This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Friday, February 18, 2011

Diversification In Action, Another Plug For Tracking Net Worth

Posted By Paul

Long time readers of Frugalize will know that I watch my net worth very closely. (see a posting from 3 years ago tracking your net worth)

One thing I didn't mention in that article was that another advantage of tracking your net worth is that you automatically get an idea of how diversified you are (or aren't), and how that's working out.

About 7 years ago I started noticing that A LOT of my net worth was in real estate (i.e. my house). That was to be expected in that my house (like many houses at the time) was growing in value quickly. As my house became more valuable it became a bigger and bigger part of my total net worth. My other investments were doing fine as well, but they just couldn't keep pace with the crazy real estate market.

My reaction to this was to make it a point to focus more on OTHER types of savings. I wasn't someone who thought that real estate was going to just keep going up forever, so I decided I didn't want to have too much of my net worth tied up in real estate. Instead I focused on my emergency fund, and other types of investments. They weren't quite as exciting as the real estate market at the time, but I figured that since I'd already gotten a piece of that I didn't need to put all of my eggs in that one basket.

So today I realized one consequence of this choice was that in the last year or so my net worth has been tracking steadily up, even though the value of my home has been steadily trending down (Of course knowing the value of your home is always tricky, but I just use zillow for simplicity, and figure it is at least in the ballpark).

So even though my house is losing value, overall my net worth is continuing to grow. This is a direct consequence of having made other investments years back that offset the cooling real estate market now.

It's nice to know that my net worth isn't completely driven by the value of my home.

I think I'm going to stick with this strategy of always trying to stay diversified. I get a piece of every boom, and of course every bust as well. Thanks to the fact that I track my net worth I can honestly say that so far the strategy is working for me and overall I'm coming out ahead.


Matt said...

You only get a piece of every boom or bust if you sell during those times.

Paul said...

Well, I guess it depends on what you mean by getting a piece of something. I meant in terms of tracking net worth, where the numbers change even if you don't buy or sell. After all if you buy a stock and it doubles in value isn't it normal to say: "This stock has been a good investment." Technically it hasn't been since you haven't sold it, but I think it's still a valid statement to make. It just means that down the road that statement can change.

Matt said...

Personally, I wouldn't use that language. I wouldn't say "This stock has been a good investment" until I sell it for a gain. I'd say something like "the stock is doing well".
For something to qualify as a good investment, you need both the purchase and the sale.

Paul said...

Fair enough. Though would you agree that even if you don't plan on selling something today that it's still of benefit to track it's value?

Matt said...

What's the benefit?

I do track my investments, but mostly out of curiosity, or in specific cases where I'm trying to determine whether to sell or not (e.g., we want to sell our rental property at some point, so we're closely monitoring that market).

Maybe you're tracking progress towards a specific goal? Or I guess I can see that in this post you're talking about tracking your relative allocations so you can direct future investments in a balanced way?

Paul said...

For me the benefit is feedback. Some things I can tell by tracking investments:

-Are any of my investments at a point where I want to buy or sell?

-How does my total net worth rise and fall relative to other things (DJIA, real estate market, etc.) and do I want to do anything to change that?

-Do my investments reflect my level of risk aversion? How wildly does it fluctuate from month to month?

And finally, is whatever strategy/philosophy/plan I have working?

I guess I cover all this in my first posting on tracking net worth.