July 16, 2003

Net Worth and What it all Means
by Marcel Chartier

Determining your net worth is an interesting exercise as it determines your true wealth level. It is interesting that the wealthy think in terms of net worth, and the middle class think in terms of income. Why? because the wealthy know that wealth is what matters, income is transitory unless it is transferred to wealth.

I tend to do a lot of reading, especially about people who have retired early, or have found ways to find steady income leaving them the time to choose when and where to work or what they would like to do, well because, that is what I would like to do. One such read, was about an American couple who retired at 40. Both were coprorate professionals making great income, $100.000 plus a year, with a large house, fancy luxury cars and all the trappings. They looked at their current lifestyle, working to pay the mortgage, the cars, "the trappings" of the upper middle class, and realized they no longer wanted any of that. After determining their net worth, they realized if they liquidated everything, they would be worth slightly over $550,000 US. Generate income at 5% and this capital throws off $27,500 a year.

As the couple had some command of Spanish and loved South America, they put what they had into conservative money market bond and dividend funds, and moved to Venezuela and lived on the beach, never having to work again.

Now, this may not be everyone's dream, but it clearly illistrates what net worth can do. If this couple realized higher gains than 5%, they would grow their principle too. Having this net worth also helped produce a lower taxable income level than when when both were working at high income. They will get to keep more after tax dollars AND not work.

The goal of any income should be to build net worth, not to enable higher expenditures. High income earners also tend to be high debt holders as the higher income usually allows more debt to be taken on. High income earners hate taxes, as this eats into disposable income, people with high net worth usually aren't quite as concerned about taxes as they recieve income from wealth such as from dividends, which are taxed at a lower rate. They also borrow to invest which lowers income tax by creating deductable interest, lowering overall taxation rates.

Building your net worth is what really matters. The old adage "it's what you keep, not what you earn", is generally true. Someone with a modest income and modest expenditures can build net worth faster than the high income, high spenders.

Determining what you need to live on is also incredibly important in determining whether you can live off your net worth. Look at the couple in my example, they realized that they could live well in Venezuela on what they could earn from investments. If they chose to live in the US, I don't think their retirement would have been as carefree.

As in one of my previous articles, halving what you make now after being mortgage free is about right for most people to maintain a comparable or slightly higher lifestyle after stopping work. Now don't you want to know your net worth? (All assets minus debts or imagine selling everything you have, pay off your debts and what do you have left?)