My Personal Finance Journey

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Conservative Net Worth Accounting

Contributed by mm | August 12, 2004 8:46 AM PST

Oftentimes we use net worth to measure one's financial success, but actually different people define net worth differently. If you ask two accountants to calculate net worth on the same thing, you may get different results. I am a true believer of the importance of sensible net worth acconting. After all, without the right yardstick, you really don't know how far the destination is.

If you read PFBlog long enough, you know I deploy a set of conservative personal accounting rules, and have a system to calculate my net worth regularly. Some of my tips:

Tip 1: Only include those items which you will sell them for cash some day, and keep good track of their true value.

Without much saying, your cash, checking accounts, saving accounts and investment accounts are your assets. And you can get an accurate fair market value almost anytime.

Is your home your asset? Yes. Even if you want to live in your nice comfy house for the rest of your life, you can still extract cash via home equity loans or reverse mortgage. Be careful when you report the value of your house. To be conservative, I only report a value of less than $320k for my house while the same house was sold for $350k+ recently.

How about your car? Yes, but also the proper valuation is the key. I put a depreciation entry to my personal finance software for the cars and calibrate the accounting value and the market value regularly. The accounting value for my cars are regularly 10-15% below the market value provided by Edmunds.com.

And your furnitures and electronics? Most of the time you will not sell your furniture, and a yard sale may only land you 1/10 of your purchase price, so you'd better not to keep them in your accounting book.

Actually, my house and two cars are the only non-liquid assets in my net worth calculation.

Rule 2: Make Proper Accrual for Your Liabilities

Credit card balance, mortgage and home equity loans and auto loans are certainly your liability, but your liability can be more than that. For example, if your mortgage is not associated with an escrow account, you should still accrue your property tax and insurance. having to pay property tax on May 1 does not mean it only becomes a liability on that day.

Another example is tax. If you sell a stock in your after-tax account for a profit, you are subject to capital gain tax. Your broker may not withhold the tax, but it is your liability anyway, and you should not wait until the tax deadline of April 15 to recognize it.

I also regularly accrue a monthly amount for the maintenance of my house and cars, because we know at one point of time they will need some facelift or heart surgery.

Rule 3: Calculate Liquidation Value Too

If you need to liquidate everything in the next 30 days, will you get the amount in your accounting book? This is where I find setting up another metric of liquidation value will help. Transaction costs come to play when you need to sell your house (realtor commissions and taxes), your car (mark-down by dealer) and even your 401(k) account (government will assess tax on the withdrawal). Take a look of my formula for liquidation value calculation.

The same CNN Money article I quoted for net worth stackup, is also a good reading for reasonable net worth accounting.

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