Is Net Worth Really The Best Measure Of Wealth?

Everybody uses it.  Some of us are obsessed with it.  Some even choose to report on it monthly in their blogs.   So, is net worth the best measure of worth?  In a word, no.

High Net Worth Does Not Equal Financial Independence

For starters, net worth includes everything from retirement accounts, home equity, and cash in the bank right down to the value of your furniture and kitchen appliances.  While the value of your retirement accounts and to a lesser extent your home equity certainly contribute to your financial security and maybe even independence some day, your DVD collection and leather couch don’t.  As Nickel said, my idea of financial independence doesn’t include having to sell my furniture to pay the mortgage.  For this reason alone, I don’t think net worth is a very good measure of wealth at all. 

Net Investable Assets Doesn’t Cut It, Either

A better measure is Net Investable Assets, which excludes personal property and the value of your primary residence (since you have to live somewhere).  This is a vast improvement over net worth because it includes only assets that can be deployed to generate a cash flow.  Owning a $1 million house is great, but if that’s all you own, you aren’t really all that well-off because that house doesn’t generate any cash flow.  If you lost your job, you would lose your house soon thereafter.  Conversely, a renter with $1 million invested in income-producing securities is relatively well-off.  If he loses his job, his investments will provide him enough income to get by until he finds another job.  He won’t have to sell everything he owns merely to put food on the table.  So why isn’t net investable assets the best measure of wealth?  Because assets can be invested many different ways, and not al of them produce substantial cash flow.  Perhaps you own a profitable business but have to reinvest all your earnings to sustain growth.  The value of your business and the cash it generates counts in your net investable assets calculation, but you can’t take that cash out of the business to live on without harming the business and impairing future earning potential.  This is an example of a large asset with little current cash flow.  Of course, one day you may either sell your business or decide it’s grown large enough, at which point you may choose to stop reinvesting your earnings, turning it into an income-producing asset.  Small growth stocks are another example of a non-income-producing asset.  Usually they pay little in the way of cash dividends, but the value of your shares can multiply relatively quickly over the years.  At some point, however, you’ll have to liquidate your shares to generate cash to live on.

Cash Flow Is King

Cash flow is the only true measure of wealth.  It’s not how large your wad of cash is that matters, but rather the amount of income it produces.  Since different types of investments produce different levels of income, the absolute value of the assets themselves is somewhat meaningless.  This blog, for instance, generates a relatively large amount of income relative to its value if I were to sell it.  Conversely, the stock market right now yields only about 2%, or many times less than this blog.  Real estate is somewhere in between those two extremes.  But if you can generate enough money to live on via a blog or side business of some sort, what does it matter what that business is worth in a sale?  True, most business owners will one day sell their business and invest the proceeds, but that doesn’t really tell you how financially well off you are today.  Net investable assets is a fun tool you can use to compare how you’re doing relative to other people, but at the end of the day it’s your cash flow that matters.