An Alternative to Networth

by Mr. Cheap

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I personally have no problem with it, but many people in the personal finance blogosphere seem to have objections to networth as a measure of wealth (and especially whether to include your principal residence in the calculation, Mike and I even disagree on this one).

While re-reading “The Millionaire Next Door”, one idea they mention in passing is that one view of “your wealth” is the length of time you could go without working (i.e. without receiving a paycheck). I thought this was an intriguing idea, as it factors in your spending and lifestyle as well as your assets.

The calculation would simply be: (assets – liabilities) / monthly spending.

As an example, my assets (after subtracting liabilities), including cash, stocks and my investment condo were worth about $87,318 as of June 1st (I’d also consider this my networth). Since I’m living on about $1300 / month, I could go for about 67 months ($87,318 / $1300), or 5.5 years without working (BIG IF: my living expenses didn’t increase and my assets didn’t decrease in value).

Alternatively, you could use assets / monthly spending (including debt servicing) if your liabilities are greater than your assets (and having a negative number would bum you out).

I especially like this calculation as it favours my approach to life :-). I’d be significantly higher on the networth ranking of PF Bloggers if we factored in lifestyle costs.

Factoring in the principal residence is still a tough issue, as selling it would probably INCREASE your monthly expenses (since you’d have to rent something comparable). *sigh*

How long could you go without receiving a paycheck? What do you think of this measure of wealth compared to networth? Any ideas for what we should call it?

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{ 18 comments… read them below or add one }

1 Million Dollar Journey

Question, some assets aren’t as liquid as others (ie. principle residence), would you assume that these assets are sold for cash before making your calculations? Also, how about the taxation issue? If people were to cash their RRSP’s, most would face a huge tax hit.

2 Matt

My biggest issue with networth is the fact that its only a snapshot in time and as Million Dollar Journey points out some assets really aren’t all that liquid. Personally I’ve always liked a cashflow statement along with a networth statement to have a good understanding of what your financial situation really is.

For example in your first calculation you might have 5 years of wealth accumulated but a significant chunk of that is in your investment property that might take a while to actually sell and use as capital.

3 jo

MDJ: I think the scenario assumes you maintain current lifestyle which presumably means keeping your house if you are living in it and don’t hold it as an investment property. As Cheap points out, frugal people have an advantage when wealth is viewed this way. If you were living on savings only and your monthly expenses are high you would indeed have to pull out RRSPs in larger chunks paying significant taxes on your withdrawals. But if your expenses are low as Cheap’s are, when he got down to living only on his RRSPs (presumably he’d leave them ’till last to put off the tax hit and maximize tax-free compounding time) he’d be able to pull them out mostly tax free given the gov’t’s allowance of a basic personal amount on which no tax is paid. At current rates, he’d pay only $1,263 tax per year – not bad (monthly exp $1300 x 12 = $15,600 – no tax on first $9,600, tax rate of 21.05% on remaining $6k). Of course, you’d pay no tax at all if you could live at or under the basic personal amount (+ GST and Child Tax Credits if applicable) which some people do. If I recall, Derek Foster’s approach results in him paying under 10% (and sometimes under 5%) tax on his income each year though . When you live on little income, you pay little tax :)

MC: I hadn’t heard of this approach – I like it! I think I’m at about 9 years, though I bet I could stretch it to 10 if I had to :)

4 Kyle

From a practical standpoint, how long you could live without an income is probably more important. Then again, that’s assuming your investments didn’t decrease in value which is not a reasonable assumption in the current economy. So I would say the ability of your assets to support you in the event of unemployment fails you just when you’re most likely to lose your job.

5 Steward @ My Family's Money

My wife and I could get by for about a year on the money we have in our bank account.

~$20,000 cash / ~$2,000 monthly expense

If we ditched our apartment and moved in with family (thus eliminating rent) we could last for twice as long.

6 Mr. Cheap

MDJ: *GRIN* those were the two points I was pretty sure someone would make, and you hit them both out of the gate! Lets assume all assets are liquid (and can be sold at the best estimate of its current price). Lets ignore transaction costs (and we’ll also ignore any income we may have derived from those assets – just to simplify things we can assume these balance out).

Lets ignore taxation too (in some cases, if your lifestyle was low enough you could withdraw from your RRSP and not get taxed).

7 Mr. Cheap

Matt: That’s true. There’s also the consideration that it would be bringing in money for me until I sold it.

8 Mr. Cheap

Jo: Wow, good for you!

Stewart: That’s nice too! A year (or two) is plenty of time to turn things around if a bad situation hit…

9 Million Dollar Journey

If that’s the case, we could live 5.5 years.

10 Canadian Dream

YES! I’m not the only one who does this! Actually I sort of like to do this once in a while to remind myself if I ever lose my job I would be fine.

I’m about 7.5 years.

Tim

11 moneygardener

interesting concept, I’ll have to figure out our timeframe….

12 moneygardener

just figured ours out..it’s about 4 years.

13 deepali

Am I understanding this right? Liquidate all your assets, subtract your liabilities, and divide by monthly expenses?
So if my condo was worth $10, and I owe $5 on my mortgage, then I have $5 in the numerator (etc)?

Damn, I could retire tomorrow. Sadly, it would only make sense to liquidate everything today if I needed to pay for life-saving surgery.

14 Mr. Cheap

Deepali: Yup, you got it. Good for you if you’re a grad student and you could retire!!!

15 deepali

Oh, I meant to ask – does my sugar daddy count as an asset? :)

Retiring tomorrow is a slight exaggeration. I’d have to get the mortgage payoff info to know for sure. But if I liquidated everything and kept to the frugal student lifestyle, I could go 20 years without the $ from the condo.
Further if I moved overseas (as I will be doing next year).

That being said, this really illustrates the reason why it’s not just about worth but also about how costly your lifestyle is.
I guess one thing not being taken into account (as an American) is that if I weren’t working, I’d have to pay quite a lot for health insurance coverage…

And before anyone thinks I’m a financial genius… it’s all my mom. :)

16 Mr. Cheap

deepali: If you stopped working you would qualify for medicade wouldn’t you?

As a Canadian I’m supposed to believe that Americans leave their sick out on the street to be eaten by hungry wolves, but I know that’s not QUITE the situation.

17 moneygardener

Call it ‘Net Freedom’ …………thanks for this post. I’ve followed up on the moneygardener.

18 Mr. Cheap

MG: Net Freedom is an excellent suggestion! This conversation is continued on moneygardener’s blog.

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