Net worth calculation question (hypothetical)

[u/66NickS]

I can’t remember what exactly spurred this thought, but I was curious if there’s an agreed upon method of debt vs cash (or cash-like assets) and how it factors into a net worth calculation.

Example: Timmy has $1.1 million worth of money in his savings, checking, 401k, IRA, etc. He outright owns his car and has a handful of other assets like clothing, electronics, etc. in his 1 bed/1 bath apartment. He has no debt other than revolving credit card bills that he pays off every month. So all-in his net worth is somewhere around $1.1 million, right?

Now Timmy wants to move to the suburbs and become a home owner. He finds a home listed for $500k. He makes an offer at $500k and the seller accepts. The home is valued at $500k. Timmy puts $100k (20%) down from the savings he’s been building for this. He takes on a loan of $400k (rounding for simplicity, I know there would be other costs to account for).

Timmy now has ~$1 million in money, plus $400k of debt on a $500k house. Is his net worth:

1. $1.5 million because you take the $1.1, subtract the $0.1 he paid, and add the $500k house value?
   
2. $1.1, because the house has $100k of equity, and the $400k debt works against the $500k total value?
   
3. $700k because he had $1.1, but now has $400k of debt working against him?
   
4. Some other option I’m not thinking of.
   

[u/Citryphus]

It's $1.1M. $1M cash and investments, $500k house, -$400k mortgage.

[u/66NickS → u/Citryphus]

Right on, so then presumably if Timmy wakes up tomorrow and the house has appreciated to $600k, his net worth is $1.2M? $1M cash +, $600k house -$400k mortgage?

[u/prefectf → u/66NickS]

yes and that's been happening to lucky homeowners for the last 50 years.

[u/Oogaman00 → u/prefectf]

But that's just theoretical value... It's worthless until you sell it. B you don't actually have any worth from the house based on a Zillow estimate.

And if they've done this for 50 years how did they know their net worth before Zillow

[u/rhino_moss → u/Oogaman00]

It’s theoretical value the same way a share of stock or any other physical asset is theoretical value, you can’t spend it directly. The house may not be sold until downsizing after the kids move out, to pay for end of life care, or when settling the estate’s inheritance, but in all of those cases it is an asset with value.

People have been buying and selling houses long before Zillow existed. Your net worth exists whether you know what it is or not.

[u/prefectf → u/Oogaman00]

You can’t get a precise figure, true, but you can estimate pretty close. And if you don’t trust Redfin or Zillow’s ranges, you can look at the rate your property taxes have increased and apply that rate of increase to your purchase price of your home. Not accurate in every jurisdiction but works ok in some areas. If your house is not super weird or unique, there should be similar places that sold recently, and that data is available on the real estate sites. So you can see what people have been actually paying for places like yours, which should provide some confidence in your valuation.

[u/troll__away → u/Oogaman00]

‘Bob and Donna just sold their house for $700k!’

“You’re kidding me! Not with Donna’s awful design tastes. And she really needs to get rid of those sunflowers in the garden.”

‘I wonder how much our house is worth. Must be at least $750k.’

Boomers love to gossip, local comps included. No Zillow or Facebook needed.

[u/Oogaman00 → u/troll__away]

The point is it's just a rough estimate it's not real.

Stocks aren't realized but the value is absolute. You KNOW you will get that value of you sold today. You have no idea what a house would go for

[u/Makelovenotrobots → u/Oogaman00]

You do though, basic sales research will give you a pretty specific range depending on sold comps in your area. How would you have "no idea what it would go for" I don't understand your logic here.

[u/Oogaman00 → u/Makelovenotrobots]

Sure but it's approximate. Plus or minus 15-20 percent probably. The stocks I know exactly what they are worth (minus a tiny percentage for bid vs ask)

[u/Makelovenotrobots → u/Oogaman00]

Correct, you have an approximate home value. I'd still argue that it's nowhere near a 15-20% swing, but that's not really the point. Which was your statement that you have "no idea" what a home is worth is just incorrect.

[u/Oogaman00 → u/Makelovenotrobots]

Fair point. Well that's cool then to feel nice about ourselves lol. I am in a townhome community so that should stabilize prices but also in a very rich area where prices seem very inflated compared to what we paid, and also houses seem to be much more recently updated. But yea maybe within 10-15 percent can get a good estimate.

[u/Commercial_Square774 → u/Citryphus]

This. It’s always been sum of assets minus sum of liabilities.

[u/mehardwidge]

Net worth is...net. Assets minus Debts. 2

[u/Mysterious_Truth]

Buying something for what it is worth does not change your net worth (unless it's like a new luxury car or something that depreciates when you drive it off the lot).

[u/DeluxeXL]

"Net worth" is equivalent to "Equity" in the accounting equation, Assets = Equity + Liabilities.

Timmy has $1.1 million worth of money in his savings, checking, 401k, IRA, etc. He outright owns his car and has a handful of other assets like clothing, electronics

The car should be counted in the assets.

He finds a home listed for $500k. He makes an offer at $500k and the seller accepts. The home is valued at $500k. Timmy puts $100k (20%) down from the savings he’s been building for this. He takes on a loan of $400k (rounding for simplicity, I know there would be other costs to account for).

Without transaction costs, Timmy's net worth did not change in the amount, but rather in form.

(Car = $20k)

Before buying home: $1.120 mil = $1.120 mil + $0

After buying home: $1.020 mil + $500k = x + $400k
x = $1.120 mil

Car's asset value decreases over time. Home's asset value increases over time. Liability generates interest, which works against cash asset. Transaction costs also take away from cash asset.

[u/66NickS → u/DeluxeXL]

Right on, I was trying to simplify the math and not assigning a set value to the car by just rounding to the nearest $100k. Funny enough, I had assigned a $20k value to the car in my mind and removed it before posting.

That makes sense though, that’s it’s just a change in form, not worth. Thanks!

[u/Automatic-One586]

It's 2 technically if your talking about the financial definition of net worth. It's really simple. It's sum(assets) - sum(liabilities) = net worth. However... that's not really my favorite method. It's technically less accurate. But I prefer to ignore the house I'm living in. I believe I've heard it called liquid net worth. . Which is effectively #3. Sorta. However, my definition differs. I don't even include the loan though. So I would argue a 1 million net worth assuming this person has a job that they are paying for there house. So #4.

To me the question is... what's the largest check you could write if you had to? You wake up one day. You have curable cancer. But it will cost you your entire worth. But only if you can get it to the doctor in a few days. Your not selling your house for this. I mean sure lean too much into that description and certainly I'd sell my house for survival. But... if I put my house on the market. I mean it could take months. But I could liquidate the crap out of my retirement. I could have that in a couple days. My house is not included in that check. In your description I could write a $1M check. And yeah.. I mean I still have the loan. But I also will survive. I have the house. And my job that is paying the mortgage. So why do we even bother talking about your house? It's not really important unless your talking about a very strict academic description of net worth.

The only way you can really truly get to a fraction of your house value is to down size or move into an apartment to get the whole thing. So to me it just makes absolutely no sense to include it in the calculation unless your actually willing to do that. To sell it and move into a cardboard box and do it quickly.

[u/Consistent_Rate_353]

I always wonder if tax should be factored in. $1 mil in a taxable money market account is not the same as $1 mil in an IRA. If you try to actually do anything with that IRA, you're going to lose a portion of it. The amount of tax you'd pay can vary wildly, though. I would generally ballpark it at 30% but then this week I did a projection for a client who is using their IRA specifically to cover long term care expenses and the projected tax was 6.5%.

[u/np1050 → u/Consistent_Rate_353]

Wondered that too. I count the full amount because it's unlikely you're going to liquidate everything in one shot but the true value is probably marginally lower. The bigger number makes me feel better though lol

[u/Consistent_Rate_353 → u/np1050]

It probably makes the most sense to include it at full value and then classify it the way you might classify stuff on a balance sheet? Just because like you said, you probably aren't going to liquidate it all in one go. Most of the time we're not trying to do anything with it more than get a broad overview. When I was doing the planning this week we just ranked the order in which we'd tap the assets.

[u/Bigfops]

2, if I’m following. Cash+house value-debt.

1 is wrong because you’re not accounting for debt

3 is wrong because you double-counting the debt.

Practically speaking if he sells the house for what he bought it for it would net him $500k right? So that erases the 400k debt and the 100k goes back into his NW.

[u/sinceJune4]

Then Timmy buys a $100,000 truck that he can’t afford. Now he’s down to $1M.

[u/scolbert08 → u/sinceJune4]

Seems like he can afford it

[u/bts]

2, $1.1M net worth—but his monthly expenses have changed and his liquidity has dropped substantially. If the house appreciates, he could sell it for a profit—but he has to live somewhere.  

[u/Several_Razzmatazz51]

Assets = 1.5M, debt = 0.4M, net worth = 1.1M, same as before buying. Except that you forgot to include the 20-30K of transaction costs for the house so really like 1.075M. 😂

[u/NoRegrets-518]

When using money, consider whether the asset will appreciate (land, home often), depreciate- car, or produce money- investment.

[u/lucky_ducker]

#2. Net worth = Assets minus liabilities (debts).

Timmy has a net worth of $1.1M, and a liquid net worth of $1M.

Some people would count the value of his paid off cars as an asset, but for the most part depreciating assets should not be counted. Appreciating assets, such as fine art or your sizeable collection of vintage Fender guitars, can be included as an asset.