Sometimes I wake up with a song in my head. Sometimes it’s from a time and place I can’t actually remember, so that officially means it came from the 60’s, I guess. You know, if you can remember them then you weren’t really there kind of thing. Well truthfully, I do remember them and I was there, but that’s a whole different post, isn’t it? So, here I am with this song in my head today.
It’s called “It’s a Question of Temperature” and it was a modest hit back in 1967 by a band from right here in NJ called The Balloon Farm.
Never heard of them or it, you say? It’s sort of a pseudo psychedelic pop song that was the trend back then a la the monster #1 Billboard hit “Incense and Peppermints” which you probably have heard a few thousand times over the years.
Right about now you may now be asking yourself this: What does this song have to do with personal finances? The answer is pretty obvious: It doesn’t. But, temperature and specifically “taking your financial temperature” does. And that is today’s post, taking your personal financial temperature.
What Does Taking the Temperature of Something Actually Mean?
When you hear that phrase or idiom being said like “they took the temperature in the room about his plan”, it literally means they surveyed the opinions on it and came up with a census, a tangible summation of the feelings and results. Taking the temperature is seeing how it’s flying, so to speak. So, taking the temperature of your personal finances has to do with “seeing how they’re flying”. Idioms are always interesting and amusing, aren’t they, because of their symbolic meaning.
Quantifying Your Value?
A person’s value is not measured in dollars and cents. Of course we can’t measure the value of a human being and especially here in a civilized world where we place virtually no limits on the value of a human life. That’s why we will spend hundreds of thousands of dollars on a search and rescue mission for a single soul lost in the mountains, in the forest, the desert, or at sea. Millions might be spent to recover a single astronaut stranded in space. No, we can’t quantify the value of a person because it’s infinite. But, we can quantify net worth, and that’s a biggie.
The Temperature of Your Net Worth
An individual’s net worth is quantifiable simply because it measures the tangible. By tangible I mean personal property, cash, works of art, antiques, jewelry, collectibles, stocks, bonds, rare books, automobiles, the cash value of whole life insurance policies, 401(k)s, IRAs, and other things that can be assigned a definitive monetary value. These tangible things are defined as a person’s assets.
On the flip side, we have liabilities. These might include mortgages, auto loans, credit cards, installment loans, student loans, and tax liabilities to name just a few. Basically, liabilities represent a person’s debt and other monetary obligations.
Because a person’s assets and obligations are dynamic, any calculation of your net worth is a snapshot in time. Net worth is always in flux, changing week to week, month to month, and year to year. Keep this point in mind.
It’s All About the Arithmetic
Calculating your net worth figure is simple arithmetic. It’s just a matter of totaling your assets and subtracting your liabilities. However, the devil, as they say, is in the details.
For example, number one on your list of assets may be your home. What value will you place on it? Purchase price? Your best estimate of its current value? The “Zillow Zestimate”? Or will you obtain an actual appraisal? The answer depends on your reason for preparing a statement of net worth.
If you will be presenting this document to a lender, you will need to get a documented appraisal of your home’s value. If you are doing the exercise to simply satisfy your own curiosity, you can get by with a reasonable estimate based on your own best judgement, realistically of course.
Your home’s purchase price is irrelevant. You may have overpaid or you may have gotten an incredible deal. What really matters is what it is worth when you snap that picture.
The same holds true with your other non-cash assets. For your statement of net worth and its temperature to be accurate and meaningful to your future goals, it must fairly represent the current market value of those items identified as assets. Some assets are easier to calculate like any stock you have, just look up the ticker. Other items may require more research.
Don’t Forget About Those Liabilities
The dreaded liabilities are staring right at you. The guidelines are the same when calculating and determining liabilities. For loans, you may want to get pay-off figures. Not all loans are simple interest loans and the pay-offs on these may be significantly below your balance. Credit card balances can be determined from your most recent statement. You get the drift. It’s a pretty simple formula that brings all of this into focus:
Assets – Liabilities = Net Worth
So What Does It All Mean?
If you are young and just starting out in life, it doesn’t mean much. Chances are high that your net worth will be very low or, more probably, a negative.
That’s because you usually don’t own any real hard assets and you might even start out in life with some real debt, big debt. Do “student loans” ring any bells? Hopefully, your debts do not include big car debts or credit card debts, but they often do just that. It means you are beginning the climb to financial security and independence in a pretty big hole!
Then again, you may be further along the road of life. Has your net worth been on a steady climb? If so, that’s great news. If not, it may be time to take a serious look at how you handle your finances. Do you need to boost your earnings? Or reduce your spending? Or maybe both?
In my view, the real value of doing this net worth exercise periodically is that it forces you to take your financial temperature and examine all aspects of your financial life. You can compare how your net worth number has changed over time, and whether your progress has been forward or backward. It puts your financial situation in perspective, highlighting your mistakes and providing guideposts for improvement. In the end, it is just a number. The real value lies in using that number to establish realistic goals and adjust spending, savings, and investment habits.
Net Worth Is Your Financial Temperature
Net worth is your financial temperature at a single point in time. Use it to sharpen your focus on developing your goals which will allow you to achieve the net worth you envision for yourself in the future.
For some people, understanding and calculating their net worth is important and even borders on an obsession. For others, it’s something they almost never think about. The happy medium is that you should know and keep on top of the numbers so that you can plan and adjust your goals as you travel along the road to retirement and financial security. But, above all, recognize that net worth is no measure of your value as a human being!
Have you calculated your net worth? Did it help you clarify your goals and the way you handle your finances?