Personal Finance

Calculating Net Worth - formulation dilema

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Jr. Member
Dec 10, 2007
138 posts
Calgary

Calculating Net Worth - formulation dilema

So it should be pretty easy to calculate net worth, right?

add up all investments and and securities subtract all debts.

some schools of thought though is you cant really include your personal residence, as it skews the valuation.

ok, so back out the residence, but then shouldnt also back out the mortgage?

my house is worth about 400k.
i owe no consumer debt, but my mortgage is an M1 super mortgage and my balance is $240,000.

I list my total debt as 240k., but if i wouldnt have that much debt if not for leveraging to buy my house.

point me to the right formula please.
25 replies
Deal Fanatic
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Apr 29, 2008
8012 posts
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Montreal
There is no right formula, it's matter of personal choice in how to calculate it.

However, either you put both house + mortgage, or either of them... your situation looks worse if you only put mortgage.

Option 1: Include House at Market Value (Estimate) and Mortgage (Balance outstanding)

Option 2: Include House at Purchase Price (to be conservative and your net worth is not based only on "market" value) and Mortgage (Balance outstanding)

Option 3: Include none of the above.

If you have good reasons to think your house is worth about 400k, you can include it in Net Worth, but it's not really liquid.
Sr. Member
Apr 11, 2003
701 posts
181 upvotes
Edmonton
Even if your house isn't liquid, its still part of your net worth.

If you got an opportunity tomorrow to ..... I dunno, get a job in another country for 5 years, and you had to sell everything and/or transfer it with you (ie: accounts, debts, etc), then its still what you're worth. Yes, if you moved you'd still need to get a place to live, but you could invest the net proceeds from your primary residence and use the investment income to rent, etc.

Also, having recently been involved in settling an estate, there's also that perspective (negative as it may be). Your 'net worth' when you pass away includes your home, so why not include it now.

I'd say count it.
Member
Nov 14, 2007
332 posts
2 upvotes
Of course you should include your house, you have been paying off that mortgage all these years, and made a down payment, and all that should count toward your net worth.
To be conservative, if you think your house appreciated since you bought it, use purchase price, if your house depreciated, use depreciated value.
Deal Addict
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Feb 17, 2005
4995 posts
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Markham
I'd use option 2

As you pay down mortgage, you are building equity. Given that it's fairly illiquid, I'd value it conservatively at either purchase price or market value, whichever is lower.
Deal Addict
Feb 25, 2007
1569 posts
1129 upvotes
Ottawa
What I do - calculate two net worth numbers

a) Liquid net worth - includes cash, investments, would include consumer debt if I had any. Does include RRSPs since they are cashable.

b) Total net worth - includes the above plus principal residence, car, locked-in pension savings (which can't be touched until 55), piano, major furniture. These are things I can't touch quickly, harder to accurately value - but still part of the financial mix that may help me manage my life in retirement etc

Note be sure to match assets and liabilities - so the mortgage goes in b), not a), even though it is liquid, since it affects my equity in a non-liquid asset
Member
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Nov 25, 2007
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Scranton, PA
Would contributions made to an RESP be considered as part the child's net worth or the parents?
Banned
Jun 19, 2006
9349 posts
57 upvotes
I think people have it all wrong when it comes to calculating 'net worth'.

A lot of people these days claim they have high net worth, because they have a house that is, based on historical rates of appreciation, and multiples of income, actually 50% overvalued.

An approach I would use is to determine the *earnings* of all of your assets, including your house, your stocks, your bonds, etc. Adjust for taxes, and then apply a discount rate to those earnings that is, for instance, the long-term rate of return of the bond or stock markets.

For instance, let's say this is my balance sheet:

House -- $24000/year after-tax/after-expense/after-depreciation income.
Car -- $5000/year after-tax income
$120,000 of the TSX index == $9000/year after-tax income
$100k of 5% GICs = $3000/year after-tax income.

Total: $41k/year after-tax income.

At a discount rate of 8%, my net worth would be equal to: $512,800

This approach is different, because it doesn't overstate the value of assets that may be in a bubble, ie: the house, or maybe the stock market. It adjusts for taxes. And doesn't give a person the delusion that they're rich, when they're not (the above example probably is a typical upper-middle class family in Canada living in a $700k house in Mississauga, for instance).

If you calculate your net worth in this way, I think you get a better idea of what's sustainable in terms of future investments, debt, etc. This model would generate a higher than 'market' net worth when asset prices are depressed, and generates a lower than 'market' net worth when asset prices are particularly elevated.

It is based on the premise that an asset has no value whatsoever unless it can provide income (and/or a dividend) in the future, to support consumption.
Banned
Jun 19, 2006
9349 posts
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demrea wrote: my house is worth about 400k.
i owe no consumer debt, but my mortgage is an M1 super mortgage and my balance is $240,000.

I list my total debt as 240k., but if i wouldnt have that much debt if not for leveraging to buy my house.
If you apply my logic, and your house in Calgary would yield a net (after taxes, depreciation, maintenance, etc.) income of approximately $18000/year if you rented it out, its value is $216,000 (@8%), and with $240k of debt against it, your net worth is -$24,000.
Member
Dec 27, 2006
226 posts
3 upvotes
Vancouver
pitz wrote: It is based on the premise that an asset has no value whatsoever unless it can provide income (and/or a dividend) in the future, to support consumption.
Of course, it's a wholly faulty premise.

By your logic, a $10m piece of art can't be factored into one's net worth.

More practically, using this valuation for residential housing is similarly flawed.

Finally, how exactly does a car provide income? If anything, it costs one money.

There's a reason why "fair market value" is around. It's exactly that.

What one might "earn" off of an asset is nice, but it generally has very little to do with what an asset is worth outside of certain classes.

I think you need to take a valuation class. Sure, the "income approach" works well for commercial or rental property, or for operating businesses.
Banned
Jun 19, 2006
9349 posts
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Jobu wrote: Of course, it's a wholly faulty premise.

By your logic, a $10m piece of art can't be factored into one's net worth.
Why not? A "$10M" piece of art can be rented out, can it not? Of course, it doesnt work too well for 'assets' that never provide income, but those assets are always based on speculation, ie: always based on the premise that there will be someone on the other end to buy them. Whereas, a house, stocks, etc., can simply be run down into liquidation, over time, hence, there is no requirement that a buyer be found.
More practically, using this valuation for residential housing is similarly flawed.
I think if more people viewed their 'balance sheets' in terms of income, they'd be better investors. To take a static, 'mark to market' view of things (which is what other posters would suggest), is to imply that it would even be possible to liquidate everything at once. Sure, in the case of $10M paintings (or gold), if people sell their items relatively infrequently, the market clearing price may very well be much higher (or lower) than the long-term value of the asset. An income-based approach removes that volatility, and speculative sentiment, from the decision-making basis.

Accordingly, if bankers used this sort of method of valuation, then they wouldn't be making loans that are certain to fail, ie: $350k loans against $400k houses in Calgary, that are only cost $200k to construct.
Finally, how exactly does a car provide income? If anything, it costs one money.
A car, just like owning a house, provides imputed income. If you didn't own a car outright, then you would have to devote $500/month or so in order to own one, through a lease or rental arrangement.
There's a reason why "fair market value" is around. It's exactly that.
But markets in housing are not very liquid, and they are subject to speculation, either upwards or downwards. If those Calgary houses were priced at $120k -- this sort of model would imply that they're worth far more, which would correctly guide an owner towards the likelyhood of future appreciation.

The flaw in strict 'mark-to-market' accounting is that it essentially invokes a feedback loop, especially when liquidity in assets dries up, where an increasingly small number of buyers, using increasing equity in existing assets, bid up the value of the assets until such an extent that the asset has a 'market' price that bears no semblance to the income that the asset can provide.

Income is also a market-based measure, "fair market income". I can do a survey of the houses in my neighbourhood, and determine, from landlords, what the income is, estimate the expenses, etc. Discount rates on specific assets are much more variable, than actual income streams. In the long term, nobody cares about asset prices, but only cares about income, because income is what is necessary to support the price of practically any asset. Without income, an asset will eventually revert to $0. Asset prices are a derivative of income, and not vice versa..
What one might "earn" off of an asset is nice, but it generally has very little to do with what an asset is worth outside of certain classes.
I very strongly disagree. Earnings are the only long-term determinant of the 'worth' of an asset. An asset that has no earnings is worth exactly $0.
I think you need to take a valuation class. Sure, the "income approach" works well for commercial or rental property, or for operating businesses.
I don't think so. I know exactly what I'm talking about here, so keep your random insults to yourself.
Banned
Jun 19, 2006
9349 posts
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ch08532 wrote: Would contributions made to an RESP be considered as part the child's net worth or the parents?
Good question; does anyone here know enough about the characteristics of a RESP to tell us?

Here's a scenario to ponder: Kid, 18, has a huge RESP saved up for him over the years. Dad wants the kid to study engineering. Kid wants to use the RESP money to study basketweaving.

Can Dad withhold the RESP money from the kid if the kid decides that he's going to use it to study basketweaving instead of engineering?

I'd suggest that a RESP would have 3 components:

a) A component in the hands of a beneficiary, ie: the component that he/she can 'realize' if he uses the RESP for education (as the RESP proceeds are taxed in his/her hands at low tax rates).

b) A component that is owned by the government, to wit: if a RESP is collapsed without being used for education, the government grants have to be repaid. In addition, the component as described in a) would also belong to the government if the RESP is collapsed.

c) A component owned by the contributor, if the beneficiary does not attend school.

Having a RESP *is* a component of net worth to the contributors *if* it allows them to avoid making contributions to their kids' education that they ordinarily would have made anyways. For instance, most upper-middle-class families are expected, in today's society, to pay for most of the university of their kids (because there is no OHIP, no Canada Student Loans, no scholarships available). If having a $100k RESP allows them to avoid shelling out $100k in education costs -- then that's definitely an asset, wouldn't you agree??

The skew between a) and b), would be derived from a statistical calculation of how likely it is that the kid would use the RESP money for an approved educational purpose, as opposed to letting the RESP expire after the prescribed length of time.
Deal Addict
Feb 20, 2006
1186 posts
48 upvotes
Vancouver
That definition of "income" (more precisely, discounted predicted future income) is interesting, but it doesn't have a whole lot to do with "net worth".

Gold might not have any income potential, and I don't think it is a particularly good investment, but for better or worth it has current value, just like a bundle of cash under your mattress, just like an overvalued house.

Note that that at least a couple of these examples are pretty easily turned into the kind of "high income" investments that result in a high NW under your definition. This doesn't seem like a reasonable definition of networth -where simply changing your asset allocation dramatically changes your NW.

The real problem is that this completely abandons the mark-to-market philosophy that you have espoused elsewhere (e.g. by arguing that banks shouldn't be able to hide massive losses in various impaired assets using new laws which abandon MTM). There is a real reason that GICs deliver less income than equity, and why low quality bonds deliver more (immediate) income than high quality ones - due to the varying risks and volatilities inherent in the instruments. Just because some chooses GICs because of lower risk tolerance Doesnt mean that this person effectively has lower wealth.

I understand that your are creating the methodology to somehow discount assets such as housing that you believe to be overvalued, but the method introduces more problems than it solves. You'll just have to live with these apparent overvaluations until they finally correct, or the market catches up or whatever.

In the meantime, the method you describe might be better positioned as a predictor of the derivative of NW, rather than a measure of its current value.
Banned
Jun 19, 2006
9349 posts
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Sanchez wrote: That definition of "income" (more precisely, discounted predicted future income) is interesting, but it doesn't have a whole lot to do with "net worth".
How else do you value illiquid assets then, without using a sort of 'model' based on the income they can produce?
Gold might not have any income potential, and I don't think it is a particularly good investment, but for better or worth it has current value, just like a bundle of cash under your mattress, just like an overvalued house.
Some people manage to create and sell video game characters online as well.
Note that that at least a couple of these examples are pretty easily turned into the kind of "high income" investments that result in a high NW under your definition. This doesn't seem like a reasonable definition of networth -where simply changing your asset allocation dramatically changes your NW.
If the income is sustainable, and greater than that of the prevailing discount rate, then its a good investment to own, and eventually it will appreciate. The key word is 'sustainability'. Just putting down that your Nortel stock is worth $110/share on a net worth statement (something that people were doing in 2000), or that your $500k Calgary house is actually 'worth' $500k, really isn't giving the whole picture, rather, its fantasy.

The real problem is that this completely abandons the mark-to-market philosophy that you have espoused elsewhere (e.g. by arguing that banks shouldn't be able to hide massive losses in various impaired assets using new laws which abandon MTM).
The assets are impaired, mark-to-model should factor in those impairments. If not, then its a fantasy.
I understand that your are creating the methodology to somehow discount assets such as housing that you believe to be overvalued, but the method introduces more problems than it solves. You'll just have to live with these apparent overvaluations until they finally correct, or the market catches up or whatever.
I didn't mean to pick on housing, we could just as easily be talking about Nortel stock circa 2000, or whatever other bubble du jour. The people who ran around in 2000 thinking they were filthy rich because they owned Nortel stock, that had a bid at $110, well, reality caught up with them -- because their investment had no income associated with it, ie: Nortel could not turn a profit. The risk is that people today are making irrational decisions as to present and planned future consumption, based on the ownership of assets that are severely mispriced, and such mispricing exists because of illiquidity.
In the meantime, the method you describe might be better positioned as a predictor of the derivative of NW, rather than a measure of its current value.
Putting such inflated valuations on assets may work for a small number of people, but if more than an extremely small number of people had to force inflated assets into liquidation, then you would get an extreme amount of downside.
Deal Addict
Feb 20, 2006
1186 posts
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Vancouver
pitz wrote: How else do you value illiquid assets then, without using a sort of 'model' based on the income they can produce?
I agree that where no market exists for a particular asset you'll need to find another way to value it, but few of the examples you've cited fall into that category - certainly Nortel, gold, online video game characters (?), houses and so on generally have a market that you can use to value assets, whether you proceed with an actual sale as well. Some of these are less liquid that others (you can only get an estimate of the value of your house) - but some are very precise (for reasonably liquid stocks you should be able to get within a few cents per share).

So I would agree that a model based valuation is valid in cases where no market exists - but not where "the market is irrational according to pitz".
Some people manage to create and sell video game characters online as well.
The relevance escapes me.
If the income is sustainable, and greater than that of the prevailing discount rate, then its a good investment to own, and eventually it will appreciate. The key word is 'sustainability'. Just putting down that your Nortel stock is worth $110/share on a net worth statement (something that people were doing in 2000), or that your $500k Calgary house is actually 'worth' $500k, really isn't giving the whole picture, rather, its fantasy.
It is not fantasy. You could instantly turn that Nortel stock into cold hard cash, with very few transaction or others costs. Houses would incur more costs, but you could absolutely sell it for approximately "the going price" which may have reached 500k in Calgary, sure.

Are you saying that if someone offered you 100 shares of Microsoft (trading at say $30), or 100 shares of Nortel when it was trading at $110, that you'd go with the Microsoft, since it was worth more based on your earnings model? I'm sure you aren't that silly - any rational person can see that taking the Nortel shares is the smarter option, and will immediately increase your net worth by 100x110 = $11,000. Whether you choose to sell these shares immediately and invest the money elsewhere (even in MSFT) has little bearing on their current, easily obtainable market value.

The assets are impaired, mark-to-model should factor in those impairments. If not, then its a fantasy.

I didn't mean to pick on housing, we could just as easily be talking about Nortel stock circa 2000, or whatever other bubble du jour. The people who ran around in 2000 thinking they were filthy rich because they owned Nortel stock, that had a bid at $110, well, reality caught up with them -- because their investment had no income associated with it, ie: Nortel could not turn a profit.
You are arguing that assets should be valued based on the future income (including capital gains) that they provide, which is exactly how assets should be valued. However, we disagree at what is the best mechanism to achieve that valuation - I'd argue we already have a pretty effective one, for most assets - the existing markets, where trillions of dollars are up for grabs for whoever can do this valuation better than his neighbor.

You think, on the other hand, that a simple model of future cash flows will better predict the price. In some markets, such as large cap stocks, you are walking into a headwind of years of academic research which shows that the best predictor of future price is pretty much the current price. Yes the market will have some Nortels, and it will have some mis-valuations on the low-side as well, but I've yet to see that simple cash-flow analysis is better than the current price, which of course incorporates the detailed cash-flow analysis of many experts, the differing risk profiles of investors, tax effects, etc.

For other markets, there may be more value in studying underlying income to determine future value - for whatever reasons they may be more subject to obvious departures from fundamental value. Perhaps housing is one of these markets, where the imputed income (rents) is relatively easy to calculate and relatively stable. Regardless, when using a model in such a market shows a different price than the current market price, and a market exists, I would absolutely argue that the current market prices (minus transaction costs) should be used to value the asset, since this price is actually achievable - just like by Nortel example above, you would prefer more valuable (per the current market price) assets to less valuable assets, since can change asset classes at will.
The risk is that people today are making irrational decisions as to present and planned future consumption, based on the ownership of assets that are severely mispriced, and such mispricing exists because of illiquidity.
Sure, I think we agree here. Basically, current net worth isn't the ideal predictor of the future ability to consume, because it doesn't capture future earnings. Two people may have an identical $1,000,000 NW, but the guy who has his nest egg in high yielding equity investments or a well-run, high return small business is likely going to be able to spend more than someone who plans to invest in something which will likely just track inflation, such as gold, who in turn will likely be able to consume more than someone who stuffs cash under their mattress. That's not what the OP is asking, however - he is after the calculation of current net worth, and that should use market prices. Again, each of the individuals above can transform into the others through market transactions, so we should be careful to separate the current value of their assets, from their predicted future income.
Putting such inflated valuations on assets may work for a small number of people, but if more than an extremely small number of people had to force inflated assets into liquidation, then you would get an extreme amount of downside.
I've been assuming that this is about the NW of individuals worth thousands or millions of dollars, rather than billions. These individuals can make market transactions in most reasonable asset classes without really moving the markets, so in asking "what am I worth" you should not consider the effect of a liquidity crisis spurred on by mass selling because your own selling will not trigger it. If this mass crisis occurs (e.g., housing the many parts of the US), and you haven't already divested your asset, then your NW takes a hit at that time, not before - since it is not predictable.
Jr. Member
Oct 11, 2007
184 posts
GTA
When I calculate my net worth I always calculate the market value of my home minus the comissions or closing costs I would pay in liquidating that asset. For example, If my house was worth 500k and I had a 250k mortgage, I would calculate my net worth as 500k minus 25k (5%) in closing/commssion costs minue my mortgage which would equal 225k...
Sr. Member
Jul 29, 2009
895 posts
14 upvotes
A GAAP approach to calculating your personal net worth would have you value your house at the lessor of what you paid, and it's current market value.
Deal Expert
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Dec 11, 2005
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You should count your house into your net worth, and subtract the mortgage. Make sure you use a conservative valuation, but definitely include it.

Not including your house would be skewing the numbers big time. All of the banks include your house when calculating net work.
YYC27 wrote: A GAAP approach to calculating your personal net worth would have you value your house at the lessor of what you paid, and it's current market value.
This doesn't make any sense at all. It would be like valuing your equity portfolio at the amount you paid for it instead of the value it is at now.

Also, I don't know why people keep tossing around liquidity. A house is as liquid or illiquid as most other types of assets. IE, if I enter in an ASK order for a stock that is 25% above it's actual market value, then it isn't very liquid. Same thing when you go to sell your house, if you are sitting on it for any period of time, then you haven't valued the asset correctly. Unless the whole real estate market in your area is in a massive downturn, you should be able to rely on being able to get at least somewhat close to fair market value for your house.
To be nobody but yourself - in a world which is doing its best, night and day, to make you everybody else - means to fight the hardest battle which any human being can fight; and never stop fighting. -- E. E. Cummings
Deal Addict
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Apr 14, 2005
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Assuming you are married, to know your individual net worth, you might be better to ask "what would I be worth after a divorce" since the divorce would most likely include selling any major assets and your home at market value and splitting the proceeds as well as clearing/splitting any debts.

I too quickly take my total assets (including house) and subtract any debts. But then I divide by 2. This is something I never see anyone do and if you have a spouse that has contributed to 'your' net worth, it is sort of offensive really.

I read a few personal finance blogs where the blogger always proclaims "My net worth is now $X" even though it is clear they are married to a working spouse and they should really be saying "Our net worth is now $X". I don't know why their spouses let them get away with it. :-0
Deal Addict
Sep 20, 2006
1507 posts
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How does the car work? Say the car costs $25,000, and I bought it 2 years ago, and still have about 15,000 to pay. Do I just take 25-15 = 10k added to my net worth.

If my monthly payment is 500, is next month's net worth 25,000 - 14.5 k = 11.5??? Doesnt' seem right, as I am not takign into account depreciation. How much are you all depreciating your vehicles every month??

Or do you just look up the vehicle on autotrader and use market value (asset side), and in the liabilities just add up the payments you have left????

Thanks

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