The “Months of Expenses” Method of Defining Net Worth

by TTMK on July 30, 2012 · 4 comments

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?

{ 4 comments… read them below or add one }

Edward Antrobus July 30, 2012 at 7:41 pm

I calculate months of expenses when I’m looking at my savings or cash flow, but that doesn’t take into account debt, aside from debt payments that are included in expenses. My savings are currently at 1 month of expenses, but calculated in the traditional method, my net work is ~ -$30,000.

Another way of looking at it could be the ratio of assets to debts. In my case, it is 1/2.

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Leigh July 31, 2012 at 12:18 am

I have monthly snapshots of my net worth and I’ve recently started tracking years of expenses as well. It’s especially cool to watch the years of expenses go up each month!

Right now, my net worth is about 3.2 years of expenses. I’m hoping that it will be close to 4.0 years by the end of 2012.

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Kathleen @ Frugal Portland July 31, 2012 at 10:45 am

I like this idea and intend to use it, but it doesn’t measure net worth. Though, in my opinion, net worth is a silly measurement anyway, since it counts things like cars that if you sold, you’d have to replace again.

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Edward Antrobus August 1, 2012 at 5:33 pm

That’s a good point and covers my rant about home values. How much is my place worth? Well, since I’m not selling it any time soon, you could consider it to have zero worth for all the impact it has on my cash flow.

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