Do you have a clear understanding of the assets that you own and liabilities that that you owe? Today I want to talk about the importance of understanding your balance sheet, or, as we often call it in our business, your Net Worth Statement.
Hi, I’m Chad Butnari, Senior Wealth Advisor with The Andrews Group at CI Assante Wealth Management.
When we first start working with a client, one of the first things we do is to build a net worth statement and get a clear understanding of what makes this up. When we go through this exercise, it often surprises me how murky this is for some people. It’s pretty common for most people to understand how much they have in their investment portfolio, but beyond that, many people pay much less attention. They may even need some memory jogging. For example, it’s common for people to forget about the insurance policy they’ve been paying into for 20 years. Or, the account tucked away for a rainy day. Or, the $80,000 truck loan that they don’t often count. There are much larger examples as well such as an investment account held through an employer, real estate, or the equity value in the business. Or, what that business might be worth in general.
I often hear clients say that yes, they own something, but they don’t really count it. This may be because the value is unclear such as the value of a business, or, the future value may not be reliable in their minds. Whatever the reason, I’m a strong believer that understanding the big picture and building a comprehensive, detailed, net worth statement is crucial for making the best financial decisions possible.
Here are a few reasons why this is so important:
1. Understanding the composition of your net worth often provides good information about the health of your net worth. For example, one good indicator is to understand the ratio of fixed assets to liquid assets. A fixed asset is typically a house, cottage, boat, vehicles, etc. In other words, these are assets that either you don’t want to sell or couldn’t easily liquidate if needed. One important typical characteristic about fixed assets is they often need constant cash flow to keep them going. Your house needs a new roof, the cottage has property taxes and upkeep, the boat has to be stored, etc. On the other hand, liquid assets like investments, cash, share of a profitable business, well, they generate cash flow. They are what allow you to maintain your lifestyle and fund the fixed assets. When a client is getting close to retirement, this becomes a particularly important aspect to look at. In retirement, you won’t have an income from work to fund the fixed assets. So, pressure is placed on the liquid assets to generate enough cash flow to fund lifestyle and the ongoing costs of the fixed assets. There isn’t exactly a hard and fast rule here, but we’ve found that if you don’t have employment income anymore, and your fixed assets represent more than 40% of your total net worth, cash flow can become tight and difficult to manage regardless of what that total net worth number is.
2. Understanding your full net worth allows you to make informed choices. As ones net worth grows, the world often opens up and can present more choices to consider. Ultimately, this is a good thing, but, it can also create real challenges for people. Here is a common example. I was talking with a client earlier this year that had been working in their job for many years and had started to do relatively well financially. They didn’t love their job, but it paid relatively well and they knew they had to keep at it in order to pay for the kids education, pay off the mortgage, and save enough for retirement. Well, that day came earlier than expected. Through diligent planning and saving, we projected that the client would be able to do all of these things now, at age 54, rather than age 64, when they initially planned to retire. By all measures, this is a good thing. They had made more progress than they expected and were in good financial shape. I still remember the look on the clients face when I told them that they had enough. It was a look of confusion and uncertainty. All of a sudden, they didn’t have to go to work anymore. Or, they could do something else. The routine and the plan that they had in their head for all these years, had now been turned upside down. While it was a good thing, it did force this individual to confront a very uncomfortable question, “what did they actually want?” Asking that question, allowed us to pursue a completely different path of financial planning, which was a lot of fun.
3. The last point I’m going to talk about is how understanding all aspects of ones net worth allows you to make the best investment decisions possible. For example, a core concept we talk to our clients about is diversification. While diversification can mean holding many stocks in your investment portfolio, it can also be applied on a personal level, when deciding which assets to hold. A typical example often comes up with real estate. If a client owns a home, a cottage, a rental property, and works in the real estate field, that’s a lot of concentration of net worth in real estate. On one hand, I get it, people invest in things they understand. On the other hand, it poses a significant risk. If we go through a dip in the real estate market, it’s possible that this individual could lose a tremendous amount of money on their properties, have reduced cash flow on the rental, and, lose their job at the same time. That’s a lot of risk. It may be wise to consider this when making investment and planning decisions.
These are just 3 examples of why we feel it is crucial to understand your net worth, and how all the pieces fit together. We update and review our clients net worth statements annually and ensure we are looking at all aspects of their lives, not just their investment portfolios. While we believe this should be something everyone does, it is too often overlooked in our industry in lieu of simply focusing only on the investment portfolio. After all, one of my favourite quotes that we use in our business is from Ben Franklin, “how can they advise if they see but a part?”
I’m Chad Butnari with The Andrews Group at CI Assante Wealth Management.
Thanks for watching. If you have any questions or would like to discuss how these concepts might apply to you, don’t hesitate to reach out. We’d be happy to help.
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