Given the diversity in how FIRE bloggers calculate their net worth and savings rate, I thought I would provide some clarification on how the Single Income Life household arrives at these two important metrics. In short, we defer to the ultimate expert on the topic and follow Mr. Money Mustache’s methodology which he describes in full detail here. MMM’s post will show you a broad example of how these two items are calculated while the details below (and in future posts) provide the specific components that make up SIL’s net worth and savings rate calculations.
I’ll start with how we arrive at our net worth, which is essentially the sum of our assets (consisting of savings + primary home + rental property + brokerage account + post-tax retirement account + pre-tax retirement account) minus the sum of our liabilities (consisting of our primary home and rental property mortgages). I cover the liability side of things here, but for now let’s get into specific line items making up the assets that go into our net worth.
This consists of three different savings accounts: household savings, rental property savings and excess cash to be invested. Our household savings account constitutes our emergency fund, which is roughly 5 months’ worth of normal living expenses. The rental property savings account holds 2 months’ worth of rental income to act as our reserve should any unexpected expenses come up. Lastly, this bucket includes some excess cash that we are hoping to deploy once the right investment opportunity arises. In total, this bucket represents our cash on hand. As a matter of personal preference, I don’t include our checking accounts since the balances are usually temporary and are spent before the month is up. It also excludes short-term savings such as our home and car maintenance, replacement car, medical and vacation funds. I exclude these for the same reason that I exclude our checking accounts. The balances are usually temporary and while it would be a nice boost to our net worth to include them, I also don’t want my net worth to decrease when I go on vacation and deplete our vacation funds, for example.
One of the big debates in the personal finance space is whether to include your house in your net worth calc. Some argue that the house you live isn’t an income-producing asset and should be excluded from your net worth. For those who track their net worth for the primary purpose of determining how much passive income they can generate in the future, this approach makes a lot of sense. People in the “include” camp argue that a house is a true asset and certainly one that you can sell in the future, upon which the equity can be used to generate income. We can debate about this topic all day long, but I’d rather not re-hash the arguments and counter-arguments here. Instead, I’ll just provide some clarification on why we chose to include our house (and its associated mortgage) in our net worth. We still owe quite a bit on it, and I find a lot of value in seeing our mortgage balance every time I look at our net worth. It’s a stark reminder that we still have a ways to go in eliminating our debt and provides an extra “push” for me to continue our debt payoff journey.
If you’ve been around FIRE blogs for any significant length of time, you’ll notice that people use a variety of data points to determine the value (in dollars, at least) of their house. Some people use their original purchase price, some use their taxing authority’s assessed values while others use websites such as Zillow. Our local real estate market has been going gangbusters since the ’08 crash and while I thought that we were buying at the top of the market when we bought it in 2014, prices have continued to heat up. Nonetheless, Zillow’s estimate of our house value seems inflated to me. Accordingly, the value we use in our net worth calc is equal to 80% of Zillow’s current estimate. There’s no magic formula behind applying a 20% discount, other than the fact that doing so results in our equity approximating what I believe would be our proceeds (after transaction costs) if we were to sell it today.
As a matter of personal preference, I hold the value of our house constant in my quarterly net worth updates. We have no plans to sell our house in the near future and recalibrating to Zillow’s arbitrary value every quarter seems like a futile exercise to me.
We also use Zillow’s estimate as a starting point for our rental property value, but this time I applied a 30% discount. The difference between the 80% we use on our primary home and the 70% here is partly due to the taxes we would pay if we sold the rental property. As with the primary home, I hold the value of the rental property constant in my quarterly net worth updates. Thus, the only impact to our net worth from our real estate holdings is the mortgage principal reduction.
Our brokerage account consists entirely of equity securities and is primarily made up of Vanguard index funds. The only individual stocks we own are those of my employer’s. I am a big fan of the public capital markets and I like to follow it religiously as a hobby. Nonetheless, I can’t stomach the volatility involved in holding individual stocks and I couldn’t possibly compete with the know-how of the analysts, banks and hedge funds that live and breathe this stuff on a daily basis. Accordingly, I am content to observe from the sidelines and happily limit my involvement to index funds.
Post-Tax Retirement Account
Okay, a big confession here: I’m not entirely sure what our holdings in our Roth IRAs are other than that it’s a mix of equity and fixed income securities, some commodities and cash. These are managed by our financial advisor and I haven’t done a very good job of keeping up to date on what he has us in. All I know is that we are mostly in actively-managed mutual funds and on top of the enormous fees that those charge, the financial advisor is skimming some off the top for the privilege of his oversight/management. One of my goals for this year is to get these accounts under control, which will most likely culminate in my firing the guy, moving the funds to Vanguard and going it alone.
Pre-Tax Retirement Account
These are our traditional IRAs and a 401(k) with my employer. Same thing here where I don’t have as firm a grasp as I should on what we’re invested in. The traditional IRAs are managed by the same guy as the Roths, and I anticipate that these will be in Vanguard index funds by the end of the year. I can’t do much about the 401(k), but I will scrub my asset allocation before the end of the year and make sure we’re in good shape there.
And that’s about it when it comes to the assets side of our personal balance sheet. In summary, the total assets reflected in our net worth calculation are cash savings + primary home + rental property + brokerage account + post-tax retirement account + pre-tax retirement account. Pretty simple, right?
In my next post, I’ll cover the nitty gritty details of the liabilities we owe. Before I close out, though, I wanted to add a quick note about additional assets I’ve seen in others’ net worth calcs that I’ve chosen to exclude from ours.
Excluded – Cars
In keeping with Mr. Money Mustache’s methodology, we don’t include the value of our cars in our net worth. We currently own two paid off, late model cars – a sedan and minivan of the Toyota/Honda variety. I can’t imagine that these are worth any significant amount of money, which is largely irrelevant anyway since we plan to hold on to these as long as possible and run them into the ground.
Excluded – College Savings
We have a 529 plan for each of our children and the primary reason I exclude them from our net worth is that I consider the money to be theirs, not ours. And just as I exclude our vacation savings so that I am not dis-incentivized by a hit to my net worth when I go on vacation and deplete our vacation savings, I also don’t want a hit to my net worth when I send my kids off to college.
And there you have it, friends. The last point I’ll make is that there’s really no right or wrong way to calculate your net worth outside of taking what you own and deducting what you owe. The items that you include/exclude in the “own” and “owe” buckets comes down to personal preference and what you deem to be important. I look at the items that I exclude as unnecessary noise in my overall net worth. I can certainly understand others’ preference to include them, though, and if it makes sense to you, I say go for it!
Fellow FIRE enthusiasts, what’s your take on the items that should be included or excluded when calculating the assets side of your net worth? Anyone have any unique items/investments that you include? If so, how did you arrive at the value that you use in your calc?