Why Net Worth Is A Poor Measure of Wealth
Author: Nick
Category: Money
Topics: wealth
Ask any person with a modest level of financial education the question “How wealthy am I?” and you should expect the following question in return: “What’s your net worth?” That’s because net worth is the most commonly recognized measure of wealth. And it’s perhaps the easiest the calculate:
Net worth = Sum of all assets – Sum of all liabilities
It seems to work pretty well, too; few would argue that a person with a net worth of $327 million isn’t wealthy, and just about everybody would have a hard time applying the same label to a person with $100,000 in credit card debt and not a penny in the bank. Since the invention of money thousands of years ago, net worth has been seen as an accurate way to determine if a person is rich, poor, or somewhere in between.
How dare I pose such a headline to this article when even the IRS sees fit to use net worth as the measure of wealth? My reasoning for claiming that net worth is a lousy way to determine your wealth is simple: money is only a small part of one’s total wealth picture.
Let that soak in for a minute. Okay, a minute’s up. Time to shock the daylights out of you rich people: having a high net worth does not make you wealthy. Oh, and I have some good news for you low net worth types: having a low net worth does not make you poor.
I’ll give you some examples of what I mean when we play America’s fastest growing wealth-analysis game show…
Let’s learn a bit about today’s first two contestants on Which Person Is Richer?:
Contestant #1 is a single mother working two jobs and going to nursing school part time. She’s ridden with credit card debt, but she’s working hard and has a plan that’s put her on track to be debt free in just a few years. Net worth: -$33,000.
Contestant #2 hails from Ngozi, Burundi, considered by many to be the poorest country in the world. He has no home, no job, and he often doesn’t know when he’ll get his next meal. But at least he’s debt-free! Net worth: 25 cents.
Now it’s time to see how our studio audience voted when we asked them which of our two contestants is the richer person:
Aw, that’s a shame. I guess you can’t be richer than anyone when you don’t have two sticks to rub together. What do we have for today’s winner, Johnny?
Today’s winner will go home with a lifetime supply of rice! Rice–it may be tiny, but it can keep you from starving to death!
Thanks, Johnny. I’m sure our contestant from Burundi could’ve really used that rice, too. Oh well! Let’s meet our next two contestants:
Contestant #1 is a multi-millionaire dictator of a small Central American nation. Most of his family has been killed in assassinations or rebellion attempts. Now he’s fleeing for his life, spending every night in a different Motel 6 to hide from his enemies. Net worth: $85 million.
Contestant #2 is an upper middle class American family man. He’ll be turning 40 next month, he has $100,000 in the bank saved for his kids’ college, and his 401(k) just hit $300,000. He’s in perfect health, and he loves his life! Net worth: $520,000.
Wow, that’s quite a life you’ve been living there, Contestant #1. Let’s hope you make it out of our studio alive! And speaking of studio, we asked our studio audience to decide which of these two contestants is richer, and here’s what they said:
Ouch! Looks like having millions of bucks can’t buy happiness for poor Contestant #1. What do we have for Contestant #2, Johnny?
It’s a free session of plastic surgery! Whether you want to look ten years younger or just hide from the people trying to kill you, this plastic surgery is sure to change the way you “face” the world.
Ha ha ha! Looks like that’s all the time we have today on Which Person Is Richer? Tune in next time when we find out who’s richer: a hunchbacked circus clown or MC Hammer.
Hopefully you get my point by now.
Certainly these are atypical cases, but they are instances where the net worth model of wealth determination completely falls apart. If using net worth to compute richness fails so badly some of the time, it’s reasonable to assume that it might have some shortcomings for the rest of us.
Tomorrow we’ll look at my proposal for a more appropriate assessment of one’s financial status that I like to call the Total Measure of Wealth™.
(Trademarked for when I score a book deal out of this.)
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45 Responses »
1.
HouseWealthy
March 13th, 2007 at 6:33 pm
That is a good assessment of “net worth”. I would also like to see a consideration for meeting all of your financial obligations on a month to month basis and having money left over … or the idea of increasing savings (seems like a novel idea in today’s society). CNN claimed today that more than 50% of Americans live paycheck to paycheck. Some of those people may have $300,000 of equity in their home, but I would not classify them as having a high net worth.
2.
Lazy Man and Money
March 21st, 2007 at 4:55 pm
It seems to me that you are building in a quality of life score into your definition of “wealth.” I’m not saying that’s a bad thing, but just an interesting thing.
3.
Nick
March 21st, 2007 at 6:52 pm
Lazy Man, you’re absolutely right. Folks who hoard their money but live in poverty might be rich on paper, but that richness doesn’t show through in their lives. At the same time, there are people who live comfortable, enjoyable lives but aren’t loaded, yet they rightfully call themselves some of the “richest” people in the world; I like to think of myself as one of them.
4.
Bah
June 16th, 2008 at 12:34 pm
I do not agree with you, because to prove your point your are choosing people from virtually different world, you should try to compare 2 people in same environment to prove your point as well or you should change your heading to Networth is a poor measurement to compare wealth of people in completely diffenrent environment
5.
PB
January 6th, 2009 at 9:53 am
Fuzzy thinking and comparing apples to oranges.
In example #1, what you are really saying is that one has much more opportunity and a better life in the US than in Ngozi. No argument but what if contestant #2 was in US and in the same position as the US citizen but with a net worth of 25 cents, rather than -33,000? I think it’s safe to say #2 would win. Also, don’t underestimate how hard it is to get out of a 33,000 debt–and that’s before any positive real net worth can be realized.
In example two, once again the loser lives in a state of desperation–much like a rich mobster with a contract on his head. What if constant #2 had similar problems for whatever reason? Their net worths hardly matter in the comparison although I would argue that with 85M, I’d get the hell out of there and live comfortably somewhere else with any family I could manage to smuggle out with me. In this respect, 85M is much better than 520K.
You are conflating many different factors to determine quality of life, which cannot easily be measured. You also fail to take into account earning potential. For example, when the Clintons took office, they were carpetbaggers without a home or much (if any net worth) but I hardly felt sorry for them. A former president almost always gets lucrative offers up the yin yang, so the prospect of the Clinton family remaining poor did not seem likely. In such a case, I’d take future income potential over most any current net worth. Granted, it is unique case though.
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July 1st, 2009 at 1:42 am
I should try to compare 2 people in same environment to prove your point as well or you should change your heading to Net worth is a poor measurement to compare wealth of people in completely different environment.
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June 9th, 2010 at 7:24 pm
Pretty smart and out of the box thinking there about why net worth is a poor measure of wealth. It’s definitely thinking about the long-term in terms of how wealthy you can be and also about what type of life you have to lead due to how you gained your wealth.
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January 15th, 2011 at 11:43 pm
I hope this doesn’t sound cliche or silly .. .but one of my favorite sayings is from a Sheryl Crow song “Soak Up The Sun.” It’s not having what you want, it’s wanting what you have. Wealth can mean so many things and that’s what helps the world go round. Great post
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May 29th, 2011 at 11:08 am
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August 10th, 2011 at 11:53 pm
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