Does Net Worth Matter?
I see all of these financial blogs focusing on their net worth progress. My question is, do I care? Not do I care about what is their net worth, but do I care about monitoring my net worth? It's kinda neat being a voyeur, watching people discuss their net worth to the world, and maybe that's the fascination. It's what the general public and media focus on. I think they are focusing on the wrong goal.
Let me ask you a hypothetical question. For simplicity, assume taxes and debt are not part of the equation. Let's say you want to get out of the rat race, and you need $60,000 yearly to survive.
|Option #1||Option #2|
|$1,000,000 that you must take out $60,000 yearly. It generates no interest.||$1,000,000 generating 6% interest and compounds yearly. You cannot touch the principal.|
Which would you choose? Both options give you a $1 million net worth. The answer is easy; you would choose option #2, it gives you $60,000 income for the rest of your life. With option #1, you would run out of money in year sixteen. Not bad, but not good either. If you started collecting at age 50, based upon average lifespan, you would out of money before you die.
Cash flow is a much more important metric to measure; how much is left at the end of the month after subtracting expenses from income. This becomes obviously important when you have low or negative net worth. If you have no savings (net worth) to fall back upon you're dead, you need cash flow to keep you going. This is the same as owning a business; the income/expenses report. If you have constant negative cash flow, you won't be in business for too long. As your net worth grows past a specific point, the interest alone can keep you going without doing anything else.
The interest is otherwise known as cash flow, or at least adds to your monthly cash flow. While it's nice to have a high net worth; it's useless if it doesn't generate any cash flow. Why do we hear of lotto winners, rock stars, athletes, who after hitting it big, are broke a few years later? It's because of bad management of their cash flow; net worth wasn't an issue. Constantly increasing your cash flow will automatically increase your net worth. This is why everyone says live within your means. If you don't have the cash flow, don't purchase it! That might seem like a no-brainer, but remind me how the housing crisis started?
Your goal should be about acquiring income-producing assets:
businesses, real estate, stocks, bonds, and royalties.
What I care about is how much money my active and passive investments generate for me monthly. Are they helping add to my net worth, or are they depleting it? If you focus on consistent positive cash flow, and ways to increase your cash flow, you most certainly will acquire a high net worth. This blog discusses ways of increasing income, and some smart ways in decreasing expenses.
So what's more important to you, cash flow or net worth? While I may devote posts discussing net worth from time to time, it's not the core reason for this blog and shouldn't be in your life.
I believe that both cash flow and net worth are important, but they have different functions.
Net worth is the result of every financial decision that you’ve ever made in your lifetime. It is the report card. An increasing net worth simply shows you that you are making progress toward your accumulation goals. When you accomplish certain goals, your net worth actually goes down (college education funding for example) so monitoring net worth as an accounting exercise is not the point. Net worth simply shows you the end result of your actions.
What gets REFLECTED each year in your net worth is how you HANDLE your annual cash flow. A negative cash flow decreases net worth. A positive cash flow increases net worth. Accomplishing certain goals also can decrease your financial net worth.
Ultimately, if you have not set financial goals, quantified how much is “enough” to save for them each year, and have an effective money management system to get from where you are to where you want to be, the whole discussion is just entertainment.
Good Point! What I think you are pointing out is staying focused on your long term net worth. What you have today is important because what you do with your wealth will determine your future net worth. Your future net worth will be detemined by your cash flow from your current net worth and how much of it you consume. Your cash flow will be determined by your ASSET ALLOCATION; the most important decision you can make with your net worth!
Great post. I couldn’t agree with you more; at the end of the day cashflow is king. But having said that, net worth is easy to track, simple to understand and should in theory be a proxy for your investment income. I monitor my networth (and enjoy looking at others), but more of a measure of how much I have. I can’t retire on it, because most of it is tied up in non-cash producing assets that can’t easily be sold over the next couple of years.
@LG – not necessarily. You can have an asset that increases in capital value (eg your home) that produces on cashflow. Investments like gold are another example. You could have millions of $$ invested and it produce no cashflow (in fact gold has negative cashflow) unless you sell some.
“Happiness is Positive Cash Flow”
Make no mistake. Positive cashflow:
1. allows for better, healthier sleep;
2. lowers your blood pressure;
3. improves all relationships, including intimate;
4. gives you personal freedom and an irreplaceable commodity: time.
cheers, Happy New Year!
@Ryan @ Planting Dollars: Thanks for visiting. Yes it’s true cash flow does dictate the value of a business. Usually it’s some multiple. I know of some businesses the multiple value is awful (only one or less times yearly earnings). In many cases you are better keeping the business for cash flow than selling it outright and getting the cash up front. I have considered selling my primary business and found this was true.
I’ll agree with you here. I’d much rather have a higher positive cash flow than a high net worth base that isn’t producing as much cash flow. However the cash flow steams of a business dictate it’s value (in large part) so it seems that net worth and cash flow tend to go hand in hand.
I wonder whether the trend in cash flow and/or net worth is more important than either metric?
Quote: “If you focus on consistent positive cash flow, and ways to increase your cash flow, you most certainly will acquire a high net worth.”
Turn it around: If you focus on consistent increasing net worth and ways to increase your net worth, you most certainly will acquire a high cash flow.
Hi LG, Thanks for visiting. Can’t they be mutually exclusive?
I think that it is important that both your cashflow and asset base continue to grow with a view to an increasing networth as well. Ultimately it is about how well you manage the cashflow. Net worth gives you leverage that cashflow alone may not.
@Financial Samurai: Yea I already crossposted my link 😉
I agree with 4%+ return and I have a blog post I want to discuss about that. It’s was more a way to make my point obvious. You can have a smaller return and still be in the boat of no money left. As your net worth increases there comes a point where even return does not matter. That’s more in the 8 figure range.
Good topic of discussion. Cash flow it is, however, the first example of a no-interest returning 1 mil nut is unrealistic don’t you think? I expect a 4% return, nothing more, nothing less.
I wrote a series of “net worth” posts under my net worth tab. The main one is “Your net worth is an illusion, sorry to spoil your delusion”. check it out.