For years, a person's net worth has been seen as THE indicator of budding wealth. But in today's economic landscape, is net worth the best way to gauge your financial progress?
Join us to find out.
Brenton: [00:00:00] For decades, net worth has been seen as the tool that measures whether you're progressing financially. In this episode, we talk about whether that's appropriate or if there are other tools that are a better gauge of your financial progress. Let's get started.
Hello. This is Brenton Harrison of New Money, new Problems, and your host for the New Money New Problems podcast. I want to thank you guys for joining us, and in this episode we're gonna talk about something that, as long as I've been in financial services, has been seen as the de facto way of knowing whether or not someone's doing well financially.
And that is your net worth. In case you are unaware, net worth is the number that you arrive to when you take your assets, the things that you own, and you subtract your liabilities, the things that you owe, and that resulting number is worn like a badge of pride for people who have a high net worth, and for people who do not have a high net worth or worse, have a negative net worth, it has been seen as a number that produces a lot of shame and a lot of guilt.
And even as [00:01:00] that shame endures net worth is still discussed as the preeminent tool that measures whether or not you are progressing. And today we want to talk through whether that's appropriate or whether there are other things that can give you an indicator of forward progress.
I'm up late a lot reading random financial news and it came to mind to talk about net worth after reading an article that came out in October of 2022. We will share this in the show notes, entitled 'The Average Net Worth of Americans By Age, education, and Ethnicity'. And in this article it goes through a number of different average net worths or median net worths, which we'll discuss, based on age, education, and ethnicity.
But in the opening summary, it states that, and I quote, ' a good way to think about your net worth is as as a financial report card, when you tally your assets and liabilities, you get a clear view of your financial life, helping you identify what's working and fix what's not'. Later on in the article it says, 'still, it can be difficult to contextualize your personal financial report [00:02:00] card, especially if you're a long way from retirement and don't yet know how much you'll need to maintain your standard of living in your golden years. How well are you actually doing?' End quote. I think that's a great way to summarize how I feel about net worth, not just in the sense of you may be 20, 30 years from retirement and you're looking at this number, trying to figure out how it translates to whether or not you can retire well. I would also add the layer of the fact that these listeners who are tuned into the New Money New Problems podcast are typically first generation high income earners, and the way that many people attain first generation high income makes it very difficult to use net worth as a tool of measurement.
After the break, we'll talk about why it's so difficult for this subset to use net worth as a tool of measurement. But before the break, I want to talk about just one of the things that sticks in my craw about how net worth is reported, and that is the difference [00:03:00] between mean net worth, median net worth and mode. I know I'm taking you back to whatever grade math class that was, but mean, median and mode come into play with net worth in a significant way in terms of making sure you have an accurate understanding of where your peers lie on the net worth spectrum.
Going back to the article, they do a phenomenal job of illustrating the difference between a mean net worth and a median net worth. They do this by giving you a group of five people that have the following net worths: -$8,500. $300, another person with $300, a third person with $300, and then finally a person with a net worth of $15,000.
Now, when you take these five people, most of whom have a net worth of $300 down to negative $8,500, when we calculate the average of the entire group, even though the majority falls below A certain [00:04:00] number, the average is actually $1,480, significantly higher than you would expect because that fifth person in the group with a net worth of $15,000 drags that average higher than their relative peers.
Conversely, median net worth is, in my opinion, a more accurate reflection of how your peers are doing with net worth. In this article, they take those same five people, and they take the median, which is the middle point between all of the different respondents.
And when they do this, you get a much lower level instead of an average net worth, which is the mean of $1,480. The median in our example is $300, which is much more in line with the typical respondent.
This radical difference is reflected later on in the article when they give you a table that shows the mean net worth for a different age range as compared to the median net worth for that same age.[00:05:00]
As an example, for a person between the ages of 45 and 54, the mean average net worth is $833,790, whereas the median, the middle point, is almost $700,000 lower at $168,800.
Now imagine you're trying to assess how you're really doing financially and you stumble across an article that says that the average person your age has a net worth of 800 and some odd thousand dollars and you're sitting here with a net worth of a hundred thousand dollars or maybe a negative net worth or a net worth of zero, and you think you are almost a million dollars behind the eight ball.
Not understanding that just the difference of one word, mean versus median, could show you that you are not doing as poorly as you thought . There may be some things that you could do better, but you cannot, in all cases without knowing all the variables, use someone else's financial situation [00:06:00] to gauge how you are doing in your life.
Now that we're back from the break, I want to give you an idea from my perspective, of why the media focus on net worth does not do a good job of encompassing the average first generation high income earner's process of building that income, but also hopefully building wealth.
The first reason I think it is very misleading is because the process most first generation, high income earners take to wealth is through education, more specifically through education debt.
As a matter of fact, a recent article that we'll share in the show notes found that over the last 10 years, the number of people who owe over a hundred thousand dollars in student loan debt has quadrupled. And I can tell you a hundred thousand dollars is where they stopped.
But I have shared that I regularly work with people who owe 200, 300, 400, even $500,000 or more in federal student loan debt.
In fact, that same article shared that if you went to a public institution for your [00:07:00] master's degree, on average, you had to take out $58,000 for either tuition or student loan debt. That same master's degree at a private institution costs $96,000. And if you got a professional degree, which they define as typically a law school degree or a medical degree at a private institution, on average you took out $243,000 in student loan debt. And I can tell you that that is conservative for many programs.
But unfortunately, just taking out the student loans is not the thing that makes net worth such a hard tool to use.
Many of these people, as a matter of fact, over 3.2 million people are enrolled in programs that are called Income Driven Repayment Plans to repay Federal Student Loan debt. These programs, rather than making you pay an amount needed to pay your student loans off in full Within a given time period.
Instead, they ask you to pay a [00:08:00] percentage of something called your discretionary income towards your debt each year. Now, unfortunately, that percentage of your discretionary income is enough to satisfy the repayment plan, but it may not be enough to satisfy the interest that's growing on your loans.
And as a result, many of these 3.2 million people on these plans make their payments towards student loans every single year just to see their student loan balance increase. If I know that income driven repayment plans are the right thing for me and for many of these professionals they are the right thing, does it still feel like the right thing if after 10 years my net worth has gone from negative $200,000 to negative $300,000?
Next. In some cases, net worth can give you a false sense of security, and the reason for this is net worth considers all of your assets and all of your liabilities, regardless of how easy or difficult it will be to access said assets. What I'm talking about [00:09:00] is home equity and in some cases business ownership.
Now as this podcast goes on, we'll talk about the many ways that you can access the equity in your home. But suffice it to say unless you are going to sell your primary residence, the ways that you would tap into its equity all require you to take on debt. You have to either sell your home or use that equity in your home to access some type of loan vehicle, but it is not what's considered liquid. The same can be true for business interest. I'm an entrepreneur, and if you look even at my net worth, a significant part of my number is the equity that I have in my primary home and the equity that I have in my business in terms of its market value. The problem with that being an oversized part of my or any person's net worth is what your intentions are with those assets.
I do not plan to sell my business. I love what I do. So while I make sure that the actions I take each day on a professional [00:10:00] basis increase its value, it is not something that I can touch or benefit in the here and now because I have no intentions to sell.
An example of this inequity when it comes to how a number can mislead you would be a person who has a home that's worth a million dollars and maybe they have a mortgage that's $500,000 on that home. So they have $500,000 of equity and maybe they don't owe anything else, but maybe they also have nothing in savings.
So they're living paycheck to paycheck. They don't have a dollar to their. , but because of that $500,000 in equity, they have a $500,000 net worth. Conversely, let's take a person who does not own a home. They have no debts and they have half a million dollars in an investment account. That half a million dollars gives them the same net worth as the person in our first example.
But who do you think is better positioned financially? A person who has a home they don't plan to sell, not a dollar to their name, and half a million dollars worth of equity? Or a [00:11:00] person who owes no one and has $500,000 that they can touch whenever they want to, to use for their future endeavors.
And lastly, and this speaks to how you are feeling about how you are doing financially, which is the most important thing. Net worth does not take into consideration the way that you want to build wealth.
We talked about this in a previous episode. There are many ways in which you can build wealth, and there's not a right or wrong way to do it.
If you're the type of person who wants to keep stacking money in that 401k and have that be the way you build wealth, then me looking and seeing that you have three or four investment properties and are putting one or 2% of your income towards your 401k would signal to me that even though your net worth may be high, you're not building wealth in the way that you prefer to build. Conversely, if all of your money is in your 401k and you said that you want to retire before age 59 and a half, and that you want to build passive income in the here and now, even if you want to transition to [00:12:00] entrepreneurship, having the bulk of your net worth in a tool that you cannot touch before 59 and a half without penalty would signal to me that there's an imbalance between what your net worth says and your preferred wealth building path.
I've said all of this to say that while net worth is a number that can be used, in the next episode we'll give you some other tools that you can use to have that confidence in your financial journey.
I'll see you then.