Many financial planners urge you to monitor your one number – Net Worth. True?
Not a bad idea at all..after if it is one number that you should monitor, it has to be the net worth. No matter where you’re starting from, you can feel good about your financial progress if your net worth is increasing.
However do you really understand that the Net worth is a very fickle number and can vary like the weather? Well lets see what are the limitations of Net Worth? But like anything else, it’s not a perfect measurement. It does not tell you everything about your financial situation and in some cases it can even be misleading.
Like many ‘single numbers’ it can be very difficult to use – like blood pressure, height, weight, current ratio,…though these are all nice single numbers you may need a few other numbers to be taken together to arrive at a sensible conclusion about anything.
It is at best an arbitrary number – and what is far more sensible is to see the journey that you took from reaching from point A to point B. That at least tells you the velocity with which you reached there. You might be interested to know whether the journey was faster than the inflation rate. When the velocity was fast was it strategy or luck..
Net Worth does not understand financial goals:
In a year that you paid for your daughter’s marriage or her higher education your net worth may have dropped!! We earn money and make money work hard so that we can use the money to meet our goals. Your NW does not understand this. So if you bought your luxury car, took a vacation, or paid for your children’s goals, your net worth could go down – BUT HEY, YOU ARE HAPPY that you achieved your goal, right?
How much net worth?
It is an absolute number and is useless for you to compare with anybody else. So if you have a networth of Rs. 20L and you have another person who has a net worth or Rs. 2 crores, what should you feel? Well if you are 22 years old and the other person is 64 years old, well, well!! It also does not tell you anything about your needs. So a Rs. 3 crore net worth may be just too much for a 65 year old with annual expenses of Rs. 4 lakhs, just not sufficient for a man with a big large family to support and a couple of challenged people with no ability to earn money, or..I hope you get the drift, right?
Net Worth fluctuates
For a person like me or people whom I advise net worth can fluctuate dramatically – when the index was 20000 vs when the index plunged to say 9000. Similarly for many others. Also it is kind of inaccurate when the NW is made up of a lot of real estate. Only equity and other financial assets can be measured with some semblance of accuracy. So if you feel great when the index is at 30,000, you are bound to feel terrible when the NW and the index both plunge down. Keeping your mind silent during such times is a huge challenge.
At what stage is your net worth?
Your net worth is also dependent on the age at which you have the same. So if you have a high net worth at age 40, you may think of doing business or following your passions. However, at age 55 your physical limitations may not help you to do some of the things that you may have tried in your younger age.
What are you doing to improve it?
If you inherited a big NW and are doing nothing to grow it, would you feel sad or happy about your net worth. I see 50 year old people with a net worth of Rs. 6 crores – but earning only Rs. 15L. Such people have a monthly expense GREATER than their current income! they are living off their ‘earned income’ (what they earn) and the unearned income (dividends from parental portfolios)..and are hoping for the ‘unrealized income’ to increase their Net Worth. Not bad, but such people will leave a lower net worth (adjusted for inflation) than what they inherited. Some others may be playing around with their asset allocation, shuffling assets, working harder, earning more, etc. to increase their net worth. What is important is to see what are you doing to improve it – or is it just left to market forces?
How is your Net Worth made up?
Let us talk of 3 people with a net worth or Rs. 35 lakhs….
- Miss. P Kumari – House worth Rs. 90L debt of Rs. 70L and an equity portfolio of Rs. 15L including about Rs. 2L cash. Has a job paying about Rs. 15L per month. Not married, parents independent.
- Miss P Kapoor – House worth Rs. 80L and debt of Rs. 50L and has Rs. 5L in her PPF account. She has just been laid off, has no medical or life insurance, has dependent parents, not married. Needs about Rs. 40k per month to run her house apart from Rs. 50,000 EMI.
- Mr. R Khan Inherited house of Rs. 1 crore, no housing loan. Has a personal loan of Rs. 40 lakh, paying an emi of Rs. 54000 towards PL for which he has pledged his house. Has a job where he earns Rs. 12L p.a. and has expenses of Rs.1L pm…no other income.
Now decide does the net worth make a difference? who is best off among the 3?
Growing your net worth is of course an important and perhaps the main goal. But protecting the net worth – and protecting the MAIN person who is creating it is important too. However well you plan, God throws googlies at all of us, does he not?
Make sure you have adequate Term life insurance, disability insurance, critical illness cover, MAKE A WILL – and protect your net worth and make sure that there’s always some cash (not just assets) available for meeting your family’s basic needs and repaying all loans, just in case.
Post Footer automatically generated by Add Post Footer Plugin for wordpress.