By Dhruv Arora
What is the true measure of your wealth on any day? Is it the amount in bank? Is it the amount of property you have or is it all the money that you have invested? Or is it all these assets combined? Networth is the sum of your assets minus any outstanding loans. It is called networth as it signifies the value of your net financial position. Examples of assets that an individual would include are bank savings, FDs, stocks, mutual funds, property, bonds etc. Loans would include all outstanding borrowings like home loan, personal loan, education loan, car loan etc.
Some consider it as a measure of an individual’s wealth today. But we believe it is incomplete. While it correctly captures all the tangible measures of existing financial position; however, it doesn’t depict the true value of an individual’s wealth. It doesn’t capture the intangible assets of an individual that will eventually be converted into financial wealth in the future. Intangible assets like education, skill set, future income growth are not included even though they will have a significant impact on a individuals’ future wealth generation.
Networth doesn’t give an accurate picture of your complete wealth. Here is an example to explain this. Consider a person who has just completed his MBA and started his career. He joins a good firm at a salary of Rs 10 Lakh. He has no savings as on today but has an education loan of Rs 10 Lakh. So, his Networth is (0 (assets) – Rs 10 Lakh (loan) = Rs -10 lakh networth)
In this case, you can observe that a young man with a bright future has negative networth. Hence, networth being a measure of tangible assets cannot determine the true value of the individual’s ‘wealthiness’. It’s obvious that he will ignore any kind of financial planning for future if he keeps looking at his networth. And looking at his existing wealth of Rs -10 lakh will surely make wrong decisions as it doesn’t cover all the important aspect. For instant, a professional, in his early career stage will see the small or negative networth and say that he will plan later when he will have money, such a behavior delays the activity of saving and investing and at the end he tend to lose on the compounding effect for the next 10 years.
Networth doesn’t cover the income that he will earn and save in future.
His income is going to increase and it will also add to his total wealth in the future. Future income is a necessary aspect of your true total wealth as on today. The farther one is from the retirement, the higher is the value of future income. His true total wealth as on today will include today’s value of his income from today till retirement and that is a huge amount. The today’s value of future income is not the sum of expected future income. It is less than that, as a rupee tomorrow is worth less than a rupee today.
Thus, at any point in time, true total wealth is the sum of existing assets and today’s value of future income.
Looking at networth it is almost impossible to visualise your financial future, what you have today would not help in planning for your future. What all can you do with your money can only be analysed once you include your future income into your current assets. Only then, you get a holistic picture of your current wealth and enables you to find answers to important questions like the following:
What value of property can you buy?
This is the question that requires a careful analysis of ones’ true financial capacity. Many a time, we come across households who hurried into a property purchase decision only to realise later that all other plans need to be put on hold. That creates unnecessary financial fatigue. Similarly, there are other questions that we keep contemplating but never seem to find a convincing and coherent answer if we look only at the current networth.
For example, How much can you spend on improving your lifestyle? Will kid’s college education affect other expenses? If yes, to what extent? What about after retirement expenses? True total wealth provides a ready value for evaluating many financial decisions and trade-offs. True total wealth helps you answering many questions related to future spending. It is the limit of all your expenses. Once you know it, you can easily figure out how can you allocate this wealth over your lifetime on various expense areas like property, responsibilities towards kids and parents, lifestyle, household essentials, charity etc.
“True total wealth is the money that you will spend in your life. It is like your lifetime spending budget. If you don’t know, you should.”
(The Author is Co-founder of www.finpin.in)