The Importance of Understanding Family Net Worth

A family statement of net worth (balance sheet) is a powerful financial tool. A statement is easy to compute, updated quickly and offers a great way to evaluate decisions.

How to Create a Statement

First, to build your family’s statement, start by listing the honest resale value of all things you own. List all houses, cars, boats, household goods, collectibles, and anything else of value (probably higher than you think, but lower than you’d like). Next, add financial assets. Include bank, brokerage or mutual fund accounts.  Include IRA accounts or retirement plans from work. Include the cash surrender value of insurance policies. In short, this list should include everything you own with the current value. (For more, see: Assets That Increase Your Net Worth.)

The second half is, hopefully, a much shorter list. Here, list everything you owe with today’s payoff value. Start with the mortgage. Then, add any car, student or consumer loans. List the balances on credit cards or money you owe family members. Don’t forget loans on insurance policies or money owed to a company retirement plan.

Simply, family net worth (FNW) is the difference between what you own and what you owe. It’s the liquidation value of your financial life. If you sold and liquidated everything you own and paid off all debts, what would be left in your wallet?

Knowing this number helps you financially. It’s a running tally of financial progress. Update the numbers occasionally and see if your FNW is rising or falling. A rising number indicates progress - one that slips requires attention. Of course, there are life stages where FNW is expected to fall - college years for children is one.

It’s also a spectacular decision-making tool. Say you’re trying to decide whether to replace a car or start a mutual fund account. Consider what will happen to your FNW five years from now. Estimate the future worth of the car and the mutual fund five years from now. Does this help decide? Similar processes can help decide between two cars (which will have better resale value?) and houses (ditto).

The eBay Test

I suggest to clients that they employ what I call the eBay test before reaching significant buying decisions. Simply, go to eBay and look for the item you are considering. Most consumer items can be entered in the search bar and an entire list will pop up. Use the exact item number from the manufacturer and you’ll likely find new, used and refurbished versions. For this purpose, we’re interested in the value of the used item.

Why? Because once you buy, the used value is what goes on the asset side of your FNW. What happens to your FNW when you take out $500 from the bank to buy a new camera? You took $500 of cash and swapped it for $200 of used camera. Nothing wrong with that, but your FNW would stay higher if you’d purchased the camera used from eBay. A refurbished item falls somewhere in between and often features a warranty just like new - the best of both worlds?

The eBay test helped you reach an informed decision. Family net worth was a helpful measurement tool.

Not every family decision is reached based on finance. But finance should be considered as part of any major decision. Understanding FNW helps all of us make better choices. (For more from this author, see: Budgeting? Go Ahead and Drink That Latte.)