Conclusive Proof that your House should be Included in your Net Worth…
…But you’ll have to wait till Monday to find out exactly why!
Happy Friday folks! I’ve been beavering away at the next post of my financial independence planning series all week, which as you’ve probably guessed by now is all about calculating your Net Worth. When I talk about Net Worth I am talking about it specifically in terms of a number that when you reach it, you can call up your boss and tell him to stick his job where solar radiation is not observable.
The big sticking point in the world of Personal Finance blogs it would seem it whether to include house equity in the calculation. There are many arguments for and against but I’ve never seen a post back up anything with hard numbers to explain their point of view (if you know of one, please let us know in the comments below!). There seems to be a lot of wishy washy chat but no one has run the numbers.
I set out to right this particular one of the World’s most heinous of wrongs, and it turns out (perhaps unsurprisingly) that there is hard evidence that you should include it. The reason I haven’t made the full post today is that I have to iron out a few last details in my spreadsheets, make them look half presentable for human consumption, and attempt to derive a simple formula from them as we did in the last post about calculating your savings rate (Hint: it’s not as simple as just including the net value of home equity into your Net Worth!).
Another very important point to note is that by including some proxy value for house equity into your Net Worth calculation, you must also consider that a similar proxy value for principle payments must be included as part of your savings, which will affect the calculation we did in the above article. For those of you who struggled through that behemoth of a post and made it to the end, apologies, but I will have to make an (hopefully very small) amendment to it, so you might have to go back and have another read of that as well when Monday comes. 🙂
Anyway, just so you can see where I am going with this, I ran a simulation of numbers for theFIRErat whereby he saved 50% of his income from the exact point he signed up for a 25 year mortgage. These are very convenient numbers because a 50% savings rate means you will retire in exactly 25 years. So, having run the numbers, I noted that when he retires and his mortgage expires, his monthly expenses drop dramatically (no mortgage left to pay). The sensible thing for the rat to do would therefore be to work out how much he needs to cover his non-mortgage expenses and then continue saving until he has that much, plus enough to pay off the rest of his mortgage.
At that point he can quit his job, which is turns out is a whole six and a half years earlier than what we are told if we follow the straight up rule of a 50% savings rate equating to 25 years of bondage to the corporate ‘cuffs.
Clearly this is not an insignificant amount of time!
So there is my conclusive proof 🙂 that we have to include (a proxy value for) house equity in our calculations for Net Worth, but you will have to tune in on Monday to read the full findings, and hopefully a simple derived formula to calculate that proxy value.
In the mean time, I hope you have a scintillating weekend my lovely readers!