Net Worth

What does Net Worth means?

According to Wikipedia:

"In business, net worth (sometimes called net assets) is the total assets minus total outside liabilities of an individual or a company"

"In personal finance, net worth (or wealth) refers to an individual's net economic position; similarly, it uses the value of all assets (long term assets) minus the value of all liabilities"

As per Investopedia:

"The amount by which assets exceed liabilities. Net worth is a concept applicable to individuals and businesses as a key measure of how much an entity is worth."

"A consistent increase in net worth indicates good financial health; conversely, net worth may be depleted by annual operating losses or a substantial decrease in asset values relative to liabilities."

I agree with both definitions. Which are basically saying:

Assets - Liabilities = Net Worth

If your liabilities are more than your assets, you are technically a bankrupt. But of course in real life you are not because of the great human invention since time immemorial called debt.

Assets - Liabilities < 0 = Technically Bankrupt

Similarly, if your assets are more than your liabilities you are technically rich.

Assets - Liabilities > 0 = Technically Rich

Why do I say only technically rich? Because if you have zero liability - no house, no car, no everything but you have $100 in your bank account. Well technically you can be considered as "rich" but we all know that is far from the truth.

In fact more often than not a technically bankrupt people live a more affluent lifestyle than a technically rich people.

However, if you want to achieve Financial Freedom you must make sure "technically" rich becomes a reality for you.

By the end of Chapter 2, you should be able to know where you stand financially. If you are among the "technically rich", congratulations for beating the odds. Your journey forward should be easier than the rest of us.

Most of us unfortunately are “technically bankrupt”.

So don't hate your banks too much. Don't curse your banks either. You may not realise it but they are actually your life saver. Without them, most of us will not be able to afford our current lifestyle.

The most important thing at this point is to be honest with yourself.

You don't have to share your findings with other people so be as brutal and honest as you can handle. After you know where you are now, then only you can chart the journey to where you want to end up financially.

“Sometimes it seems safer to hold it all in, where the only person who can judge is yourself.”
― Sarah Dessen

“Most men would rather deny a hard truth than face it.”
― George R.R. Martin

“Denial is an ugly thing.”
― Nicholas Sparks

Assets

 

I remembered once I posted in my Facebook status "Is the house that you bought and stayed in considered as your asset?" One of my friends actually asked me back "Is that a trick question?"

What exactly can be considered as an Asset?

According to Wikipedia:

 

"In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset. Simply stated, assets represent value of ownership that can be converted into cash."

Investopedia defines an asset as:

"A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit.”

My definition of an asset is something that can generate you income now. As you can see it is slightly different than the classic definition. It is stricter. I will only consider those that provide immediate benefit as an asset.

This means the house that you bought and stayed in is not your asset. Neither is the car that you use to ferry you around.

An endowment policy that you make payment to every month in anticipation of a lump sum payment in the future is not your asset. You can only consider it an asset if you surrender it or when it is matured.

While you are still paying for it, it could however arguably be recorded as an asset to your beneficiary. I'm kidding! Well technically if you die then it is an asset to your beneficiary.

All the above are actually your liabilities.

Why do I say that? Because you still have to pay for it. Even if the car and the house that you use are fully paid, you still need to maintain it and that will cost you money.

What can be considered as your asset then?

Your job is actually an asset. So cherish it. Don't hate your boss or bad-mouth your company too much! Unfortunately you can't include it in your net worth calculation because it is not your “real” asset. You could be fired tomorrow!

If your net salary is more than your expense then the excess cash is your asset.

If you invest the excess cash in unit trusts or shares and they generate dividend income then the investments are your assets.

Your Employee Provident Fund is an asset. Now aren't you glad that the authority makes it a compulsory contribution and also makes it difficult to do pre-retirement withdrawals?

For most people that could be the only asset that they have.

Unfortunately it is not a liquid asset. So unless you are above 55 years old, if you want to be strict and want to know your real net worth you should exclude it in your calculation.

In my case, I include it but I put it under “non-liquid” asset category. This is to ensure that I will monitor it but at the same time I know that I can't access it now.

What about property investment?

If you buy a house as an investment (instead of to stay), technically it is an asset. It could be a performing or non-performing asset depending on circumstances. A performing asset if it gives you rental income, non-performing if it doesn't (still in building stage or left empty unrented). I know that this is not in sync with my definition of asset above.

The reason why I include the non-performing asset in the asset list is due to the fact that you need to include the housing loan of the non-performing asset at the liability section of the Net Worth Statement.

If you only list the housing loan, you will overestimate your liabilities. Even though I am fine with that, your heart may not when you see the numbers!

For prudence sake, it is recommended to use the purchase price instead of market price as the value.

How about gold, jewellery, paintings or expensive watches?

Those are non-performing assets. They don’t generate any passive income. There are only potential capital gains if you chose wisely and sell them later at a profit.  

If you buy them purposely for investment, then you may put them in your asset at cost price. If you buy them for day to day use, you should exclude them from your list.

Homework: Make a list of your assets in Excel spreadsheet. This list will be part of your Net Worth Statement in Chapter 7. If you are like ordinary people, this should be a short exercise.

Liabilities

 

I think this is the scariest part of all to most people.

 

Who wants to do know how much liabilities one have right? A lot of people actually think that ignorance in this case is bliss. This is actually very far from the truth.

People who doesn't monitor their liabilities more often then not will pay more than people who does.

For instance, if you own a house you have to pay to the local council assessment fees twice a year and quit rent once a year. They have fixed deadlines year in year out.

If you conveniently forgot the deadline, you will be automatically fined. The fine may not seem much but why do you need to pay even a single cent more than necessary?

I have a colleague once that was slapped with late payment charges on his credit card bill every month. It is not that he doesn't have money to pay. In fact he paid his bill in full every month.

When I queried him about it, he said that he simply forgot the due date. When the bank called him, only then will he make the payment. I think the amount of late payment charges accumulated over the years can probably pay for his family's vacation to China!

Like all unfounded fears, you need to face it heads on before you can conquer it. It is a lot easier and much less painful than going to a dentist you know. I’m not joking!

What exactly is a liability?

In Wikipedia, a liability is defined as:

"an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future."

Investopedia defines it as:

"A company's legal debts or obligations that arise during the course of business operations. Liabilities are settled over time through the transfer of economic benefits including money, goods or services."

"Outside of accounting and finance this term simply refers to any money or service that is currently owed to another party."

A mouthful I know. My definition of liability is a lot simpler, anything that costs you money to maintain.

Which means your house, your car, your scooter, your smart phone, your iPad, your insurance, your club membership, your hair cut, your 0% easy payment, your weekly gathering of BFFs, your rumba class, your hamsters, your kids, your parents are all your liabilities. The list can go on and on depending on your lifestyle.

 

"Whoa! Stop it right there! My parents are not my liabilities. They are my assets." said the righteous indignantly.

Well maybe they are right. Some "kids" still ask their parents for money even after they have kids of their own so their parents are indeed their assets!

It is a commendable practice for children to give money to their parents every month once they started working. It is a sign of filial piety. Thus, in financial term this obligation to pay is considered a liability.

Something to look forward to I suppose. Your kids once they started working could potentially be your assets but I won't hold my breath if I were you!

Homework: List down all your liabilities in Excel spreadsheet. It may take some time so take a week at least to compile. Think about it deep and hard. This is very important so make sure you got it all.

Don't bother to tag monetary values to it yet. If you do that, you would probably stop before you even start. Do that later after you have calmed your nerves.

This list will be part of your Net Worth Statement and Cash Flow Planning (refer to Chapter 7).

“Do one thing every day that scares you.”

- Eleanor Roosevelt

“You gain strength, courage and confidence by every experience in which you really stop to look fear in the face. You are able to say to yourself, 'I have lived through this horror. I can take the next thing that comes along.' You must do the thing you think you cannot do.”

- Eleanor Roosevelt