Two Numbers

Jonathan Clements

WHAT’S THE STATE of your financial health? Forget your credit score, the past year’s handsome increase in your home’s value or how your salary compares to your brother-in-law’s. In the end, financial fitness comes down to two key numbers.

First, there’s your net worth, which is the value of your assets minus your debts. There’s some debate about what should be included. The easy answer: Don’t delude yourself by counting the value of your car, furniture or Beanie Babies collection.

More contentious: I probably wouldn’t include your primary residence, unless you’re committed to tapping home equity in retirement, either by trading down to a smaller house or taking out a reverse mortgage. Instead, when counting assets, I’d stick with true investments, such as rental properties and money in bank and investment accounts.

Even more contentious: If you aren’t adding in your home’s value, maybe you also shouldn’t subtract any outstanding mortgage debt or, if you do, you should include a mental asterisk. Why the asterisk? If folks go from renter to owner, their net worth would immediately plunge if we ignored their home’s value but took into account mortgage debt—and yet, in all likelihood, their house is worth more than their mortgage. Indeed, eventually, homeowners should end up in much better financial shape than those who continue to rent, because owners lock in their monthly housing costs.

What’s the second key number? How much you add or withdraw from savings each month. There are many folks who see great virtue in carefully tracking how much they spend. I’m not convinced. As I see it, as long as you save enough every month during your working years and don’t spend too much in retirement, it doesn’t much matter whether the dollars you spend are lavished on Jack Daniel’s or Ben & Jerry’s.

In midlife, many families are both adding to savings and have a positive net worth—a pleasant position to be in. Matters are often less comfortable for those who are older and younger. Young adults may be spending less than they earn, but often their net worth is negative, thanks to student loans. Meanwhile, retirees are in the opposite situation, with an impressive net worth, but one that might be slowly shrinking, as they gradually draw down their savings.

Neither situation is necessarily alarming. Young adults have 30 or 40 years of paychecks ahead of them, which they can use to get their debts paid off and turn their net worth from negative to positive. Meanwhile, for retirees, dissaving may be unsustainable in the long run—but, if they are careful, they’ll give out before their nest egg does.

Indeed, you can think of your net worth through life as a broad arc. In your early 20s, it might be negative. But as you pay down debt and add to financial accounts, your net worth should gradually climb, so that you retire with a sum equal to perhaps 12 times your final salary. From there, matters go into reverse, but—fingers crossed—it’ll be a slow reversal.

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