I was recently trying to decide on a goal of how much I want to be worth. Did I want to be worth a million? Ten million?… more?
Don’t chase after net-worth
I kept thinking about it and I couldn’t ever really make a decision. I guess the problem is that I keep asking “why stop there?”
It’s like a rhetorical question I was asked lately: “What defines famous?”
There’s really no answer because you can never put an actual number to quantify fame and say “now you’re famous.”
So these people who chase fame are never really satisfied with their life, because they are chasing something that has no solution.
Yes, I want to be wealthy. But no number can really define “wealthy” vs “not wealthy” since it’s a relative statement.
The girl that grows up with ponies always thinks she is poor because her friends all have horse ranches. The boy that grows up taking first-class instead of a personal jet thinks he is poor.
The American earning $30k/year is amazingly rich to the family earning $2/day on some continents.
Don’t Chase Net-Worth
After thinking for a bit, I settled on asking myself how much passive income I want to achieve to live my goals. Of course, I’ll never stop growing my revenue streams, but I can be satisfied once I reach my goals.
I won’t spend a lifetime chasing something with no meaning.
Instead, I like to look at net-worth differently – I look at it as a tool to work backward into my goals.
Why Net-worth is a terrible goal
Let’s look at it from a different perspective. Let’s say your goal is to reach a million dollars in investments.
Let’s say they are earning a solid 8%. Great work! You are earning an impressive $80,000 a year without working. So, you build a lifestyle around that income.
Bet then inflation ticks up or returns drop and suddenly you find yourself taking home 6%, or $60,000. You are now $20,000 short of your goal. Clearly, you’d need to get some more cash stashed away in order to bump up that income.
In real estate, net-worth is even more meaningless
Imagine that you have a number of rental properties and they are paying you $80k per year after all expenses. Just for argument’s sake, let’s say your equity in these properties is also a million dollars.
Then something happens – something happens and property values drop 20%. Suddenly you’re worth $800k. This actually happens more often than you think.
But, what’s different? Your rent still comes in and you are still earning $80k.
Or perhaps property values go up 50% in a few years. Now you’re worth $1.5 mil!
Your rent still comes in and you’re earning around $80k.
Of course, I’m simplifying this. I know rents vary over time, but I’m getting my point across – Rent income is not directly tied to the equity you have in the property.
Net-Worth is better as a tool to measure goals
Going back to the first example:
At 6%, how much do I need to save to reach that $80k? Simple math shows us $1.33 million.
See how quick we are to change our goals for net-worth and focus on that yearly income?
Parsing the sentence you can see that $80k/year was actually the goal. $1.33 million is just an estimate of what you need in order to achieve the goal.
And in example 2 – net-worth may be completely detached from yearly income.
Focus on Your Passive Income and less on Net Worth
Now I’m not saying net-worth is completely meaningless. It does measure your value at a specific point in time. Of course, we all want to know what we are worth.
You also don’t want to have a negative value. If something tragic happened, you need to be able to liquidate some assets to get money to cover the costs.
And you can’t forget to include taxes on your capital gains. People don’t realize that a massive chunk of wealth will disappear as soon as everything is sold.
This is why I focus on that cash-flow. My yearly take-home income generated by my assets.