So What’s Your Net Worth?

Your net worth to the world is usually determined by what remains after your bad habits are subtracted from your good ones.
— Benjamin Franklin

Your financial Net Worth is perhaps a bit less noble and a whole lot more practical.

Please refer to Important Disclosure Information at the end of this research note.

I should begin by admitting that I don't know of anyone, besides the students in my personal finance class,  who has gone through the exercise of creating a personal balance sheet.  Even my students view it as a tedious assignment. 

Reasons why you may not have a balance sheet

  • Don’t know what it is and why it may be useful
  • Believe that it only applies to those in financial trouble
  • Gathering the paperwork is tedious and reminds us of tax season
  • No time
  • Afraid you won’t like what you find

Reasons why you should

  • Understand your liquidity situation: in a crisis, can you pay your bills with cash on hand?
  • Know your solvency buffer: what kind of financial shock can you withstand?
  • Ensure your Net Worth (more on this below) is growing at least in line with inflation
  • Learn if you need an investment portfolio to supplement your paycheck

Building a balance sheet

Here is a sample personal balance sheet that can be tailored to your individual needs.

 

Things to note

  • Total current liabilities: 
    • Includes all bills coming due in the next 12 months.
    • Examples are credit card bills, rent (or mortgage), car loan payments, and utilities.
  • Know your Liquidity Ratio:
    • Measures your ability to cover your current bills with your liquid assets even if you lose your source of income.
    • Liquidity Ratio is calculated as Total Liquid Assets divided by Total Current Liabilities
    • The higher the ratio the better, preferably greater than 100%.
  • Investments:  
  • Home purchase:  
    • If you can afford it, consider purchasing a home, instead of renting, while rates are low and home prices are generally rising.
  • (Auto) Do you own or lease? 
    • If you lease because you want to drive a luxury car that you can’t afford, then maybe its time to re-evaluate.  
    • The total cost of leasing is rarely cheaper than ownership.
  • Know your Net Worth:
    • Net Worth, which should be a positive value, is calculated as Total Assets minus Total Liabilities.
  • Know your Solvency Ratio:
    • The higher the ratio the better your ability to withstand a financial shock.  If your ratio is 10% that means you can withstand only a 10% drop in your asset value before you become insolvent.
    • Solvency Ratio is calculated as Net Worth divided by Total Assets.

 

Inflation - The retiree's worst enemy

Your cash assets tend to erode in value over time.  A 2-4% inflation rate can erode the purchasing power of your cash assets by 35-55% over 20 years.    

A home and a prudently constructed investment portfolio are valuable hedges against inflation.

 

Concluding thoughts

As busy professionals we rarely have the time, or the inclination, to build our personal balance sheet.  Yet, a carefully crafted balance sheet enables us to make informed financial decisions and develop a long-term plan for retirement.

 

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Burr Capital LLC), or any non-investment related content, made reference to directly or indirectly in this research will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this research serves as the receipt of, or as a substitute for, personalized investment advice from Burr Capital LLC.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Burr Capital LLC is neither a law firm nor a certified public accounting firm and no portion of the research content should be construed as legal or accounting advice.  A copy of Burr Capital LLC’s current written disclosure statement discussing our advisory services and fees is available for review upon request.