Happy day to you. This is Ken Kaufman and I am thrilled you’re here for Episode 58: Net Worth in Crisis. I want to go back to some basics now in this episode. I just want to go back and retouch on net worth and what it means during time of crisis.
Now, as you will remember from prior episodes or if you have any type of refresher on this, you can back to episodes 1 through about 7 or 8 where I dive into what net worth is and how it works. The quick summary is net worth is merely all of your assets minus all of your liabilities and the result of that math formula tells you what your net worth is. For example, if I have a home and it is worth $100,000 and I own $50,000 on it and I have no other money and bank accounts, no other liabilities, no other assets, that $100,000 of assets minus the $50,000 of liabilities would mean that I have a net worth of $50,000.
Really quickly if we are trying to move ourselves forward financially and we are not focused on net worth, we can get very distracted and cause a lot of debt to rack up overtime and then that starts to suck cash flow and then that eliminates our ability to invest in assets or to set those dollars aside in a bank account to build and grow net worth. When you are careening toward a crisis, some type of economic crisis, the more net worth you have, the more stable you’re going to be, and the more you are going to be able to weather whatever storm comes your way. The less net worth you have or I could even say the more negative your net worth is where you’ve borrowed more than the cash and other assets that you have, all of that together is worth, the more painful an economic crisis is going to be quickly and can very quickly completely destroy lives and families. I’ve seen this happen before where an individual’s really excited about investing or buying up a whole bunch of things and they lever themselves way up to do that using leverage. And, as you remember, debt or leverage, it merely accelerates outcomes and emphasizes and creates more dramatic outcome. The more leveraged you are, when things go bad, it goes even more bad. When things go well, it goes even more well; that’s why people use leverage.
But, in the case of getting into an economic crisis where stock prices are down, home prices are down, perhaps you’ve lost your income or some of your income is impaired in some way, all of this creates strain and pressure on your net worth and the bigger your net worth is, the more strain, and the more duress, and the more of a beating your net worth can take. And you can still stay alive and keep pushing forward and moving forward from a financial perspective. Now, there’s emotional tolls. There’s other things that come when disasters like this happen. But, speaking just from an economics standpoint or perspective, that net worth becomes the bedrock for you overcoming and making it through a financial crisis.
Back in 2008, 2009, one of the main things that caused that economic crisis was people had levered up, and levered up, and levered up in real estate and then that market slowed down and then people couldn’t service that debt. And then banks had to come in and start to foreclose. And home prices went down because your supply and demand of homes got way out of whack, and it created a very, very significant strain economically on a macro level. But when you go to the micro level of an individual person or a family, those who had high net worth survived through that just fine. Those who had low or negative net worth collapsed. They had to head towards bankruptcy or work out divisions of banks because they were so far behind and there was no real prospect of them being able to dig out of the situation that they were in.
Now, you guys know me. There’s no shame or judgment. Wherever you’re at right now, it is what it is. I’m bringing this up for this one point. Right now is the time to realize and look around outside of us and see what’s happening and then do an internal introspective activity where you say, “Okay, now maybe what should I be doing and how can I start to be thinking about rebuilding my life around focusing on net worth?” because net worth creates that stability. It’s cash in the bank. It’s a bunch of extra groceries stored away, say, one month’s worth of groceries or it’s a 72-hour kit of materials and goods that you would need to be able to survive just for a few days. It’s cash. It’s investments. It’s tons of equity in your home so that your market goes down and you could still sell it and get out and be fine. It’s a series of all those different things.
Now, I am definitely guilty of being conservative when it comes to personal finances and my family finances. I am that way for a very specific reason. I do not have nearly as much to worry about in a crisis like now as a lot of other people do. That’s where I want to be. That’s who I want to be. I want to be able to weather these financial storms and be able to continue to focus on the places where I can contribute and the places where I can add value.
Again, this is a perspective but the math does not lie and no shame or judgment around this. The more we can focus on building up our assets, growing assets and saving our money and having more and more assets exist and less and less debt or liabilities exist, the more safe, the more secure, the more stable we are going to be. The more capable we’re going to be able to take on any type of crisis when it comes.
Now, does it mean we’re potentially forfeiting some potential benefit on the upside? Possibly. For example, if I went in and I decided, hey, I’m going to buy a house because I see the market going up, or it could be, “I’m going to buy stock or anything else and I’m going to use leverage.” Let’s say the house costs $100,000 and I get $50,000 loan and I put $50,000 cash into that house. Well, if the house goes up from $100,000 to $200,000 or that asset, if I only put $50,000 in and it goes up $100,000, then I just turned my $50,000 into $100,000. I sell the house for $200,000, I pay the $50,000 off to the bank, and I have $150,000. I started with $50,000. If I had just gone in with $100,000 cash and that asset went up, then I got $100,000 in return but it was only a doubling or 100% return, not 150% return because I tied up the full $100,000 of my own assets to create that return.
The problem is if things go sideways or south. All that leverage can get you in trouble. Leverage needs to be used carefully. It needs to be measured. It needs to have constraints around it so that you can still mitigate risk to the very best of your ability without overexposing yourself to too much liability. When you do it, you can definitely accelerate and maximize returns but you can also maximize negative economic impact if you are in too much debt or if you are over leveraged. So, again, it’s a very simple formula—assets minus liabilities equals net worth. The more net worth we have, the more stable and secure we are and we can be investing and doing those things. But we’re trying to avoid leverage. We’re trying to reduce our liabilities and maximize our savings and the amount that we can put away and prepare for the future. Again, it’s in the form of cash and investments and those things but it’s also vehicles. It’s houses. It’s real estate. Anything else would be considered an asset.
So I hope this has been helpful. I just wanted to get back to the basics, touch base on this very, very critical point. It’s actually the whole premise upon which I started this podcast in the first place. I care about trying to help all of us think about our net worth and understand that it is truly the measurement of our success and our financial growth and it also is the true measurement of how well we are prepared to weather any type of financial challenge or economic crisis that could potentially come into our lives. Again, I hope this has been helpful. I am again grateful. I’ve mentioned this on a few episodes but grateful for first responders, healthcare providers, those who have done so much to help all of us through this difficult time. I just want to say many, many thanks to you for joining today. This is a wrap for Episode 58. Happy day!