In my column last week, I explained why your net worth is so important — and showed you how to calculate and evaluate it using the example of Hannah, a college grad with a good job, living in a Seattle apartment she owns.
This week, I want to give you a more complex example. I’ll tell you about a friend of mine who earns a ton of money, has decent net worth, but who has left herself quite vulnerable.
Kate is 37, lives in New York City, works in fashion and makes $250K a year. Sounds nice, right? She lives in her $1.2M apartment (sweet) and takes luxury vacations at least twice a year. She owns a Prius that she keeps in a garage during the week and drives upstate for weekends away with her fiancé.
Okay, so far she sounds pretty killer: a self-made woman. But let’s break down what she owns and what she owes.
First, she only put down the minimum on her $1.2M apartment with a mortgage that is around $6K a month. Her job requires that she always dress the part, so her clothing, shoe, and accessory budget is $1.5K a month. While that may seem absurd to you, it's practically a job requirement when you're earning multi-six figures in the fashion industry.
While she has no student loans, she has $40K in credit card debt — from those vacations — just sitting on her cards at 16 percent interest. The car costs her $300 a month plus parking, and then there’s her lifestyle, which includes fancy work events and checking out new hot restaurants, bars and destination spots to the tune of $5K a month.
She has very little savings — about $3K in her emergency savings account — which is not even one month’s worth of expenses saved, and $50K in her retirement savings.
So! Given this mess of numbers, what exactly is her net worth? And, what’s working for her?
Here’s how Kate’s numbers break down:
Residence current resale value: $1.5M
401(k) : $50K
Car resale value: $28K
Emergency fund: $3K
Credit cards: $40K
Car loan: $18K
Total Net Worth:
$1,581,000 - $1,018,000 = $563K
Kate has a phenomenal income and an enviable apartment and career, and net worth that’s appropriate for her age. But she’s left herself very vulnerable. How?
All of her income goes into supporting her lifestyle and her residence. And, her retirement safety net essentially is her real estate (her 401(k) is small). If the housing market drops, her nest egg could be destroyed. (It’s New York, so that’s unlikely, but like I said, it’s risky because she’s undiversified.)
True, the value of her apartment, her main root, is likely to appreciate in New York. But, it also costs $1K+ a month in co-op fees and maintenance. Given her credit card debt, her wings aren’t great. Having strong wings means the ability to access cash when you need it — a robust savings account (otherwise known as liquidity). She doesn’t have that either.
Amazing but true: even though she lives in a million-dollar apartment and has a big income, she doesn’t have liquidity and she doesn’t have stability. So while her net worth looks pretty good on paper, her roots and wings are not strong.
She could lose her job and spend three months finding the next one. In that time, her credit card debt would likely double and her savings would disappear completely. She might even have to sell her apartment, incurring large moving costs. Kate would still look great — but her financial situation wouldn’t be pretty.
Next week, we’ll look at a solid net worth scenario — on a modest income.