Alternative Ways to Calculate Your Real Net Worth

There’s kind of a weird saying that I’ve always thought was a bit odd, and it goes like this: “There is more than one way to skin a cat”.  Thankfully, nobody (we can hope!) actually means that they’re going to remove the fur of one of our feline friends.  Rather, they’re of course thinking about the concept of different ways of accomplishing the same goal.

In the personal finance arena, this saying can apply to the topic of net worth.  For example, we have previously discussed many ways to grow net worth, ranging from embracing continuous learning to being persistent to building relationships.  Along those lines, focusing on net worth again, there are also multiple ways we can measure it.  Yes, I really think that there are different ways we can calculate our net worth or financial “value”.

Here are 3 of them, one traditional and the other two more “alternative” in nature:

Traditional Method

The way that net worth is commonly calculated is by looking at one’s assets and liabilities, and subtracting the difference.  Hopefully, the assets exceed the liabilities! If so, you have a positive net worth according to this standard method.  Having more liabilities than assets results in a negative net worth.

For example: let’s say someone has a $200,000 home, $100,000 in retirement savings, and $20,000 in cash.  That would equal $320,000 in assets, not net worth.  If the same person had a $120,000 mortgage, $15,000 in an outstanding car loan, and $5,000 in other personal debts, that would equal $140,000 in liabilities.

Total net worth? $320,000 minus $140,000 equals $180,000.  This person has a net worth of $180,000 according this approach.

Alternative Method #1 – Months of Expenses

I think this is one approach to calculating “net worth” that isn’t considered by many, and might be dismissed by others.  But, it’s practical and customizable to each of us.  It’s what I call the months of covered expenses method.

Really, it’s simple – and we’ve talked about covered expenses here before, albeit a long time ago. First, figure out your net worth according to the traditional method above. In this case, $180,000.  Then, determine your monthly expenses.  Let’s say in this case you’re spending $4,000 per month.

In this case, you have 45 months of covered expenses.  That’s your net worth, or practical measure of wealth.  A person with lower monthly expenses would actually be wealthier with the same exact traditional net worth, based on the customizable nature of this approach.

Alternative Method #2 – Cash Flow Valuation

Thinking back to my days in business school, I recall that there were different approaches to valuing companies.  One might be a market comparable method, measuring versus other companies similar on various characteristics.  Another would be a discounted cash flow valuation.  Could we measure personal net worth based on discounted cash flow analysis?  Sure, I think it’s possible.

The concept is to take future net cash flows and discount them back by an appropriate rate of return (inflation?) to determine the present value.  This could, in turn, represent your “net worth”.  Just as a company might be valued based on a discounted cash flow model, perhaps we could apply this model to us as individuals as well.

In this case, let’s say one person (we’ll call him “Person A”) might have a traditional net worth of $300,000, and another – “Person B” – has a traditional net worth of $50,000.  They both might also have comparable spending patterns.  Comparing them based on the two methods shared above, the first person would obviously have a higher net worth.

However, if Person B had a budding career where he was likely to earn a very high salary, and Person A had a more modest job in an unstable industry, things might be different.  An objective forecast of their future cash flows might indicate that Person B might actually earn a lot more over his future years than the other guy.  Thus, he might end up having more “financial value” than the other person.

Not that we want to reduce ourselves to assets that investors can trade, but you get the idea.  If companies could be viewed this way in terms of valuation, perhaps the same concept could work in terms of measuring net worth of people.

Bottom Line:  There are many ways to “skin the cat” in terms of calculating net worth and – by extension – wealth.  It’s good to keep an open mind and view things from different angles.

My Questions for You

How often do you calculate your own net worth?

Do you strictly look at the traditional method, or do you consider other approaches? If so, what are they?

Have you ever considered the alternative ways to measure wealth as described above?

 

Comments

  1. says

    Haha, you ask a question at the end to get the comments going, but it’s a question I have no answer to. How do I calculate my net worth? I don’t. I don’t see the point. Maybe you could do a post on that — explain the point of figuring out your net worth. I don’t like the idea of people figuring out their worth based on money. And then on top of that, I don’t understand what that’s supposed to do for people. My wife and I put into retirement, we pay our bills, we’re almost done with our loans… *shrug * seems pretty good. If I was forced, I guess the alternative method #1 up there is not a bad way to do it. I dunno though.

    • Squirrelers says

      TB – I think there’s a good reason to assess net worth. Even if we make good decisions each day and avoid the big mistakes, it’s good to know what we have overall. At the very least, the traditional method is straightforward if nothing else.

  2. says

    Great post! The thing I like most about the alternative methods is that they don’t view net worth as a static number, but one that’s based on your future behavior. The cash flow valuation method seems like there’s a lot of subjectivity to it, I like that it takes into account career path, whether you have marketable skills, etc. – things that are often overlooked when measuring true “wealth”.

    • Squirrelers says

      Anne – Thanks! I too like the behavior aspect of cash flow views of net worth, as it’s a customizable way to measure worth.

  3. says

    I just calculate with the usual method. Monthly wise, we have enough to cover 30 years, but that’s with our current spending. If you add in college education, health care and other unexpected expenses down the line, then who knows…
    I like the cash flow method too. Our cash flow is pretty tight now that I’m not working a corporate job anymore. I’m definitely worth a lot less than previously.

    • Squirrelers says

      Krantcents – smart not to include a residence. I agree that it’s a bit different than other assets.

  4. says

    My worth is a negative number. Investments and savings $9,000. HELOC debt $17,400. Net worth = negative $8,400.

    I choose not to include my house ($200,000) in my net worth. I have to live somewhere and I have no plans to sell it. I may sell it in 20 years to have some extra money when I am in my 70s but right now it is just a maintenance, insurance and property tax expense.

  5. says

    In an intangible way, net worth can also be determined using non-liquid assets such as ‘existential good will’ or ‘professional contacts’. For example, if donating $1,000 to a charity, or volunteering time to a business is considered an expense regardless of its tax status, it lowers net worth either in terms of cash flow out or opportunity cost.

    However, the business relationships, and community development that emerge out of donating money or volunteering time are sometimes beneficial to future income earning opportunities. Thus, can donations really be written off as an expense that lowers net worth when considered in this way?

  6. Debbie M says

    There is a value to buying a house, and that value is that you don’t have to pay rent. So if you’re excluding the value of your house, you should also reduce your expenses in alternative method #1 by the amount of your principal + interest. Or, for method #2, reduce future cash flows by that amount beginning when the house will be paid off. But even so, your calculations don’t let you see any advantage to prepaying part of the mortgage, which is less fun if you’re prepaying your mortgage.

    I use a combination. I look at my traditional net worth. And then I look at my retirement savings in terms of months of expenses.

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