 4% to 6% of your net worth each year. This is called the sustainable withdrawal rate. With a Net Worth of $250,000, this investor should expect to receive an unending sustainable retirement income of $12,500 per year although, she might have to sell her house and car to achieve that goal. While doing this, the principal of $250,00 should continue to grow just a little bit.

Depending on her age and income, this balance sheet could be very healthy or very discouraging. In either case, it is very lopsided because nearly all of the assets are tied up in Real Estate.

The single most important way to protect your Net Worth is to diversify between Real Estate, Equities, and Fixed Income Investments. Typically, in the distribution years we expect to move our investments more into Fixed Income and during accumulation years we tend to own more Real Estate and Equities. By being diversified, we can draw income, during the distribution years, from whichever of the three sectors is doing the best. Not being forced to sell assets into a depressed market to fund retirement income is a huge advantage. In the same way, during the accumulation years, we should choose to invest in the sector that is most depressed in price in order to improve our upside potential.

Depending on the years this investor has given herself to achieve a work optional status, and given the current low interest rates and the just recovering equity market, a financial planner might consider an emphasis on investing in equities, locking in the house mortgage and not buying any fixed income bonds until interest rates go back up.

Because Real Estate, Equities and Fixed Income are such important investment vehicles, I'll take some time in the next blogs to talk about them individually.