If you’re humble enough, you’ll learn something new every day. Sometimes it’s mundane stuff. Like that word you’ve always known but whose pronunciation you’ve never bothered to confirm. Until you read it out loud in public and embarrass yourself. For me that word was chasm.
Other times, it is the funny stuff. Like when you want to impress and order collard greens at a pretentious hotel, only to start contesting that you didn’t ask for sukuma wiki when your order finally comes. Makes others question your apparent sophistication.
But sometimes, you learn things that change your thinking in profound ways.
Recently, I learnt about a different way to look at an individual’s financial position.
If you read my articles (and tweets), you know I never waste a chance to tout the net worth statement as the most fundamental step towards calling sanity into your personal finance. That remains true. A net worth statement is a simple yet powerful tool that everybody who’s serious about attaining financial peace, tracking progress, and keeping themselves accountable should have.
But even as I waxed poetic, extolling the virtues of the indispensable net worth statement, I have had some questions.
First, unlike companies that can include intangible assets like goodwill and patents on their balance sheets, the personal net worth statement only accommodates monetary and physical possessions. Is this all we have?
Second, given that the net worth number is diminutive for a significant number of years into employment for most people, isn’t encouraging people to prepare their net worth statement the surest way to get them to give up about their finances?
I think of the diligent college student: full of stamina, talent, and potential, but who has taken out multiple loans to pay for school, to the point that they have a decidedly negative net worth. How helpful is a net worth statement to them?
It turns out, a net wealth statement addresses these deficiencies. It can do so because, not only does it account for the usual items that appear on a net worth statement, but also intangible assets and liabilities -both present and future. And yes, it accounts for potential – although that’s not what it calls it.
On the assets side, you then list all the intangible assets – current and future. For many people, the most significant asset will be your earning power. If your salary is Sh. 50,000 and you expect it to increase at an average of 5% per year until retirement, there is a way to discount all that expected future income into one single number. Think of it as the amount someone would have to pay you today to quit working forever. The same can be done for any business income, pension, non-monetary benefits, insurance policies etc.
Of course, the same applies on the liabilities side. The biggest liability will probably be your expected future personal expenses. These future expenses represent a liability owed to yourself. Again, you can discount the sum of your expected future expenses into one number. Think of it as the amount of money you would need right now to fund the rest of your life. (This is called present value in financial parlance)
It is important at this point to mention that, a net wealth statement is simple in theory but complicated in practice. Indeed, a satisfactory net wealth statement might require some fair tinkering with mathematical finance concepts. This includes time value of money calculations which, thankfully, can be easily dealt with on Excel or with special calculators. However, figuring out things like the appropriate discount rate to apply for the calculations will require more arcane finance skills.
The net wealth statement is also subject to significant subjectivity, including estimates on future income, length of life or employment. If one estimate is way off, it can invalidate the entire analysis. Proper execution in all honesty calls for a qualified, meticulous financial advisor.
The point is not to show you how difficult it is to come up with a net wealth statement. But given the complexity of the endeavour, most people should stick with the humble net worth statement.
However, if you are a nerd or have been discouraged by your persistent or growing negative net worth and were looking for ways to be more upbeat, then a net wealth statement could be just what you need.