Wednesday, 08 April 2020 / Published in Architect Blueprint, General

WHERE IS MY MONEY? WHAT NOW? WHAT NEXT?

How much do you think your net worth has fallen as a direct result of CoVid?

It seems a simple enough question.

I hear of many people seeing the lower value in the equity mutual fund portfolio statements, comparing it to the highest they have seen it to be in the recent past, and concluding that their net worth has fallen by 25-50%. And feeling sad. Or angry. Or confused. And then asking experts if they should withdraw all their money from mutual funds.

Calculating and keeping tabs on your net worth is a worthwhile exercise. But only when you do it correctly. We need to do the calculation correctly. And we should ensure it’s rising on perhaps a yearly basis. Measuring it on a daily basis is impossible and injurious to your mental health.

Calculating net worth – what to include and exclude

The simplest way to calculate net worth is to make a list of all your assets and then subtract all your liabilities.

The list of assets includes own home, own business, investment properties, investment portfolio, cash and fixed deposits in various bank accounts, gold and jewelry, and value of pension accounts. The liabilities include home loans against any properties, business and personal loans, outstanding balances of credit cards, and any margin loans against the investment portfolio.

The things I tend to leave out are cars and the loans against them and insurance policies. Why? I believe it’s simpler to define asset as something that provides, or will provide in the future, an income stream. So unless you’re using your car as a business, which of course Uber drivers around the world do, I think it’s simpler to leave it out.

I also believe it’s better if people see the premiums for term plan life insurance policies as a necessary annual necessary expense, just like their necessary living expenses of food, rent, utilities, health insurance etc. This way, they are less likely to buy insurance policies such as traditional/endowment policies that promise some money back. ULIPs (unit-linked insurance policies) should be included in the investment portfolio. Yes, the life insurance will pay out a lump sum to your dependents if you die prematurely, but that’s not your net worth…it will help your family replace your lost income.

Valuing the assets – not as simple

After you’ve made the list of assets and liabilities, you need to estimate the value of each item. Yes, it can be a guesstimate. But even that’s hard.

The reason your financial adviser, or an aggregation/reporting portal, can provide you the value of your portfolio is because financial products like mutual funds calculate a daily unit price, also called Net Asset Value or NAV, based on the value of the underlying securities being stocks and bonds. They take the market price of the stocks, that is, the last transaction price that the stock was traded at. This is easier for large stocks, which have good volumes, but is trickier for smaller stocks, which do not.

In the case of bonds, the calculation is even trickier as the markets for those tends to be ‘over the counter’ i.e. between two parties, rather than on a listed exchange where everywhere can see all the bids and offers.

Let’s turn to the biggest assets that most of us own – our homes. I know I like to believe that my home is worth at least as much as I paid for it. Maybe even include the cost of renovations. But that’s wishful thinking – that is not reality.

Real estate is an asset class with sectors such as commercial (office), retail, industrial, hospitality etc. Residential real estate is just another sector within the real estate asset class. An asset class (of investment opportunities) has investors. So investors value residential real estate, just like they value any other type of real estate or investment. They use valuation techniques that basically estimate long-term rental potential and apply a ‘discount rate’, which in turn is based on the prevailing interest rates. Just because you are not paying rent to yourself doesn’t mean they can’t estimate it.

For people who own businesses, the valuation depends on whether it’s in a limited liability structure, (like a private limited company, limited liability partnership), or a proprietorship/partnership. If former, you would have financial statements. If latter, the business finances are mixed up with your personal finances.

If you want to include an estimate of your gold jewelry, you need to divide them into two piles – the pieces you bought yourself and have receipts for, and the pieces you received as gifts and don’t have receipts for. For the latter, you could estimate based on net weight (after subtracting the weight of stones) and whether it’s 14, 18 or 22 carats.

I could go on about valuing assets….but hopefully, you get the idea. It’s hard to calculate your net worth in a few seconds or minutes if you haven’t given it serious thought earlier.

So should you panic?

Of course not. Yes, you could use the lockdown time to give it some thought now.

I believe it’s always better if you can do any thinking in a coherent framework. However, tracking net worth as a number by itself is not really healthy as it’s likely to encourage comparison with family and friends, and maybe result in other negative feelings that you could do without.

My suggestion is to see your net worth in the context of your goals. The following table summarises this approach.

Mental buckets	Goals	Net Worth (Assets minus Liabilities)
Needs (Now)	Certainty to meet basic lifestyle Health (including health insurance) Basic living expenses (including food, rent, utilities, transport, education, insurance)	Essentials Foundation Income to cover basic living Emergency cash to cover 6-12mths of basic living (savings/FDs) Own home (for some people) Family/friends support (which you may have to repay some day)
Needs (Later)	High probability of meeting goals Children’s education Children’s weddings Retirement	Growth Pillars (when goals are 7+ yrs away) Equity portfolio (perhaps using core/satellite approach) Freedom Slab (when goals are 2-7 yrs away) Income portfolio (govt bonds, investment grade corporate debt, real estate rental yield, infrastructure etc)
Wants	Current lifestyle living (if better than basic) Vacations	Growth Pillars Reinvesting in own skill sets
Desires	Possibility of moving up in life Getting happier through getting closer to potential Getting rich through – Becoming famous through some talent Selling business for a great valuation	Fun Roof Speculative investment property Own business ESOPs Trading account Philanthropy/legacy intiatives