Here’s a mistake that people usually make when determining their worth: measuring their personal finance using net worth instead of liquid net worth.
People think that their net worth value is all that matters and treat it like the Stan Lee of finances. It gets all the attention and the movie cameos, while net liquid assets are treated like Steve Ditko, the co-creator of Spiderman.
Didn’t know who Steve Ditko is before I told you? That’s exactly the point.
People don’t even think about liquid assets even though it’s also important in determining your current financial health.
That’s why some millionaires still feel they’re poor even though they’re worth a lot. So if you ever want to achieve financial freedom…
Pay attention to your liquid net worth!
A true fan of the FIRE movement knows better than just to look at what’s on the surface.
Here’s one way that you can look at it: you can’t sell a $100,000 watch to pay for your groceries. You technically can do this, but that would be like selling your mom’s figurine collection to buy an action figure. It just won’t end pretty.
That’s why your net liquid assets are so important. It lets you do normal transactions so that that:
- You’ll always have a financial lifeline. I mean this literally. If you somehow thought it was a good idea to do a drunk backflip on a dare, you can use the value of your cash equivalents for your medical bill.
- You don’t have to let go of your bigger assets. If you lose your job, you’ll have something to fall back on without destroying the gains you worked hard for.
- You’ll always be ready. Life is full of surprises. If you’re dealt a crappy hand, you’d be able to manage your losses without having to move to a hastily-repainted apartment that reeks of sadness and regret.
Plus, it can also be a vehicle for you to grow your money even more quickly. For example, having the downpayment on hand for a great property means an additional source for your growing passive income.
A net worth calculator may give you the full picture, but it won’t tell you what really matters. And in this case, you should focus on the tip of the iceberg – your metaphorical net liquid assets.
Why your net worth value means nothing
Your net worth value is just your assets minus your liabilities.
On the assets side, you have everything you own including your house, your car, the money in your bank account, and everything else that’s worth something.
For liabilities, you have credit card debt, mortgage, that $100 you borrowed from a friend, and everything else that you owe.
Pretty simple, right? But there’s a problem here. Your net worth value does NOTHING to tell you about your financial situation.
Having a huge net worth can give you a false sense of security. This can lead to you making bad decisions down the road.
The opposite is just as dangerous. A mortgage may make you feel like you’re in deep debt because it can take a few years for your investment to pay off. If you feel like you’re doing things wrong, you may change your tactics.
For people under 35, the median liquid net worth is $3,000 – not even enough to cushion the shock of having to buy a car. That’s why your net worth is only valuable if you want to know when you’ve hit millionaire status.
You can have lots of property investments. But unless you can pull that asset out for an emergency, it won’t matter much. So focus on liquid net worth instead.
What is liquid net worth?
Your net worth calculator won’t do you any good now. Although it’s in some ways similar, liquid net worth is actually just a subset of your net worth. Here’s the formula:
Liquid net worth = liquid assets – liabilities from liquid assets
Basically, it just means look at everything that you can liquidate quickly. Think everything from cash to cash equivalents like anything you can pawn (more on this later). Then, subtract liabilities from liquid assets like credit card debt.
Still not convinced on why you should care about your liquid net worth? These findings from the 2016 Survey of Consumer Finances should help change your mind:
- Home equity gets the biggest chunk of people’s net worth. And sadly, selling your house isn’t a great idea if you run into financial trouble.
- Low liquid net worth is associated with higher reliance on home equity for financial security. In short, those who don’t take care of this are screwed. They’ll either drown in debt or maybe even file for bankruptcy.
- Home equity is practically useless unless you’re old. You can’t get into a reverse mortgage in your 30s. I don’t care what that fortune-teller told you!
Have I sufficiently scared you into giving a crap about this? It’s time to find out just how strong your defenses are against financial uncertainties.
There’s no liquid net worth calculator, but I’ll help you make the computations on your own.
What should be included in your net liquid assets computation?
For the computation, we just need to identify what exactly are liquid assets and the liabilities from them. Whip out your trusty calculator, and you’re done!
The liabilities part is pretty easy. It’s basically anything that you can pay in full using your liquid assets. So this would include your credit card debt, medical debt, late child support payments, and anything else that you wouldn’t have to lose your home after.
What counts as liquid assets?
1 – Cash
This is the ultimate definition of liquid net worth!
And really, you can’t get any more liquid than cold, hard cash because the whole point of an asset being liquid is it can be converted to, you know, cash.
I don’t recommend that you account for everything down to the lost quarters in your couch because if you have to do that, maybe it’s time to clean your couch too. That’s a bigger problem than just a few quarters.
Basically, if it’s in your bank account and you can get it out easily – count it. (If you have a purse where you keep coins for the parking meter, you don’t have to include that. But maybe it’s time to open your secret-under-the-mattress cash stash, then immediately hide it again after counting.)
The point is, cash is as liquid as water! But you’re not going to pay that emergency bill with pennies. So be smart about how you approach counting your cash.
2 – Rental properties
Selling your own home may suck, but selling a rental property is just business. But not just any rental property because otherwise, it would be so easy to sell any real estate. These have to be actually good rental properties that aren’t just rotting in the middle of nowhere.
And if you have good ones, you can sell your property within a month. This is from my personal experience.
Even the properties that aren’t worth it for me were sold quickly. But I know that my experience isn’t some fluke because:
- Demand for rental spaces always increases. 90% of the world’s millionaires are in real estate. They know that a good rental property is always a good investment.
- Supply is relatively limited. The habitable land in the world is finite. This means the value of real estate property will increase in time.
- With leverage, returns are amazing. Some of my properties get me 26% per year in returns. With that kind of earning, another investor would gladly buy it from you.
3 – Stocks and bonds
Listen. I don’t like to sell either, especially when the market is not quite right. But if you really, really need the money, you can pull some of your funds from stocks and bonds.
That’s why it’s so important to invest in these early on. Your odds of coming out in the positive are way better if the money’s already been there for a long time.
It’s also why I stuff my emergency funds in stocks and bonds. Personally, I do 70% stocks and 30% bonds. But you can always adjust this based on your risk appetite.
The average return is 9.2% yearly for index funds. For bonds, it’s a little lower. But it’s also more stable than stocks.
As far as liquid assets are concerned, this also covers money market accounts, mutual funds, and other financial vehicles meant to grow your money.
4 – Savings and checking accounts
If you don’t have a lot of cash lying around, it’s probably here. And what makes them liquid is their contents are literally just stored cash. You can withdraw the money (through an ATM or cheque) to access it.
Savings and checking accounts can be great because they keep your money safe. No one can steal the money unless you publicly announce bank details on social media.
So you know, keep relevant details safe and you’d surely be able to rely on this non-cash cash anytime.
5 – Cryptocurrency
Cryptocurrency is fun if you like to gamble, but that’s basically it. That’s why I don’t like crypto.
It takes too long for them to verify payments, transaction fees are insane, and the government can just ban it.
But if you already have some money in crypto, this would count as liquid. Just don’t rely on it to retain its value. If you’re lucky, its worth would skyrocket. But if you’re not, you might lose a lot of money.
6 – Retirement accounts
Particularly, this would apply to Roth IRA and 401(k).
Do I recommend that you withdraw from these accounts? Not as your first choice. But if you need it, it’s still better than losing your home.
Let’s talk about Roth IRA (Individual Retirement Account) first. This is a tax-advantaged account that lets you withdraw money tax-free. But unlike your traditional IRA, your deposits here aren’t tax-deductible. Historically, it earns around 8% annually.
For 401(k), withdrawals are free once you reach 59 ½ years old. But if you decide to cash in early, you’ll have to pay a 10% withdrawal fee on top of applicable income tax.
So I repeat, don’t do it unless as a last resort. You can’t enjoy retirement if you’re out of cash… that’s unless your idea of fun is silently judging people from your porch.
7 – Pawnable or easily sellable items
“So all the stuff in my house are cash equivalents?”
No, this is not an invitation to get rid of stuff in your house without discussing it with your family. You don’t want to accidentally sell the baby’s stroller while it’s still in use.
But if you have valuable items in your house like collector’s items and jewelry, you can have them appraised.
These items can easily boost your liquid net worth so you don’t have to part with your non-liquid assets if a financial disaster strikes.
What should you NOT include?
1 – Home
Like with rental properties, you can also easily sell your home to be more liquid. Its value probably increased after many years, and that sounds exciting at first.
But the question is, where are you going to go? The value of the entire neighborhood probably increased too, so it’s not like you can just buy another one and pocket a few thousand bucks.
Nope! Chances are you’ll end up renting a place that isn’t half as good as your home. Or worse, you’ll have to relocate way outside your area of work.
If we’re talking about your vacation home that you only visit twice a year, go for it! Consider it as liquid as your rental properties.
The ONLY way that your home (where you’re probably reading this article right now) would be liquid is if you’re moving. At that point, keeping your home wouldn’t make sense unless you’re going to rent it out. And speaking of rent…
2 – Rental income
Cash may be liquid, but rental income isn’t. You don’t have whatever income you’re expecting next month, and you can’t count on what you haven’t earned yet.
It’s the same reason your salary isn’t considered liquid. Sure, you can reliably expect to get paid for as long as you’re employed. But there’s no way that you’ll have your salary until the next payday.
Can rental income be liquid? Yes. But only after you collected it already.
Liquid net worth = your measure of financial freedom
If you lose all your income streams tomorrow, how long will it take before you hit zero dollars?
Or let’s say you decide to drop everything right now. How many months or years do you have to do everything you want to before going back to your old routine?
If the answer is
- Less than whatever number of years you think you have left, OR
- Not long enough to truly enjoy your sabbatical,
…keep growing your liquid assets.
You can always use it to grow your wealth even more quickly. Let’s say you have a liquid net worth of $100,000 right now. You may choose to invest again in real estate to improve your passive income stream potential.
Use it in any way that you want! Because at the end of the day, that’s really what net liquid assets give you: that sweet, sweet freedom.
Frequently Asked Questions (FAQ)
What is net worth and liquid net worth?
Net worth is your total assets minus your total liabilities. Meanwhile, your liquid net worth is a subset of your net worth. It’s your liquid assets (like cash, stocks, and bonds) minus liabilities from liquid assets (like credit card debt and other short-term unsecured loans).
What does liquid net assets mean?
Also called liquid net worth, it’s what you get when you calculate the worth of your liquid assets and subtract your liabilities from those assets. That number should give you a sense of how strong your financial anchor is against uncertainties like illnesses and home repairs.
Why is liquid net worth?
Liquid net worth predicts your financial ability to weather any unforeseen spendings, something that net worth can’t tell you. High liquid net worth means you’ll be able to survive just fine. But if it’s low, you may need to focus on beefing up your liquid assets.