It’s fairly common for personal finance bloggers to track their Net Worth. Some even post their Net Worth on their blog for the world to see. For various reasons I’m not one of them. The first obvious reason to long term readers is the impact on others. But, there is another reason. Net Worth is not all that important for my financial plans.
Now let me start by saying, yes, I obviously do need a certain Net Worth number when I retire. In order to sustain a living, post-work I need assets. Also, yes I have a sufficiently large amount of Net Worth to be considered Financially Independent at least in the most basic sense. However, both of those are one time milestones way out in the distance. Focusing on them in any significant way would likely just demotivate me since they are way in the future. So at least in the near term Financial Independence and a Net Worth capable of supporting my desired retirement are not my primary motivation.
Net Worth is Not a Good Metric
I know those who have been reading here for a while are now saying, Didn’t you say to set milestones and sub goals to support your longer term goals? If my long term goal is Financial Independence, as is everyone’s, then shouldn’t I set Net Worth Goal Posts along the way? Well, yes I did say that, but Net Worth is a terrible measure of my yearly progress towards Retirement and prior to that Financial Independence. You see Net Worth is not a SMART Metric, especially once you’re approaching Financial Independence.
Most Net Worth Changes Around and Above Financial Independence are Outside Your Control
A few weeks ago in a comment on Physician on Fire the topic came up of what happens when your investments return more then you can save in an average year. The Green Swan spoke to this point a few weeks before referring to it as the Inflection Point or Fire Starter. The problem with this point is it swings both ways. So let’s take 1999 for example. The S&P 500 increased almost 21% in 1999. If you had a portfolio with a Net Worth of 1 Million dollars invested in the S&P 500 then your investments increased your Net Worth $210K. That means if you put absolutely nothing into your savings you could still in theory claim success. On the flip side look at 2008. The return of the S&P 500 was -37%. Or on the same portfolio you would have decreased your Net Worth by $370K. Now imagine if you saved almost 100K in 2008. That means your Net Worth only decreased by $270K. So is 2008 a failure from a financial perspective? Is it worse then 1999? Was your behavior flawed in 2008 if this hypothetical situation was you?
Would investing 100K in 2008 be worse or better then $0 dollars in 1999.
Well, let’s step back and think about those questions for a minute. Which Situation is Superior, saving 100K in a down market or investing 0 dollars in a year where the market returned 19%.
Saving is Inherently a Good Behavior
The first is the obvious, if you are saving something your behavior will lead to more long term success then if you spend all your earnings each year. Sure 0 dollars savings in 2008 wouldn’t kill you. But if you never invested another dollar again from a million dollar portfolio then you’d likely outlive your money unless you chose a really specific frugal lifestyle. So savings rates like in my hypothetical 2008 example are definitely preferable behavior.
In the Long Run Contributing Savings in Addition to Reinvesting Market Returns is Superior
The second point may be less obvious. What happens to that portfolio over time. Sure the market tanked in 2008, but depending on when the money went in, it was invested at a lower stock market valuation then 1999. So let’s assume a mid point in 2008 as when the money was invested. So half of -37% is down 19%. So in 2008 the portfolio lost another 19% after you deposited the 100K. You’d leave 2008 with 737K. However, if you did not invest another dime it was up in 2009 by 26% (928K) and 2010 by 15% (1,068K).
1999 meanwhile was up 21%. So at midpoint lets assume 10%. So in 1999 you’d have a portfolio of $1100K . However in 2000 you’d lose 9% ($1,001K) and in 2001 you’d lose 12% ($880K).
So the end result in the long run is the person who invested the 100K in 2008 did better then the person who did not invest in 1999. Now sure there are scenarios where the sequence of returns will come out ahead for market returns over savings in the short run. But over the long run saving new money will exceed just relying on your returns every time. And yet if you use Net Worth as a yard stick you would not view 2008 as a successful financial year. It might even demotivate you from further savings.
Net Worth is Not All That Important For My Financial Plans
For these 2 reasons, Net Worth is not all that important for my financial plans. Simply put, I want to encourage myself to execute good financial behavior like savings rates, spending controls, and investing for the long run. I want each milestone to reward proper performance at the time they occur, not years later as in 2008’s case. As such I set my goals and plans against things I can control. Things like savings rates and my yearly expenses. I leave Net Worth as something I check a few times a year mainly for re-balancing purposes and to ensure my end milestone has not snuck up on me.
Do you measure Net Worth? Have you done so through a down market? Do you use Net Worth as a goal or part of a plan?