How do you define the concept of “net worth”.
There are many different ways one can look at net worth, and what it represents. A conventional way is to look at one’s assets, subtract out liabilities, and then take the difference as being net worth. If you have assets of $300,000, and liabilities of $200,000, your net worth would be $100,000. Simple enough, right?
Well, I’m not sure that there is truly a one size fits all definition of net worth that’s applicable to everyone. For example, we all have different levels of income and different levels of expenses.
With respect to those expenses, they might vary by a whole range of factors. This could include pre-existing debt, size of one’s family, a person’s health, local cost of living, age, and so one. In the case of the $100,000 net worth as calculated above, we can see how that amount might mean something different to one person versus the next. To a healthy single person living in a low-cost of living area, it might go a long way. To a person with 5 kids and health problems, it might not go so far.
This is why I like the concept of months of covered expenses as an alternate way to view net worth.
What do I mean by “months of covered expenses”? Well, it means looking at how many months of expenses you have saved up, with the thought that you will have zero income during that time period as well.
For example, let’s say you have savings of $100,000 and monthly expenses of $4,000. You then have 25 months of expenses that are covered by your savings. Let’s also assume that you have a friend that has $200,000 of savings, and monthly expenses of $10,000. This person then has 20 months of covered expenses. Thus, at that rate, your friend would go broke before you, in lieu of any income or other help.
Of course, we need to be realistic in terms of what makes up these expenses. As I mentioned earlier, this could be different for each person. However, the assumption here is that we would try to cut expenses to what we could feasibly get by with given our individual situation.
Anyway, the net result of looking at it this way is that your “wealth” is measured by how long your money will last you, based on your own needs.
My Question for You
What do you think of this concept of “months of expenses” as a measure of net worth?
Do you use any other ways to measure net worth?
Do you frequently keep tabs on your net worth?