A recent article by Laura Rowley in her Money and Happiness column on Yahoo discusses The Question of Measuring Financial Progress.  In the article she argues that measuring Net Worth is more of a feel-good exercise than a true measure of financial goals.  She supports her argument with an example of her children’s college savings which, according to her, exaggerates her net worth because in 15 years her kids will have graduated from college and the money will be gone.

Her point is corroborated by Charles Farrell, a principal with Northstar Investment Advisors in Denver: “It’s as if a company looked at its assets and included the pension plan it owes to employees.  You can’t do that.  It’s not net worth that I consider important, but ‘am I going to have enough money to support myself in retirement’”?

According to Farrell a focus on net worth can distract from a person’s primary financial goal which he says should be “to create a pool of assets from which you can generate income for your retirement years”.

In the article How Much Are You Worth? I stated that net worth is the most important measurement of financial success, and I stand by that statement.  I would agree that net worth is not the only measurement of financial success, but I still believe it is the most significant.  Let’s take a closer look at the points made by Rowley and Farrell.

Rowley argues that you net worth is overstated by your kid’s college savings because that money will be gone in a few years.  I don’t buy that argument, and here is why.  If you follow the same logic, you would have to say the same about your retirement money, because that money will also be gone some day, so it should not be included in your net worth.  How about your other assets, like your home and other investments?  Well, based on Rowley’s way of thinking , unless you are planning on leaving those assets for your heirs, they should not be included in your net worth either.   I don’t know about you, but if I were to follow this logic I would end up with a negative net worth!

Farrell says that your primary financial goal should be to generate income for retirement.  While that is a key financial goal for most of us, it is not the only goal.   In fact, depending on what stage of life you are in, it may not even be the primary goal.  A young person fresh out of college needs to think about paying for school loans and buying a first home.  Parents need to think about paying for their kids education, and may have other goals, such as moving to a bigger home, or even travelling around the world with the family.

The point is that your net worth (assets minus liabilities) should support all your goals, whatever they may be.  It’s not all about retirement.  Most of us expect to exhaust our entire net worth by the time we leave this world anyway.  So the idea that any assets that will be used in a few years should not count towards your net worth makes no sense at all.

Your net worth should increase up to a certain point in your life, and then it will naturally start to decline.  The trick is to plan it so that you use up your net worth just right to cover your estimated life span.   

Farrell argues that you should use a number of financial ratios to measure your financial progress, such as mortgage-to-income ratio, education-to-average-income ratio, etc.  He says the inspiration comes from Corporate Finance where financial analysts use complex financial ratios to measure the true financial state of corporations.  Seriously?  Most people have a hard time keeping track of simple financial metrics.  How in the world will they make any sense of complex financial ratios?

I think the point Rowley and Farrell are missing is that people are not corporations.  Unlike corporations, people do not live forever, and therefore, excluding assets that will be used in a few years from their financial measurement does not make sense.  And unless you have a number of financial analysts working on your behalf, I would recommend you forget about complex financial ratios and keep your metrics simple.  Measuring your net worth and your rate of savings will go a long way in helping you achieve financial success.