Just last week, Kyith, better known as his online moniker Investment Moats, shared an article on Facebook. It was a link back to La Papillion’s article published in his blog Bully the Bear in November last year.
The title of the article was ‘I have Zero Net-Worth‘. Extremely catchy, and had it originated from anyone else, I would have dismissed it as click bait immediately. But having come from not one but two doyens, I know it is definitely worth reading about.
Asset minus Liability
Now we all know that the definition of Net Worth is Assets minus Liabilities.
[Free Ebook] How should you invest your first $20,000?
We asked 14 Singapore finance bloggers to share what they would do if they could go back in time and invest their first $20,000. They can no longer rewind time, but you can learn from their experience and hopefully start with a better footing.
The math is simple. We take everything we own and subtract from there everything we owe. If the final figure is positive, we would have more assets than liabilities and our networth would be positive. What this means is if we sell off all our assets and use the income to pay back our loans, at the end of the day we will still have money left over in the bank.
Conversely, if the number turns out negative, we are actually in debt. The implication is that should creditors decide to call in all our debts at the same time, we will not have enough to repay even after selling off all our assets.
If you are a newbie to personal finance, calculating your networth is a good place to start getting a grasp on your financial standings.
Back to LP. In his article, he shared how he stumbled upon the realisation one day that his networth is zero. Like what we would all have done, LP added up his assets and liabilities. They work out to be like this.
It did not take long for readers to realise that LP has left out a major ‘asset’ in his computation of his networth – his HDB flat. Had he taken that into consideration, his networth would have been radically different. It would have been very positive.
If you have not read the article, I strongly encourage you to head over for a better picture. There is also a very lively conversation going on in the comment section over there. Many have questioned the deliberate exclusion of his greatest asset. Here is a short summary. #thebestofLP #tohellwithnonbelievers.
Dustin Hoffman and the Money Jars
Behavioural Economist Richard Thaler was the first to come up with the concept of Mental Accounting. In his book Nudge, he shared an anecdote about Hollywood legends and long time friends Gene Hackman and Dustin Hoffman.
Gene recalled that many years ago, when they were both struggling actors, Dustin tried to borrow money from him for food. They were standing in Dustin’s kitchen and sitting on his shelf were money jars. The jars were labelled – Rent, Food, Utilities, Transport etc etc.
All the jars had money in them, all except the food jar. Dustin Hoffman had run out of money to buy food, and it was totally unthinkable him to remove money from other jars for food. His had inherited this habit from his parents and it had served him well. He would rather borrow.
Hear it from the guys themselves.
The comfortable way of looking at money
We practice mental accounting all the time. We have these little money jars in our heads where we compartmentalize money. Our brains do not have the computational ability to see money as individual units and in grouping them, we make money matters easier to comprehend.
Another awesome personal finance blogger Lionel has written a three part series about Money Jars. By predetermining how we want to spend our money, we remove the thinking from many money decisions later on. Money decisions become automatic. The battles within ourselves on whether to splurge on a holiday or a new bag we have been eyeing no longer wreck havoc on our psyche. We feel a lot better about money.
The idea is great and I have no doubts that it is an effective personal finance set up. However, I do want to caution that the idea will work well up to a point where things are humming along smoothly and all the jars are filling up well.
The complication sets in when one of the jar is emptied, like the case of Dustin Hoffman, or when we start taking debt (and the cost of money) into consideration.
Take for example a young couple saving up to get married. They do the money jar thingy with their finances. The thing is, they both have student loans outstanding. The logical thing to do would be to stop take any excess money to pay off the student loan because it is incurring the highest interest.
Unfortunately it is much more comfortable to see money piling up in the bank accounts. In the search for comfort, we make sub-optimal decisions about money.
The curious case of LP’s missing house
Human beings are creatures of comfort. It is a natural tendency to seek comfort in everything we do.
In choosing to do his sums this way, LP has effectively siphoned away his biggest asset and taken it off his balance sheet. Not only has he locked and sealed the HDB jar and labelled it untouchable, he has gone as far as the hide his biggest jar away from (his own) prying eyes. It is a very comforting thought indeed.
I just want to end off the article by saying that such creative-comforting accounting is not only practiced by individuals. Despite being subjected to accounting standards and regulations, many listed companies also engage in such ‘activities’. Case in point, companies who value their properties at cost despite the common understanding that the actual value has already appreciated significantly.
In doing so, they under declare their Net Asset Value (networth). Like LP, these companies are actually worth a lot more than they are made out to be. Our very own CNAV Investing Strategy identifies such companies to buy on the cheap. Find out more at our Value Investing Mastery Course.
image credit: homefirstcertified