I find the great thing in this world is not so much where we stand, as in what direction we are moving. -Oliver Wendell Holmes, Jr., United States Supreme Court Justice from 1902 to 1932
The Stockdale Paradox teaches that facing the reality of your current situation is a necessary step to improving it. The way to do this in personal finance is by calculating your net worth, which is the best measure of your current financial situation. Your net worth measures how well you have lived the Micawber Principle in the past. It is the sum total of all of your past financial decisions and gives you a good snapshot of where your finances stand at present.
Let’s start with a couple of warnings. First, your net worth does not measure your worth as an individual. There are many things in life more important than money. It also doesn’t say anything about what the future holds for you financially. It is simply a measure of where you are now, and it establishes an anchor point you can compare yourself against as you work to improve your situation.
Calculating Net Worth
Your net worth is the total of everything you own (your assets) less the total of everything you owe (your liabilities). Imagine that you sell everything you own (including financial instruments) and pay off all your debts. The cash you have left would be your net worth. The net worth formula is: Assets – Liabilities = Net Worth. One important property of net worth is that you can increase it by increasing your assets (saving & investing), decreasing your liabilities (paying off debt), or any combination of the two.
To calculate your net worth add up the total value of everything you own. Include:
- Cash (checking & savings accounts, CDs, money market accounts, etc.)
- Stock and bond funds
- Retirement accounts
- Other investments
- Other valuable property (be conservative – what could you realistically sell them for?)
Then subtract everything you owe. Include:
- Home equity loans
- Student loans
- Credit card debt
- Car loans
- Other debts
The difference in value between what you own and owe, either positive or negative, is your net worth.
You should calculate and track your net worth at least once a year, but not more frequently than once per quarter. There are several ways to do this. If you are using Quicken or mint.com to track your personal finances it is easy to set up a report or graph that will calculate your net worth with a click of the mouse. I like the graph because, by including several past calculations, it provides an instant visual picture of your progress over time.
The calculation is also simple enough that you can easily calculate it using an old fashioned pencil and paper or a simple spreadsheet on the computer. Finally, there are many online net worth calculators that will do the math for you if you enter in the values of your assets and liabilities. One of my favorites can be found at: http://cgi.money.cnn.com/tools/networth/networth.html. If you use an online calculator make sure you write down the dates and results so you can track your progress over time.
Your homework assignment over the next week is to calculate your net worth. If you haven’t been tracking your net worth I would be interested in hearing what you learned from this exercise. Was it higher or lower than you expected? How did facing your current financial reality make you feel? Remember not to despair. Along with facing the brutal facts the Stockdale Paradox also demands that we never lose faith in the future. The important thing is not where we stand, but the direction in which we are moving. Next time we will discuss how to interpret what your net worth means.