Q. In a recent column, the question came from a man who gave his net worth as $1.1 million. I do not have a clear idea of my net worth.
I am 74 years old. My wife is 71. We are both retirees. Our combined annual taxable income is about $125,000. It consists of our retirement pensions and our Social Security benefits. We also receive an annual payment from our IRA held by Merrill-Edge.
Our liquid assets, including an annual payment from our Merrill funds plus our various bank accounts, total about $250,000. Zillow usually shows our house worth about $500,000. We owe only a small amount on our mortgage.
We would very much appreciate an explanation from you as to how to calculate our total net worth. Also, just what this information means. That is, what is its practical meaning? —D.F., Claremont, California
A. Your net worth has nothing to do with your income. It has everything to do with your assets. A typical personal balance sheet has lines for what some call “personal capital”— the value of your house, your car or cars, furnishings, jewelry, art work, second home if you have one, etc. These are consuming assets: they don’t produce income. Instead, they consume it by having costs of maintenance, insurance, etc.
Another category is “financial assets” such as checking and savings account balances, assets in brokerage accounts, stocks and bonds you hold directly and the value of investments in qualified plans such as 401(k) and 403(b) plans. Many people also have net assets in life insurance policies. Some people also own a business or business assets. These can range from owning an operating business to an interest in commercial real estate, mineral rights, timber rights, etc. Add all those and you have your gross assets.
The next step is to subtract obligations such as personal debt, car, home equity and mortgage loans, credit card balances and any other form of obligation. The result is your conventional net worth. That’s the most commonly referenced number.
The conventional net worth, however, can misrepresent your actual financial condition because it ignores what we’ll call virtual wealth— the rights to income that many people have because they are receiving Social Security benefits or a pension. The value of that income can be equated to the cost of a life annuity contract that would provide the same income.
This distinction is important. While virtual wealth can’t be left to your children, it can make a material difference in your standard of living and personal security. It can also make a difference in how you invest your financial assets.
You can see the difference by comparing a college professor and a medical doctor. The college professor has a salary of $120,000, saves regularly in a 403(b) plan, and knows he will have a pension as well as Social Security. In fact, a professor with long tenure can retire with a combined pension and Social Security income that is greater than his final salary. It’s rare, but it happens. So his saving any financial assets will all be “gravy.”
The doctor, on the other hand, may earn twice as much (or more). But he won’t have a pension. So his retirement income will be based on Social Security and whatever he has saved. Since Social Security will provide about $30,000, he will need to have financial assets of about $2,250,000 in his retirement accounts to provide an additional $90,000 of income.
It will take this amount to be able to live as well in retirement as his college professor friend with the pension. The doctor, of course, can leave an estate. He can also borrow more easily from his conventional net worth— but to the outside observer the virtual wealth of the college professor is doing exactly what a lot of real money is doing.
Another important distinction is between earning assets like stocks and bonds and consuming assets like our homes, cars and personal possessions. Lots of people are personal asset rich and earning asset poor. They like to think they are well off, but they are not.
You are only well off when you have enough income from earning assets or virtual assets to sustain your standard of living and payment obligations. Until that happens, you are as vulnerable as your paycheck.