- Paper Profits: Investments have not made a penny until you cash out the profit ("realize" the gain). The housing bubble is bursting and middle-class people are waking up to find that their houses are worth $100,000 less than they thought. 401k profits are unguaranteed against market losses and uninsured against blatant theft. One 61-year-old woman found that her 401k lost nearly a half-million dollars before she knew it and a fraud victim found a 401k account cleaned out at $0. Social Security is no better, as those periodic statements of future payments include fine print that declares the estimates void of any guarantee, and the government rewrites your fictional “account” balance any time it wants by changing the retirement age or changing the calculation formula.
- Real Costs (Present Value, Future Value, and Time Value of Money): Not only is $1 today worth more than $1 tommorrow in a typical inflationary environment, but people forget that different discounts apply to different assets/liabilities. $10,000 in a mutual fund does NOT cancel out $10,000 of credit card debt if the fund earns 11% but your debt costs 13%. Instead, you would lose about $5,000 over 40 years so, if you are trying to measure your long-term financial health, you should discount your mutual fund to $5k or increase the debt value to $15k (I will adress the misuse of tax-deduction modifiers in a future post). Another dangerous ommission is tax liability.
- Illiquidity: It is not your money anymore, or not yet, as nowadays so many people sign away rights to their money by chasing tax deductions which restrict access. Whatever money people do not make inaccessible in retirement funds, they trip over themselves to bury in real estate (more on this in a future post).
Phantom Wealth and Broke MillionairesThese factors can result in an alleged paper “millionaire” who cannot make a mortgage or car payment. There are people who complacently carry tens of thousands of dollars of credit card debt because of an imaginary "wealth effect."
As for restricted nanny-state allowances (Social Security, IRA, etc.) and non-money assets (home equity), most people will not convert them into direct buying power until almost 70 years old (relocating home equity from one address to another does not change anything)--and maybe never before they die (when the heirs liquidate the house to pay off the legal, tax, and health-care bills).
Meanwhile, borrowing against assets is a sucker's game.
Resist the urge to borrow against your inaccessible wealth. Paying the interest penalty to borrow against asset value tells you that the asset itself is unavailable, which is why you have to pay someone else to use your own rumored "wealth."
That is quite a trick, being “wealthy” and still having to borrow money. If your "net worth" meant that you actually had money, you could lend to other people and make money by earning interest--instead of losing money by paying interest. Some people pay twice, since they paid an 8% mortgage to "build equity" and then paid another 8% for a home equity loan, which combined is not much different than a 16% credit-card rate. Try defining your wealth by the absence of borrowing.
Next: Learn how to measure wealth realistically in "Practical Wealth V. Phantom Wealth."