Net worth is a joke, cash flow is better
yeah I said it.
If you stop working today, how long can you survive financially? 3 , 6 , 12 months or 1 day?
To me, having enough cash flow is the real reward.
What good is it when you have a big house and a Mercedes park in the garage and no cash to put gas in the car? If that car and house is not making you money, you cannot survive off it. Sure you can sell them, but you now will be out of a car or house. And a 401k technically is not your cash. So when you don’t have enough cash to whether a storm, your net-worth becomes a joke.
I’m starting to think a little different when it comes to my finances. I still keep up with my net worth but I am not fixated on it like I use to be. I’m starting to gravitate more toward creating more cash flow than looking at numbers on a page. Now I have to figure out how to increase my cash flow without depending on a job. LOL
How do you guys value your net worth? Does it reflect how long you can survive?
March 13th, 2008 at 10:50 am
I never looked at net worth because most people I know only have money in home equity or a rental and we all know that the value does not count until you sell it.
I look at liquid assets cash, non retirement investments and cash or dividends that comes from your assets, I always exclude home equity as my net worth
March 13th, 2008 at 10:53 am
I hate it when I see CNN Millionaires in the making and the home equity is the main vehicle where they have money.
As you said 401k, usually does not count because you cannot cash it out w/o paying a major price.
So when you look at it most people have big balances in retirement and house where it’s just money on paper not cash
So I guess cash flow is more important than net worth.
March 13th, 2008 at 10:55 am
@ jeff, I agree cash flow matters most.
Because you cannot easily sell your home orcash out your 401k, so cash flow is better. That what you need to survive (pay bills, food, and expenses)
Good article Monk.
March 13th, 2008 at 11:03 am
Net worth IS a joke because once you sell everything you own, Your net worth easily dimished 30% because of fees and penalties from a 401k and commission from selling a home.
If you have car worth $20K and you owe $10K. It may put $10K in your pocket but in reality it only works if the seller pays you $10K, most will negotiate to 8 or 9K
So net-worth is never what it appears to be.
March 13th, 2008 at 11:18 am
I keep track of my net worth because when it hits X amount, that is when I will achieved my goal of financial independence. However, I don’t include any home equity in my net worth.
To me, net worth is more valuable than cash flow. However having an increased cash flow will definitely increase my net worth. I do think it’s important to have a variety of asset classes though (i.e. cash savings, taxable investments, tax-deferred investments, etc.).
We have probably 1.5x our gross annual salary in a variety of accounts (retirement and non-retirement) so we could probably live for 2 or more years without selling our house or changing our lifestyle. I think an important part of financial planning is having an ‘oh sh*t’ plan as in if we both lost our jobs on the same day and couldn’t find news one indefinitely (which is unlikely but I say plan for the worst but expect the best).
March 13th, 2008 at 11:55 am
If wintoday (or anyone else) has a rental that doesn’t count until they sell it, I’ll gladly hold onto it for them until they do sell it.
March 13th, 2008 at 12:15 pm
@ minumum wage- sorry I have tenants in it
March 13th, 2008 at 12:48 pm
Net worth is what it is – and yes, home equity does count as does your 401k.
Sure net worth isn’t/shouldn’t be the primary measure of financial success or independence or security. Liquidity is important and income is even more important.
Consider – a young doctor is making $400,000 a year. She may have a negative net worth due to a couple hundred thousand in student loans, but who cares? She’s still got thousands of dollars to spend – or save – as she pleases each month!
Or consider a trust fund baby with no job. He might have $2MM in a trust fund wrapped up in illiquid investments, but if that trust fund is controlled by family lawyers (or a crotchety older relative) then it doesn’t really do much for him. Plus if he’s living off that trust, the value is only going down and he’s getting poorer and more financially insecure every month.
March 13th, 2008 at 1:42 pm
Okay, here comes the pseudo-lawyer in me
Yes, home equity is a part of net worth. However, I choose to ignore that portion of it as it relates to achieving my personal goal of X net worth because I can’t live off my home equity unless I sell my home which I have no intentions of doing.
I feel that income is more variable than net worth, therefore not quite as important. I could lose my job at any moment and go from $Z/yr to $0. Barring total financial collapse of the US economy, my investments aren’t going to drop to $0 at a moment’s notice.
I would rather be the trust fund baby than the young doctor. If she loses her job tomorrow, she has no income and no assets, only debt which sure doesn’t pay the bills. Assuming 10% annual return, the trust fund kid can live nicely ($200K/yr) without ever touching his principal.
March 13th, 2008 at 2:34 pm
@ gecko- how many out of work doctors, you know? She has skills to work anywhere ( unless she losses her licence)
My networth is there, but income/ cash flow from different sources keeps you surviving.
I just want several sources of income, so if I lose my job, I will still have enough cash flow to maintain.
I just hate when people list furniture, art and other crap all as networth because the chances of you surviving off of this is zero.
NW and cash flow are both good to have, but cash flow is what makes you survive.
The more cash you have the less you have to touch your assets.
House rich, cash poor is not surviving
March 13th, 2008 at 2:53 pm
Sure she has the skills but what if she does lose her license or becomes disabled tomorrow and can’t work as a doctor anymore? No income and no assets.
I totally believe in having multiple streams of income but a high income doesn’t necessarily mean a high net worth. I still think the trust fund kid is in a better financial situation than the doctor.
Also, FWIW I don’t include furniture, art, etc. when I’m talking about net worth. You’re right that you can’t live off that stuff.
March 13th, 2008 at 3:57 pm
FWIW?
gecko- no matter what we talk about you seem to always have the last word. LOL
March 13th, 2008 at 7:04 pm
wintoday – that’s okay, i can wait until your tenants move out
March 14th, 2008 at 10:22 am
I agree. Good post. People tend to have money tied up but not much liquid. In a real emergency, you need cash and that’s good to consider. Having a decent liquid nest egg is really important in addition to adding to your net worth. And, this is just me but I don’t look TOO closely at my investments. If I do, it leads me to want to move things around too much. Things go up and down and that’s life and the market. It always bounces back in the end.
Jerry
http://www.leads4insurance.com
March 14th, 2008 at 11:02 am
This sounds contradictory to everything you say against emergency funds. How can you value cash flow over net worth when you abhor large emergency funds (the most liquid asset), but prefer to use your cash flow for investments? I’m confused.
March 14th, 2008 at 11:54 am
nothing wrong with an emergency fund. I still want cash flowing if I were to stop working from somewhere
What good is it when my money is tied up in a home or car? So my networth is not that reliable when I stop working.
I still concentrate on net worth, but i want to concentrate more on how to survive without relying just on my job income
March 14th, 2008 at 4:40 pm
I’m not disagreeing with you. I just don’t understand your conflicting thoughts. One one hand you say cash flow is more important than tied up investments. But on the other, you say you only need a $3k emergency fund and all other money is invested. It just doesn’t make sense to me.
You don’t have to explain yourself. Maybe this is one of those things about your philosophy that I’ll never understand. And that’s ok. It obviously works for you.
March 14th, 2008 at 5:32 pm
How timely, I just posted on something similar.
http://www.feministfinance.com/2008/03/net-worth-not-impressive-my-coping.html
I do track net worth (I include house equity, not my car value or other personal belongings) because it’s a single number that allows me to track the net effect of paying off debt and increasing various forms of savings reserves. Its benefit for me is purely psychological (you’re right in that it doesn’t convey how long I’d survive if I were thrown to the wolves, but anyone who uses their networth number for that purpose, it seems to me, misunderstands the nature of a net worth calculation). The fact that net worth is mostly just a psychological trick doesn’t mean it’s useful.
But with the stock market sucking, I am going to get more real, useful psychological benefit from easing off the focus on net worth and instead tracking debt reductions (since my home value and investments will likely continue to fall for the foreseeable future, along with everyone else’s), tracking the percentage of my income I’m saving, and tracking the number of shares I am buying each month (rather than tracking their value).
April 6th, 2008 at 3:46 pm
I agree with money monk. Without cash flow to sustain yourself, assets that are producing no money currently are useless, and only good when sold. They aren’t helping you live,basically and you have to use all the money you have from your jobs to pay for everything and you have to lose all your principle money. But if you have cash producing assets like real estate or books with royalties or anything else that puts money in your pocket then you can use less of your own hard earned money and more money from the asset. So that your money is working harder than you are. Once the necessary cash flow assets are in place there really isn’t any need to work traditionally, not to mention traditional work, gets taxed the most. The funny thing is only the really wealthy people understand this concept everyone else don’t because their families taught them a poor or middle class way of dealing with money, every class in the us sees money and investments differently, and I agree whole heartedly its better to have cash prdoucing assets than idle assets that are appreciating but are putting nothing in your pocket currently. In other words would you rather become wealthy in a few years or would you rather become wealthy when your 60 and barely alive to enjoy your money, thats the difference. People should strive for cash producing assets from their jobs or businesses to get out from having a job, and strive to become an investor or businessmen, so that theres less taxes and you have money working for you instead of being in the rat race, trying to make money to spend money and make money to spend money, never to make money to spend money on an asset that produces cash and then that asset produces cash that you can spend on another asset that produces cash, thats the way people should strive for. Hopefully you people out there understand if not well keep thinking about it.
June 23rd, 2008 at 9:17 pm
using your net worth wisely can increase your cash flow! If you invest your net worth (equity) wisely, which translates to an investment with good ROE (Return on Equity), the returns will increase your cash flow AND net worth!
August 8th, 2008 at 11:02 am
One interesting thing about this conversation is that it seems like all the comments focus on people with positive net worth – people who are “solvent” – their assets are more than their liabilities. So if they had to “cash out” they’d walk away from the table with something. I think that in that case, it’s good to have lots of liquidity in your assets in case of emergency, and you won’t be able to assess that by looking at net worth. That’s not to the exclusion of having income-producing assets, though, like a rental property, for example. That’s where the usefulness of net worth calculation seems more complicated. A person might have a mortgage on rental property – it’s worth to the investor consists of both liquid receivables (rental income) and equity on paper (market value minus the mortgage) which only really matters if you sell the place or try to pull equity out for some other income-producing reason.
But if you’re like me, and your net worth is negative, none of that matters. If I wanted to “cash out” any time soon, I’d end up washing dishes in the back room. At this point in the game, I’m just trying to get solvent while building my assets and getting rid of liabilities that hem up my cash flow. At this point, a lot of my liquid assets are basically being banked to spend money, like April’s Anonymous said. Now some of the money is or will be spent on income-producers, but so far, few of what I’m purchasing are assets where the wealth produced will be liquid (a home, an IRA). Outside of readiness for an emergency, it doesn’t matter to an assessment of my wealth whether I’m measuring liquidity or not with my net worth calculation. I’m just using the net worth calculation to gauge progress in climbing from deficit to surplus, not whether or not I can weather unemployment or stop working.
August 8th, 2008 at 11:27 am
like anonoymous said – assets are only good when sold.
When you have good cash flow, no need to sell anything to maintain your lifestyle or to pay bills
September 4th, 2008 at 6:37 pm
Get a 2nd job or income. I got a 2nd job 17 years ago, working about 10 hours per week extra. It is a consulting job averaging about $40.00 per hour. My hours are very flexible. I usually work a couple of hours a night on weekdays only.It has given me about $19k of extra cash every year. I have made over $300k in extra money in the last 17 years. I have never spent this extra money. I have tracked every dime I have made. I have invested it in stocks that raise dividends every year. My cash flow is great now. What did I give up? Well, I have watched no stupid sitcom TV shows in 17 years. I have never seen American Idol or Dancing with the Has Beens. I am not familiar with any of those shows. I hear people talking about those shows during the workday at my day job. I basically gave up nothing and set myself up with financial independence.
March 29th, 2009 at 2:35 pm
Positive cash flow will assist you in increasing investable capital; however, it does not necessarily translate into increasing in net worth. Reminded me of one individual in the news who poured earnings (cash flow) into Enron. (I know it’s an extreme example). Also, how about having a positive cash flow real estate property that the market value has decreased by over 70%+? Is it still a good deal if the price doesn’t recover anytime in the near future? How about those who had great cash flow created by high leverage and the house of cards fell to the ground? Yes, cash flow is important, but It ultimately comes down to what you do with that $$. Like a business, one should be tracking personal finance in various ways (eg. income statement, cash flow, balance sheet, etc..) and make informed financial decisions. Measurement of net worth is just one of those tools.
June 14th, 2009 at 12:26 pm
Reading these comments, I think the one thing everyone is missing(particularly the author) is that in most cases(unless you retired from the military or some other service or job with a pension) having a large cashflow each month typically REQUIRES a high networth.
For example, someone may not have any built up cash savings/emergency fund, or may not have a million plus in stock equities or any other high value liquid means, but they own 3 businesses that produce them 10k in passive income per month. Well guess what? Those businesses have value and i'll bet they have a very LARGE value that when you analyze your networth portfolio, low and behold you have a high networth.
So the thing many are missing here is that in order to have a nice high passive cash flow, this usually MEANS that you have a HIGH networth, they are still usually one and the same. It's just dispersed differently than someone with an equally high networth, rapped up in their home and 401k.
September 18th, 2009 at 1:21 pm
Hey Money Monk – Included a shot out to you at the end of my post "Your Net Worth Is An Illusion." Thanks for stopping by! Great topic and conclusion you have here.
Financial Samurai
January 24th, 2010 at 6:07 pm
We can not forget that there is one calculation for networth, which is ASSETS LESS LIABILITIES. Regardless of the type of assest or liability, networth will be what it is going to be. We have to remember that we can only chose our assets and liabilites, we can not alter the calcuation.
MoneyMonk I understand that your personal preference is to put an empasis on the increasing liquid cash vs obtaining objects or investments that have the same value, utimatly leading to a higher networth.
I actually wrote about this in December on my blog: http://ifiwereawealthygirl.blogspot.com/2009/12/networth-miscalculations.html
February 19th, 2010 at 7:55 pm
Totally agree that Net Worth is a futile figure. Personally pre-the credit crunch I was looking towards an income goal that would ideally be interchangeable with earned income. Often income is steadier than capital values (e.g. property, dividends in normal times).
Evasive action as we went through 'the worst crisis in three generations' etc made me divert a little from that plan, but I still think it's a far better strategy to look for income (ideally with the potential for real growth and capital appreciation) then a net wealth snapshot.
February 20th, 2010 at 12:55 am
Totally agree that Net Worth is a futile figure. Personally pre-the credit crunch I was looking towards an income goal that would ideally be interchangeable with earned income. Often income is steadier than capital values (e.g. property, dividends in normal times).
Evasive action as we went through 'the worst crisis in three generations' etc made me divert a little from that plan, but I still think it's a far better strategy to look for income (ideally with the potential for real growth and capital appreciation) then a net wealth snapshot.