It’s been a minute since I’ve written an entirely personal finance article. So, today I’m going to focus on the topic of liquid net worth. What is liquid net worth? More importantly, why should it matter to you?
Table of contents
What does Liquid Net Worth Mean?
How Do We Define Liquid Net Worth?
I’m an educator, so it’s no surprise I’ll break the phrase into component parts to build understanding.
Liquid: In finance terms, this means assets you can spend – usually cash.
Net Worth: The total value of all your assets minus all your liabilities.
So, What Does Liquid Net Worth Actually Mean?
It’s the value of all your cash (or easily converted to cash) assets minus all of your liabilities. In short, it’s what you could spend on short notice if necessary. Liquid net worth does not include any fixed assets that you have to hold or would take time to sell.
The time horizon for liquidity varies. Some people consider liquid to be cash only while others count investments that can be easily converted to cash in a few days. Like all things personal finance, be wary of hard rules – but know what it means to you.
Liquid Net Worth vs. Net Worth
Often, in financial independence discussions, you’ll find lots of articles that tell you how to calculate and track your net worth. As mentioned above, this is done by adding up all your assets, and then subtracting all your liabilities.
As with everything, there is nuance in what you include. Some people include cars, collectibles, and other “hard” assets in the number – while others do not. (We do not.)
Liquid net worth is a subset of net worth that, again, includes only spendable assets. It is usually less than total net worth. The most significant reason for this is that real estate is almost always excluded from liquid net worth.
It takes time and transaction costs to convert real estate into cash. By definition, that is not liquid. This may be true of other things you own that have value.
For example, here is the same net worth calculation done – one with all assets, and the other subtracting the fixed assets. I’ve kept it simple in concept and numbers to illustrate the differences.
That’s a very different picture for the same financial situation. It doesn’t really change the day-to-day steps you’d take, but it should have an impact on your long-term financial decisions.
I’m not arguing that one is better than the other. It’s a good idea to understand how you measure up in both.
Why It Matters
There are two reasons I think understanding the difference between liquid net worth and standard net worth is important.
The first: It’s important to know what money is available for different purposes. In the example above, gold buried in the back yard might be a worthwhile fund for apocalypse style emergencies. It’s not a great standard emergency fund, though.
Also, note that debt matters a lot because you still have to pay on debt even if you can’t easily sell your assets. This may be important in the case of job loss.
The second, and more important, reason for understanding the difference is how it impacts your financial independence planning. We often work with the 4% rule which means you can draw down roughly 4% of your assets a year and be okay for 30 years.
(That is a simplified version, but this is a quick article! You can dig all the way into the safe withdrawal rate here.)
Unfortunately, I often see people calculate this using their total net worth – including their primary residence. While your house and cars can be converted to cash, in most cases you’d have to replace them somehow.
If you have $500,000 in house value, it is highly unlikely that will generate $20,000 for you to spend. Including your house value in your FI number calculations may leave you very short.
So, once you’re clear on your total net worth vs. liquid net worth, it’s only a small step to get clear about what invested assets are generating return.
Calculating Your Liquid Net Worth
Honestly, it’s as simple as the example table above. Add up your liquid assets then subtract all liabilities. There you have it!
Okay… while it really is that simple as with anything there are a number of complexities. People have hard stands on what should and shouldn’t be counted as liquid. I encourage you to read and define this for yourself.
I’ll share my thinking on this. I exclude basically anything that is a physical object. These things have value, but are not quickly spendable:
- Real estate
- Precious metals in physical form
Retirement accounts (like 403b) are another often disputed item. Many do not include them in liquid net worth. That said, most retirement accounts are as accessible as any investment but with a penalty. I *do* include them, but discounted for the penalty I’d pay for early withdrawal.
As always, do what works for your situation and needs. Improving your personal finance understanding and situation is a worthwhile journey!