John is worth £1 000 000 and Mary is worth just £800 000. So, John is in a much better situation as he has £200 000 more than Mary. However, everybody knows from CIA action movies that ‘things aren’t always as they seem’…
A financial advisor will always use same magic formula, saying: “Your first task is to determine your bottom line or net worth”. But what exactly does this mean? Is net worth really that important for everybody? There are many people who don’t even know that net worth exists. They live their lives happily, with no concern for it. Why should we be concerned?
Your net worth is the difference between what you own and what you owe. More precisely, it is the result of a subtraction. On the one side is everything you have. On the other side is everything you have to pay back. The result of this subtraction is your net worth.
Let’s make it easier to understand using an example:
John has a mansion worth £2.5 million, and £100 000 in his bank account. He also has a mortgage of £1.6 million. So, his assets are £2.6 million, and debts £1.6 million. If he can sell his mansion for £2.5 million and pay the mortgage, he will have £900 000 left over. This sum of money together with his £100 00 bank account will be £1 million. This is John’s net worth.
Everybody can see that John’s £1 million is more than Mary’s £800 000.
However, the Slavic nations (Poland, Russia, Ukraine) have a proverb: “The deeper into the forest you go, the more trees you see”. This means that if you dig deeper into an issue, you will see more things; more myths, lies, and stereotypes. Then, because your perspective grows wider, you can understand the issue in better depth. So let’s take a few more steps towards a better understanding of net worth…
Net worth has many similarities with time.
How does it sound and look if we know that John’s net worth is developing like this:
5 years ago £8.5 million
4 years ago £6.3 million
3 years ago £4.4 million
2 years ago £2.6 million
this year £1 million
And Mary’s net worth is developing in this manner:
5 years ago £180 000
4 years ago £270 000
3 years ago £420 000
2 years ago £615 000
this year £800 000
You don’t need to be a highly-qualified financial advisor to see a simple difference! John’s net worth is continuously going down, while Mary’s is growing all the time. At this point, most people would agree that it’s better to be Mary than John. Furthermore, that there must be something wrong with John’s finances, while Mary’s situation gets better year after year.
A few more trees – ‘passive’ and ‘active’ net worth
As we know, some people like to complicate things. So do I, as a financial advisor. In my opinion, net worth can be divided into two categories: passive and active.
What is the difference? John’s net worth is the sum of £100 000 in his bank account and the remaining value of his mansion after the sale. As we have already discussed, £900 000 + £100 000 makes £ 1 million.
Now let’s look at Mary’s situation:
5 years ago £180 000 ( bought a flat and paid cash)
4 years ago £270 000 (£180 000 flat + £90 000 in her bank account)
3 years ago £420 000 (£180 000 flat + £240 000 in her bank account)
2 years ago £615 000 (£180 000 flat + £435 000 in her bank account)
this year £800 000 (£180 000 flat + £620 000 in her bank account)
John’s net worth is £1 million, and Mary’s net worth is ‘only’ £800 000.
However, John has £100 000 in cash and Mary has £620 000 in cash.
Who would you like to be? John or Mary?
Some may consider it naive, but I would prefer to have Mary’s situation, even if she has £200, 000 less than John in terms of net worth.
And this is the difference between passive and active net worth. In simple words, we can express it like this: The difference between passive and active net worth is the rule of cash in total net worth.
If real estate has a greater portion of the total than cash, we have passive net worth.
If cash has a greater portion of the total than real estate, we have active net worth.
Sometimes we hear that a company has some financial problems because they invested too much. They ‘over-invested’. Your personal life is absolutely the same. Terry has a flat worth £830 000 and £15 000 in the bank. Khalil has a flat worth £445 000 and £400 000 in the bank. Both total net worths are equal, but Terry’s is passive and Khalil’s is active.
And now the net worth mystery.
I used the pound sign in this article, but you could substitute it for any other currency. It could be American Dollars (USD, $), the Thai Baht (THB, ฿), Japanese Yen (JPY, ¥), or the Israeli Shekel (ILS, ₪). This will only mean the amount has more or less value in the list of world currencies. The main issue of net worth stays the same.
So to finish, I would like to quote ‘Mirabeau Bridge’, by Guillaume Apollinaire:
“Let night fall, let the hours go by
The days pass on and here stand I”
I, your Net Worth.
Dr Andrzej Fesnak, EFC (European Financial Consultant)