The Wealth Game: Your Net Worth. Why is net worth so important?

Why is net worth so important?

Extract from ‘The Wealth Game – An Ordinary Person’s Companion.

By Peter Alcaraz, writer, and creator of The Wealth Game.

 

Your Net Worth.

This is a measurement of your wealth at a point in time. You have a net worth right now, and the sooner you know it, the better. Whether positive or negative, large or small, solid or uncertain, it is your starting point. Every player should know his or her approximate net worth and be no more than an hour away from calculating a reasonably accurate figure.

 

The definition of your net worth is the total value of all your cash and assets, less any debt or other obligations for which you are liable. Other commonly used terms are net assets or balance sheet. They all mean the same.

 

Assets can be split into two categories: real and financial. Real assets are property and other physical assets, and financial assets refer to money in its various forms, securities, and receivables. Debts are obligations to repay loans in all their forms: term loans, mortgages, overdrafts, IOUs, credit, hire purchase, finance leases, and so on. Other liabilities refer to any other sums due.

 

Why is net worth so important?

Net worth is the little porridge pot, the well or font of wealth that delivers the cash we so desperately need to live. When you have no wealth, the only route to survival within your gift is to work for money. State benefits, bequests, or charity are at the discretion of others and, therefore, are outside your control. There will come a point in your life when you are physically or mentally unable to work any longer, and, more often than not, there will come a stage sometime before this when you don’t want to work for money anymore. Your net worth now steps in, allowing you to feed, house, and clothe yourself and your dependents; remain self-sufficient, and be free of financial poverty.

 


 

A new approach to assets

You might think that real and financial assets are self-evident, and on one level, they are. A starting definition of an asset is something that has positive, realizable monetary value. In other words, it can be exchanged or sold for a positive cash sum after selling costs. Such items should be fairly easy to spot.

 

But in the wealth game, what matters is whether your asset is trending up or down in value. All assets, including cash, don’t stay the same value for long. Some inexorably appreciate over time, others waste away to nothing, and some bounce around without any clear sense of direction. Many are consumed and disappear immediately. An asset may have a positive value one day and a negative one the next. It may even become a liability if the costs of keeping and maintaining it outweigh the benefits.

 

From the outset, it’s important to realize that everything tangible we call an “asset” falls into one of three baskets. You should learn and understand the names and characteristics of each, as they all directly affect your wealth, either for good or bad. I have never seen them labelled in this way, but more than thirty years of personal practice bears them out. Every time you see an asset from now on, ask yourself, “Is it this type or that type?”

 

Appreciator

 

This is an asset whose value can be expected to increase over time, despite short-term fluctuations. The time frame we are concerned with is how long we plan to hold the asset. Will its value increase over the period you plan to hold it for? If the answer is yes, it is an appreciator. You need to understand its value and the drivers for it in order to have a reasonable basis for believing this. Some of this is intuitive or common sense, but more important are acquired knowledge and experience.

 

There are two types of appreciators: one that, as well as appreciating in value, produces an income or is capable of doing so is called a productive appreciator, and one that does not is called an unproductive appreciator. Examples of a productive appreciator might be a residential property that can be rented out or company shares that pay a dividend. Unproductive appreciators include precious commodities, such as metals, jewels, art, or antiques.

 

You might ask whether a business is an appreciator. The answer depends on whether it is likely to prosper. If it is run badly and losing money or its products or services are falling out of favour with customers, it is unlikely to appreciate.

 

Appreciators are the basis for building wealth. Your job as a player in the wealth game is to find, acquire, and, if you are able, build them.

 

Depreciator

 

These wasting assets have a value that inexorably declines, possibly to nothing or to a negative value. Their value literally wastes away, perhaps because they wear out or become obsolete.

 

Again, the concept of productivity applies, as even a wasting asset may generate income during its life. A car, boat, caravan, bicycle, television, or computer may be rented out to others for money and become a productive depreciator. If used as a private asset, it is an unproductive depreciator. Cash is a productive depreciator because although inflation erodes its value over time, it can earn interest if deposited with a bank or other borrower.

 

Even though you include depreciators in your personal balance sheet, every penny you spend on them erodes your net worth over time.

 

Consumable

A consumable is literally that—an asset that doesn’t survive long enough to merit inclusion in your balance sheet. It is destined for near-term consumption and has no realistic resale value in the meantime. For example, if I spend two pounds on ice cream and then eat it, for a moment after purchase, I hold an asset possibly equal in value to the money I have spent. Once eaten, I’m down two pounds and up a few ounces in weight. A poor deal was it not for the pleasure hit. All food and drink are consumables, as is fuel in the car. I also include all personal effects, like clothes, shoes, books, CDs, DVDs, toys, leisure and hobby items, and so on.

 

🔴Do not include consumables in your net worth calculation. They have no meaningful value and don’t produce income. 🔴

 

Let’s consider the car as a prime example of a depreciator, a rapidly wasting asset that may become a liability. No income is generated, so its financial value is the open-market resale price. This reduces each year, as the car depreciates until it has only scrap value. At the same time, the license, insurance, and MOT fees rise each year in line with inflation, and maintenance costs grow exponentially as the vehicle gradually wears out. In simple terms, at the point when the annual running costs exceed the resale value, the vehicle has a negative net worth and becomes a liability in your personal balance sheet.

 

It is no more than a solution to your land transport needs. It may outlive you or not, but, either way, it has a temporary lifespan. If you buy it outright, you are making a payment in advance against these needs, and if you rent it, you are paying as you go. Either way, it is money you won’t get back.

 

 

The first proper car I bought was a red Alfa Romeo. It sat gleaming in a small mews off Lancaster Gate in West London. Up until then, my cars had been bangers—bought cheap, often shared with friends, and driven hard until they died or were towed away and left in the pound. The Alfa brought a smile to my face every time I saw it, and accelerating through fourth gear at about seventy miles per hour, she pinned us back in our seats and made us laugh for joy. In the second year, insurance rates doubled, and the garage at the mews took her back for half the original cost. After interest and a few meagre repayments, the purchase loan hadn’t changed much. I repaid the shortfall out of savings.

 

Does anyone view a car as a financial investment?

I hope not unless he or she is a collector of rare marques with a large garage. For the rest of us, cars are there to satisfy our needs. In the case of the Alfa, my only need was the desire to drive fast and look good. I lived in London, so I had no practical need for a car. A blast to the south coast and the beloved Isle of Wight was bonus territory. Before that, I’d happily caught the train. Beyond pure hedonism, our needs include transport to work, getting to the shops, doing the school run, and escaping from it all without encountering the general public. We tick our preferences against a long list: acceleration from zero to sixty, top speed, brake horsepower, torque, miles per gallon/litre, emissions, safety record, boot space, number of seats, optional extras, service costs, tax bracket, and so on. Depreciation may be on some people’s lists but is unlikely to top many.

 

But who considers a car to be an asset? I suspect rather a lot of people, judging by the number of new and expensive cars being sold or leased each year, recession or not. As well as the sheer pleasure factor, cars represent an outward sign of success, status, and style. People might live in dismal homes or have hopelessly indebted statuses, but many see cars as pure life enhancers, potent drugs worth almost any price if they can muster the means to pay for them.

 

Aside from food and drink, clothes are a popular consumable. Their basic utility is in covering our nakedness and shielding us from the elements. Beyond that, clothes are used to enhance our physical appearance, to signify membership of one group or another, and to make a personal statement. You should consider this carefully and understand it. Imagine a world in which everyone wears a versatile and adjustable garment of the same style and broad type of natural fabric, depending on what’s readily available—a thick, heavy one for cold climates and a thin, lighter one to wear in the heat. Dyes could be used to add any colour or shade desired. Production requirements would be standardized, with no need for designers, and without brands, retail would simply be a case of purchase and delivery.

 

Life would be simpler for everyone, and much time would be saved—no creating wardrobes or planning outfits. Just buy a standard garment, wear it until it falls apart, and buy another one.

 

In our global consumer society, the range and volume of depreciators and consumables dwarf appreciators. They are everywhere and overwhelm us. Your only escape is to cut off or heavily restrict Internet and media sources and stay away from shops, which is hard to do while you are engaged with the world of working for money. All you can really do is to develop a constant and deep awareness. In the cold light of day, when the packaging and the embossed shopping bags have been thrown away, the credit cards have been paid off, and the sun has gone in, our assets are more often than not exposed as valueless clutter, like sediment at the bottom of an empty wine bottle.

 


 

I now want to deal with another important matter. This simple three-way categorization of assets is based purely on their financial characteristics, but how do we account (if we can at all) for the non-financial benefits they can provide? The pleasure, pride, excitement, thrills, and so on.

 

The answer is quite simple. In the wealth game, only the financial consequences of a decision matter. Nothing else. It is a trap to place the financial and non-financial effects of a decision on the same footing. By doing so, you encounter the double risk of first not being dispassionate in your financial assessment (it’s very easy to tweak the assumptions), and second, when comparing the two, placing equal or greater weight on nonfinancial benefits that are large, colourful, and immediate. Objective financial analysis is overshadowed, and muddled thinking follows. And this applies not just to important life-changing decisions but also to small, everyday ones that you make without discussion or even conscious thought.

 

It is vital to develop a mindset that measures every decision against its impact on your net worth, now and in the future. Once you’ve done that, pause and reflect. In the financial industry, this is called “cooling off.” Then, weigh the nonfinancial benefits of your proposed decision, and decide whether they are an adequate reward for any negative impact the decision has on your net worth. They may be, or they may not be, but that’s for you to decide. This may be new territory. You enter a zone where, despite being able to afford something with ease, you choose not to buy it because there is a bigger game afoot.

 

There is clearly much more to be learned about assets, but if you get no further than grasping the contents of this chapter, you will benefit. Consider the game Snakes and Ladders. Depreciators and consumables are like snakes, which send you backwards, and appreciators are the ladders that propel you ahead.

 

The debt-and-liabilities side of the net worth calculation is instinctively easier to comprehend, as it tends to be solid and unavoidable. All I would say at this stage is that debt is one of the most powerful sources of wealth creation and destruction in existence, and as such, it deserves to be studied, understood, and respected. I devote a section to it later.

 

How do you plan to achieve financial freedom? Share your thoughts with us 😀

 


 

The Swiss Association supporting professionals to join, navigate & succeed in the blue ocean that is Family Office and Private Wealth solutions.

➡️ Join the Private Wealth & Family Office (PWFO) Association Community here  

➡️ Or on socials:

 

The Swiss Association supporting professionals joining and navigating the blue ocean that is Private Wealth & Family Office services. 

Story


FAQs

Meet the team

Members Directory

Advice & Inspiration


PWFO Updates

Blogs