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In a previous blog (See: WHAT’S YOUR NET WORTH?) I went through the mechanical aspects of deriving a Net Worth Statement and Net Worth number. In this blog, I will explore the functional aspects of a Net Worth number, what net worth means, and how it fits into an integrated retirement plan.
Everyone who read the blog WHAT’S YOUR NET WORTH? should realize that in most cases, deriving net worth requires expending time and effort to locate and catalog all assets and liabilities. The more complex a person’s financial situation, the longer the process will take to complete. This blog will explore and answer the question: Is net worth only a number and is all the time and effort worth it?
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Is the Time and Effort Worth It?
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At the heart of this exercise lurks the question: Is Net Worth merely a number, and in deriving Net Worth is the time and effort well spent?
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Net Worth as a Placeholder
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The true essence of Net Worth is that in its purest form, it is a placeholder. Net Worth tells your present financial position. Period!
For Net Worth to shine we must release the lock on “Net Worth is only a number” and look at Net Worth in a larger context.
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Net Worth and the Big Picture
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- Net Worth as a Placeholder– it’s true, that net worth is only a placeholder, but even a placeholder tells you where you are at present! If you’re on a journey, knowing where you are presently is important information. On a life, journey, knowing where you are at any given moment is also important. It’s great to know where you are, but only if you understand what that Net Worth number indicates in the greater scheme of Financial Independence.
- Net Worth as a ruler– using the same “journey” analogy and knowing where you are at any given moment provides a good estimate of how far you’ve traveled from your starting point. Periodic Net Worth statements will tell how far you’ve traveled and how much progress you’ve made (or lost) between Net Worth statements, and between your current Net Worth statement and your starting point.
- Net Worth as a guide– you’ve decided that your ultimate goal is a Net Worth of two million dollars. You started with zero dollars and have a present Net Worth of five hundred thousand dollars. You have completed one-fourth of your goal. Periodic Net Worth Statements become a guide from the start to the finish of attaining your personal financial goal.
- Net Worth as a Marker– the goal you set is a marker. It is the destination of your immediate journey. It’s important to understand that a Net Worth goal is only an intermediate marker and will change and grow over time. As one goal is completed the marker is re-established at a new goal.
- Net Worth as a target– net worth can be a target to attain. Setting a target of “X” dollars as an ultimate goal gives you a finite number that you want to attain at some future date you decide (For example I want to have a Net Worth of two million dollars on January 1, 2030.)
- Net Worth as a step in a ladder– If you’ve decided that your “X” number is two million dollars by January 1, 2030, then intermediate net worth goals can be placed as “steps” on the ladder to your ultimate goal. (For example: if I want $2 million by January 1, 2030, then I’ll need $100,000 by December 31, 2023, $250,000 by December 31, 2024, $1 million by December 31, 2026, and I’ll need $1,750,000 by December 31, 2029.) Setting up these intermediate steps along the ladder to $2 million helps to visualize the ultimate goal, and what steps need to be completed along the way.
- Net Worth as a set-point– in previous blogs I’ve posted about the effect of written goals. By formulating a written Net Worth statement and Net Worth target you formalize and memorialize your present thoughts and desires. Your brain will begin formulating a plan to achieve your written goals. A Net Worth Statement and Net Worth target provide a pathway to success, but each person must still do the work of walking the path to completion.
- Net Worth as a Bragging Point– some people use net worth as the basis of a bragging point (For example I am rich, and I am worth “X” dollars.) This is irrelevant to our discussion but is not an uncommon occurrence.
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Net Worth in the Larger Context
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Many financial advisors use a person’s Net Worth as the advisor’s “go-to” number. For their clients to be financially independent, they must reach “X” Net Worth number.
In many cases, clients leave an advisor’s meeting feeling disheartened by an extraordinarily large net worth target indicated by the advisor. In their minds, the Net Worth target is both unreasonable and unobtainable.
So, instead of helping, the advisor creates confusion and dejection by proposing a Net Worth Target the clients feel is beyond their reach!
Net Worth can only be relevant and essential when used in the context of the bigger picture. This means that each person must first know and understand that Net Worth is one part of a bigger Financial Master Plan.
Let’s use Warren Buffett as a means to a better understanding of net worth in a larger context. In March 2023 Warren Buffett’s net worth was $108.6 billion. Using the industry standard of a 4% annual withdrawal rate, Warren Buffett could theoretically withdraw approximately $4.3 billion each year for living expenses.
Yet, according to CNBC: Billionaire Warren Buffett is famously frugal. In fact, the 92-year-old has lived in the same modest home for 65 years.
The Berkshire Hathaway CEO still resides in the five-bedroom home in central Omaha, Nebraska that he purchased for $31,500 in 1958, which is about $329,505 in today’s dollars.
The 6,570-square-foot house is located on a corner property in Omaha just a five-minute drive away from Berkshire Hathaway’s corporate headquarters. The original 1921 stucco structure appears to have some additions as well. It’s currently valued at about $1.2 million, according to Zillow’s estimate.
According to Markets Insider: As Berkshire’s CEO and chairman, Buffett recommends to his board of directors how much he should be paid, and decides the rest of the executives’ compensation. The 92-year-old has received $100,000 a year since 1980 — a fraction of the $18 million average pay of S&P 500 CEOs in 2021.
Buffett doesn’t earn much from other sources either. He netted double his salary in annual directors’ fees in the 1990s and early 2000s, before he resigned as a director of The Washington Post Company and stepped down from other corporate boards.
The highest annual compensation he’s ever received at Berkshire was $525,000 in 2010, comprising his $100,000 salary, $75,000 in directors’ fees, and $350,000 allocated to his security costs.
Using Warren Buffett’s highest annual compensation of $525,000 and multiplying this number by 25 (25 times annual earnings is considered to be a standard of total required Net Worth) would equal an estimated required Net Worth of $13.125 million. So, Warren Buffett’s net worth, while being over $108 billion, far exceeds his true net worth needs of a little over $13 million.
And even this estimated net worth needed of $13.125 million may be greater than his actual necessary net worth because his spending includes $350,000 in annual security costs. His true actual annual spending is closer to $175,000.00. Using an annual spending rate of $175,000 equals a necessary net worth of $4.375 million.
The numbers above are irrelevant. The concept illustrated is that net worth should be a function of actual living expenses, and not some multiplier of salary, or some arbitrarily derived number.
Net worth estimates and targets should be used in concert with annual spending, annual salary, and estimated retirement living expenses and discretionary spending (See: AVOIDING A FINANCIAL HURRICANE BY CREATING AND UNDERSTANDING A FINANCIAL PLAN.)
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So, is Net Worth Important, and Worth the Time and Effort?
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Net worth is a critically important part of an integrated financial plan and a necessary piece of the financial planning process. The danger lies in using an arbitrary net worth number or target that is not well thought out or well defined within the context of a complete plan.
On a personal note, I started creating net worth statements, many years ago, and still create an annual net worth statement. Not only does it tell me my current financial position, but it also tells me where I am financially relative to my Net Worth Statement from one year ago. My annual net worth statement is extremely useful in providing basic information and guidance in the implementation of my personal withdrawal strategy (See: FUNDING SOURCES FOR YOUR RETIREMENT PAYCHECK, SOLVING A BIG PROBLEM- CREATING A RETIREMENT PAYCHECK.)
It would be much harder for me to plan and implement my retirement strategy if I did not have an annual net worth statement, along with all of the information my net worth statement provides. So, for me, it’s a no-brainer! Each year going forward I will continue to generate a net worth statement to help with the planning and implementation of my retirement plan.
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Final Thoughts
- Generating a net worth statement requires both time and effort.
- The more complex, a person’s financial situation, the longer it will take to generate an annual net worth statement.
- In its purest form, net worth is only a placeholder. It tells us where we are at any given point.
- Net worth can provide many different forms of information, but the true worth of a net worth statement is in its integration into a comprehensive retirement plan.
- My feeling is that net worth is an integral part of initial retirement planning, and is essential in ongoing annual retirement planning, and implementation of spending strategies.
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