Posted by Robert on October 1, 2012
This is a guest post by Robert, who lives in Calgary and worked as a financial adviser before retiring at age 35. He is married, has three kids and has returned to school with the goal of eventually living and working overseas.
On a regular basis, Tim publishes his net worth here, showing the changes over time and giving an explanation for what caused the changes. While I don’t publish my net worth, I calculate it each quarter (four times per year). I see a number of benefits to keeping in mind the factors that cause changes to my net worth. Thinking in this manner can help to make better long-term decisions.
Most people, when making spending decisions, think only of how it affects their wallet. For example, if I’m carrying $100 and I want to buy lunch, I have to decide if I want to break a $20 and reduce the amount in my wallet by the cost of lunch. This type of decision is based on a short-term perspective of cash-on-hand. But I seldom carry any cash at all, and I’m not faced with the same decision when I use a credit card or a debit card. In fact, spending is pain-free when using plastic.
Further, making short-term decisions based on how much cash I happen to be carrying isn’t suitable for saving and investing decisions. For example, I have never thought: “I have five $20s in my wallet, I think I’ll deposit one to a savings account.” If you do this, I applaud you. But most of my transactions are completed electronically, so I only withdraw cash that I plan to spend. And with investments, it’s rare that any particular investment will put cash in my pocket. At the very best, it’ll put cash in my investment account, which I can transfer to my bank account before withdrawing at a bank machine. It’s too convoluted to consider in a concrete manner when debating alternate investment choices.
The preference is then to make spending, saving and investing decisions in terms of my net worth. First, I consider spending within the context of how it increases or decreases my net worth. There is a certain amount of fundamental spending (food, shelter, transportation, clothing) that is required to survive. (Without spending on food, my net worth would drop to $0 as my children inherit it .) After that, would I prefer to own a new computer, or shares of Apple stock? (Disclosure, I don’t own Apple stock, but I wish I did.) I would also prefer to save than spend, unless the spending will improve my net worth either now or later.
The drawback that I see to taking a long-term view of how choices affect my net worth is something called “the wealth effect.” It means that as the real estate market drops, affecting my net worth, I feel less wealthy and I tend to spend less. It also means that my outcomes are affected by things outside of my control, especially the stock market. I compensate somewhat for this by accounting for my house and car on a cost basis, not revaluing them every quarter, but holding them at their original price (unless the market price is very probably much higher or lower).
How do you balance long-term and short-term thinking when making money-related decisions? Do you calculate your net worth?