Wednesday, December 9, 2015

Don’t Focus on Net Worth

As part of personal development and financial education, one of my long term goals is to learn constantly and make better decisions as I mature. As investors, we all strive to take emotion out of our decisions, yet most of us fail and panic when there is a market crash eroding our wealth. Over the course of last six years, we have had an amazing bull market run and it has been extremely easy to make great investment returns. While this is all well and good, we need to take a pause from patting ourselves on the back and prepare for the next downturn.

The Net Worth

The market always moves in cycles. A downturn is around the corner and sooner or later, we will hit a new recession and the economic cycle will have come a full circle since the financial crisis of 2008/09. Preparing emotionally and financially are key to surviving the market turmoils. One key area that I have been thinking more about is the total net worth. My total net worth is something that I have never shared on this blog, and don't intend to – as it changes on a day to day basis considering most of my wealth is tied to the stock, bond, commodity, forex and housing markets. I do share a breakdown of how my net worth is divided and is represented in the chart below.
Net Worth - Oct 2015

Before I get into a rant, I want to preface by saying that: Keeping an eye on net worth is still a good idea to keep track of overall progress and checking up on it from time to time. However, getting obsessed with net worth numbers and getting into the mindset that your overall worth is high is something you should avoid.

Wealth Effect

The wealth effect is defined as:
The wealth effect is the change in spending that accompanies a change in perceived wealth.
The keywords are “perceived wealth”. Our perception of wealth gets skewed when the markets are at all-time highs. Unless we sell our assets and lock in those profits, that wealth is not ours and is simply just a number that should be taken with a grain of salt. This is not only true for stock markets, but also other markets – housing market, bond market, forex market or commodity markets.

Home prices have seen an unrelenting rise over the past decade in Canada (Americans saw a similar market a decade ago) and have reached insane levels where dilapidated shacks sell for $1M in Toronto and $2M in Vancouver. This, coupled with stagnant wages result in homeowners (an incorrect term really, but should really be called ‘mortgage owners’) left with massive debts that some will never be able to pay off in their lifetime. New homeowners are simply looking to ride the wave with no intention of paying off the mortgage. The debt-to-income ratio for an average Canadian is now at 164.6%, according to Statistics Canada. This has pushed Canadians to borrow more and an average Canadian consumer debt (non-mortgage debt) stands at $21,028!

Those numbers listed above should raise eyebrows and seem massive to most folks (unless you belong to the 1%) but lenders have been happy to push consumers more into debt at the record-low interest rates and this euphoria can only end in one way. In fact, thanks to successful marketing, I am reminded of Scotiabank’s (BNS) marketing catchphrase “You are richer than you think”. Repeat it enough times, and its ingrained in your brain that it really is true.

Don’t Focus on Net Worth

I believe this mindset stems from us focusing too much on the net worth numbers. With most of our fortune tied to stock market (we are at all-time highs), bond markets (interest rates are at record low, and remember bond fund prices drop when interest rates rise) and housing markets (Canadian housing market is in bubble territory, and same goes for a handful US cities). We tend to think that we are richer than we are, but this is due to perceived wealth. This increased perceived wealth is what gives us the confidence that we have money to spend on non-essential luxuries. But if our wealth is tied to the markets, volatility will eventually bring us back to reality.

What are your thoughts on net worth? Does the perceived wealth cause you to take financial and investment decisions that you wouldn’t take if your net worth wasn't as high? Share your thoughts below.

This article was written by Roadmap2Retire. If you enjoyed this article, please consider subscribing to my feed at Roadmap2Retire.com/feed

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