Why Net Worth Is the Wrong Metric to Track
One of the media’s favorite financial metrics to talk about is net worth.
As a result, this single number has been ingrained in our minds as the ultimate marker of wealth and accomplishment. However, it’s not the end-all be-all metric that it’s made out to be.
Today, I’ll be explaining why net worth is the wrong metric to track as well as going over 2 personal finance metrics that paint a more holistic picture of our financial well-being.
With that being said, let’s dive in!
What is Net Worth?
Net worth subtracts the value of our financial liabilities from our financial assets in order to determine our financial worth.
The formula for net worth is:
Below is a comprehensive list of what the Federal Reserve considers assets and liabilities:
Why Net Worth is the Wrong Metric to Track
The best way to think of net worth is as a financial report card. That is because our net worth is the aggregated sum of our financial habits over time.
Financial habits that lower our net worth include:
- Buying things on credit
- Spending more than we make
On the other hand, financial habits that increase our net worth include:
- Consistently saving and investing
- Decreasing expenses
- Paying down debt
While our net worth undoubtedly provides a snapshot of our financial standing, it fails to capture the complete financial picture. As a result, I would argue that it’s more valuable to measure our individual day-to-day financial habits that compound over the long-term.
To bring this point home, let me use an example from my own life.
Last year, my wife and I completed many unavoidable (and very expensive) house projects. We were spending way more than what we were bringing in on a monthly basis. Despite bleeding cash, our net worth continued to rise due to our retirement accounts performing well and our home increasing in value.
If I were to judge our “financial success” on our net worth (and ignore the very real fact that we were spending more than what we were bring in), then we were killing it! By this logic, we should continue spending more than what I bring in, because who cares, our net worth was still going up!
See how silly that sounds?
Sure, we experienced short-term asset growth. However, consistently spending more than what we bring in over the long-term would inevitably result in our net worth decreasing.
2 Personal Financial Metrics that We Should Track Instead
Let’s now go over 2 personal financial metrics that provide a more holistic perspective of our financial well-being.
1. Savings Rate
Savings rate is the percentage of money that we are able to save on a monthly basis.
The formula for savings rate is:
Our savings rate is the most important metric to track when it comes to financial independence.
Think about it this way: if we spend 100% of the money that we bring in then we will be always be reliant on trading our time for money with an employer. We would not have any money leftover in order to buy income producing assets that can then be used to fund our lifestyle in retirement.
Mr. Money Mustache, a financial blogger, does a great job explaining the correlation between different savings rates and years to retirement in his “Shockingly Simple Math Behind Early Retirement”.
2. % to Financial Independence
% to Financial Independence (FI) measures how close we are to financial independence.
The formula for % to FI is:
One of the biggest misconceptions that I’ve seen online are people confusing FI number with net worth. While they are similar, they measure completely different things.
Net worth subtracts the value of our financial liabilities from our financial assets in order to determine our financial worth. On the other hand, % to FI only looks at our FI assets (assets that we will rely on in financial independence) relative to our FI Number.
As an example, home equity is typically included when calculating net worth but not when calculating % FI. That is because unless we plan on selling our home in retirement to fund our lifestyle, it should not be counted as a FI Asset.
If you need help calculating your % to FI, I wrote a step-by-step guide on how to accurately calculate your % to FI.
Final Thoughts
While net worth is definitely an interesting number, we should embrace a multi-dimensional approach to measuring our financial health.
This includes measuring day-to-day financial metrics that give us the entire picture.
If you are interested in more personal financial metrics and calculations, I recommend checking the essential personal finance calculations that everyone should know.
Thank you for reading 🙂
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Disclaimer: Nothing in this article should ever be considered advice, research or an invitation to buy or sell securities. I am not a financial advisor.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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