Question to Desi, Bobus, RRK and others on networth...

RSquare · Post by **RSquare** » Fri Mar 25, 2011 9:25 pm

Hi Financegurus,
I had a couple of questions on networth calculation.

1. Do you list the equity in your primary home in the networth calculation ? The reason why i am asking is - the primary home is the place where you stay. You cannot sell it and go anywhere else to live. Until that situation exists i wouldn't put the primary home equity as part of the networth calculation.

2. Jewellery - Especially for desis we have a huge fascination for jewellery - gold, diamond, silver, etc. It could be the jewellery that we got in marriage like mangal sutra, earrings, bangles, etc. Usually we tend not to sell them ever and it gets passed on from one generation to another generation.

3. 401K, IRA, etc - At this moment in time you cannot withdraw those without incurring some significant penalty. So should the penalties/taxes, etc be included at the time of calculating today's networth ?

4. Vehicles - Many people have the habit of including their cars ( equity or fully paid) in their networth. I mean these cars would be needed for transportation, right ? And who knows we might drive them into the ground :-).

So far this is what i have been doing.

1. Excluding equity in primary home
2. Excluding jewellery
3. Subtracting 20% from 401K and IRA
4. Not including any equity in my vehicles

Please let me know and let me know the reasons for including/excluding as well.

Thanks,
kcube

Desi · Post by **Desi** » Fri Mar 25, 2011 9:51 pm

kcube06;378054Hi Financegurus,
I had a couple of questions on networth calculation.

I am not a finance guru. However, I will attempt to answer.

Networth is ALL your assets minus liabilities. It is a measure of your total financial worth.

Yes, one can sell the house and live in an apartment, with relatives, with friends.
Yes, one can liquidate IRAs and pay penalties if one has a dire need.
Yes, if one is going hungry and do not have money for next meal, they can still hang on to the bangles and mangalsutra to pass it on to the next generation or decide to use that to do what is necessary.

Point being, anything that can be meaningfully liquidated is part of net worth including the value of cars.

Now when it comes to "Investable Assets" or "LIQUID Net Worth" then for calculating those, one can and should exclude jewellry and equity in home, but not the 401K/ IRA assets as they are investable.

RSquare · Post by **RSquare** » Fri Mar 25, 2011 10:48 pm

Desi;378069I am not a finance guru. However, I will attempt to answer.

Networth is ALL your assets minus liabilities. It is a measure of your total financial worth.

Yes, one can sell the house and live in an apartment, with relatives, with friends.
Yes, one can liquidate IRAs and pay penalties if one has a dire need.
Yes, if one is going hungry and do not have money for next meal, they can still hang on to the bangles and mangalsutra to pass it on to the next generation or decide to use that to do what is necessary.

Point being, anything that can be meaningfully liquidated is part of net worth including the value of cars.

Now when it comes to "Investable Assets" or "LIQUID Net Worth" then for calculating those, one can and should exclude jewellry and equity in home, but not the 401K/ IRA assets as they are investable.

Desi, thanks. If you and Bobus are not gurus i don't who else is. Had another question. If you would include IRAs, 401K, etc would you subtract the penalties/taxes value from them while calculating the networth ?

Others: Please post your comments on this as well. I want to hear others' views as well. That way i can learn more. I had been browsing some things on google. In some cases they say your primary home should be excluded from networth calculation, some say it should not be.

-kcube

Desi · Post by **Desi** » Fri Mar 25, 2011 11:01 pm

kcube06;378087Desi, thanks. If you and Bobus are not gurus i don't who else is. Had another question. If you would include IRAs, 401K, etc would you subtract the penalties/taxes value from them while calculating the networth ?

Others: Please post your comments on this as well. I want to hear others' views as well. That way i can learn more. I had been browsing some things on google. In some cases they say your primary home should be excluded from networth calculation, some say it should not be.

-kcube

There are many gurus out there but not me. I continue to learn about finance as you do.

Net Worth = Total Assets - Total Liabilities.

I include the fair market value of the house in Assets. I include the costs of selling and the mortgage in Liabilities column.

re 401K, I include the total value in Assets column and in liabilities column I include anticipated taxes and penalties if any anticipated.

RRK · Post by **RRK** » Fri Mar 25, 2011 11:23 pm

I use two figures while doing AAP.

1) Net Worth

2) Investable assets that can be used for meeting financial goals.

1) Net Worth = Total Assets - Total Liabilities.

2) For Investable assets :
I take 75% of the IRA and 401k Value, exclude jeweleries, living home, cars, tv, ipad, remote controls etc., 75% default value arrived with assumption of 15% tax and 10% penalty. The number 75% depends on the investor situation.

NoChaos · Post by **NoChaos** » Sat Mar 26, 2011 4:18 pm

kcube,

You missed human capital in calculating networth calculation. A young person has more human capital as compare to older person. Similarly a doctor has more human capital than school teacher.

Although I'm not guru but IMHO

Desi · Post by **Desi** » Sat Mar 26, 2011 10:03 pm

Guys,

What is the purpose of Net Worth calculation?

Net Worth calculation should not be confused with Net Investable Assets or Liquid Net Worth (Liquid net worth is what assets you can put together for your near and long term investments, which can be readily moved around or liquidate for investment purposes).

Total Net Worth is liquidation value of the person - this is sum total of all his tangible assets that would get passed on were he to either die or liquidate everything and go live in a forest.

Value of equity in house and personal items as jewellry and care are tangible personal assets and belong in Net Worth calculation. You better believe it that IRS will count those towards your estate for estate tax purposes.

Human capital is not a tangible asset. The future earnings either from human capital or from tangible assets are not part of Total Net Worth. The PRESENT Net worth of human capital is zero. Future earnings cannot be discounted to PRESENT value as PRESENT value is present tangible value calculation.

For most people, Net Worth just tells you your liquidation value and what you will pass to your heirs, were you to die today.

On the other hand if you are trying to do your AAP, you would be more interested in Investable assets and liquid assets and these numbers will almost always be different than net worth.
So, if you are trying to calcualte, you should know the following:

ALL

NoChaos · Post by **NoChaos** » Sat Mar 26, 2011 11:03 pm

Desi;378211
Human capital is not a tangible asset.
.....
On the other hand if you are trying to do your AAP, you would be more interested in Investable assets and liquid assets and these numbers will almost always be different than net worth.

Recently Human capital consideration is becoming popular in portfolio/AAP planning. Assuming everything is same (e.g. risk apatite, age, goal, retirement age etc) a doctor's portfolio will be different than an school teacher 's, to achieve same objective. It's expected that Doctor's future earning will be more than the teacher's, so doctor's AAP needs to be less risky than teacher's, however both have same risk apatite.

Desi · Post by **Desi** » Sat Mar 26, 2011 11:37 pm

NoChaos;378222Recently Human capital consideration is becoming popular in portfolio/AAP planning. Assuming everything is same (e.g. risk apatite, age, goal, retirement age etc) a doctor's portfolio will be different than an school teacher 's, to achieve same objective. It's expected that Doctor's future earning will be more than the teacher's, so doctor's AAP needs to be less risky than teacher's, however both have same risk apatite.

If all factors are the same, then their starting capital will also be the same. One factor is different, however. The anticipated new addition of money, year over year is greater for the doctor, thus making his net worth vs year graph have a steeper slope. Sure, this anticipation of higher capital in future years does not warrant a higher risk. If these future earnings are figured in devising a portfolio, that does not change the present net worth.

The purpose of structuring a portfolio is for a desired end goal. The contributors to the desired end goal are expected earnings on the portfolio as well as additions to portfolio from doctor's earnings, hence these are figured into the computations. By no means it is part of net worth, it is anticipated future capital, not present.

In any case, perhaps we differ in our thinkging. I do not and will not consider human capital in present Total Net Worth. It is unrealized and not distributable as part of estate.

RRK · Post by **RRK** » Sun Mar 27, 2011 12:03 am

NoChaos;378222Recently Human capital consideration is becoming popular in portfolio/AAP planning. Assuming everything is same (e.g. risk apatite, age, goal, retirement age etc) a doctor's portfolio will be different than an school teacher 's, to achieve same objective. It's expected that Doctor's future earning will be more than the teacher's, so doctor's AAP needs to be less risky than teacher's, however both have same risk apatite.

Selection of assets would be based on several factors. Current and Future earnings/savings definitely has an influence. So, if doctor's earning is going to be more than the teachers, this will show up in the portfolio. We dont need to confuse that with human capital.

Also private practicing doctors have fluctuating savings, ( life style, risk in private practice, lawsuits etc) while a teacher can have a predictable savings pattern. When some one has a steady job, they can afford to take more risk with equity portfolio because the probability of them dipping into their investment due to loss of job is less.

A careful planner will consider several aspects like this while planning the portfolio. We don't need to confuse these factors with human capital. Desi's #7 post explains this clearly.