Monday, November 28, 2011

How Much Are You Worth? (Part 2)

In Part 1, we talked about why it is important to have an estimate of your worth and how to determine the value--specifically, the market value--of the things that you own.

However, you are not just worth what you own: your potential to generate future earnings--your human capital--is an asset that significantly contributes to your value.

Human capital

In computing for the value of your human capital, you need to have an estimate for the following things:
  • Your total salary and other monetary benefits in the latest year, after taxes. You can include bonuses if you think these will reliably recur year after year.
  • How much your non-monetary benefits are worth per year, excluding SSS/GSIS or any pension plan benefits. These will already be implied in the simple model that we are going to use.
  • Your annual expenses. You can get this figure from your monthly budget plan, if you have one.
  • The rate at which your annual salary (and expenses) will grow per year, on average.
  • Your discount rate, or how much interest rate per year you can earn from your investments, on average. To be conservative, you can just use the prevailing after-tax yield of high-grade corporate bonds, which should be 5 to 6%.
Conceptually, your human capital is just equal to the present value of your expected future after-tax earnings, less expenses. To simplify the computation, we can just assume that you'll get wages practically forever, using your pension in lieu of your salary after retirement, and use the constant growth present value formula.

Human capital = PV of (future annual earnings - expenses)
Human capital = (current annual earnings - expenses)(1 + salary growth rate)/(discount rate - salary growth rate)

Please note that this simplified model will only work if your discount rate is greater than your salary growth rate; if its the other way around, if you think your salary will grow at a higher rate than what you can earn from investments, then your human capital would be infinite which, needless to say, is quite unrealistic. Of course, if you are already familiar with the concept of time value of money, you can always use a more detailed approach in computing for your human capital.

Your assets thus consists of your physical assets (e.g., house, car, jewelry, etc.), financial assets (e.g., stocks, bonds, UITFs, etc.), and human capital. 

Your liabilities are what you owe other people, banks, or other credit providers. It includes your credit card balance, personal loans, car loans, and housing loans, among other things.

Your net worth is just the difference between your total assets and total liabilities; in other words, it's what remains after you have completely paid off everything you owe.

Net worth = total assets - total liabilities

Finally, to better understand how all this works, let's take a look at an actual example.


Pepe is a single, 25 year-old male. His gross salary of 35,000 per month is taxed at 20%, although his 13th month pay is tax exempt. On top of this, he gets additional non-monetary benefits of around 3,000 pesos per month. 

Pepe is quite a frugal guy. On any given month, he makes it a point to save 30% of his after-tax monthly salary and all of his 13th month pay. And because of his hard work, Pepe estimates that his total earnings per year, after taxes and all expenses, may grow by at least 3% per year.

Pepe does not own much. He bought a second-hand car exactly one year ago by paying an 80,000 peso down payment and taking out a 300,000 peso car loan. Today, he owes the bank 250,000 pesos, but he just found out that his car is now just worth 300,000 pesos. Pepe's only other valuable property is a rare toy robot that he received as a gift 20 years ago; the same toy is now selling for around 20,000 pesos on eBay. 

Pepe owns some UITF units, currently worth around 50,000 pesos. The price of this particular UITF has risen by an average of 7% per year in the past 10 years. Pepe also knows how to use his credit card wisely, so he uses it for purchases of around 7,000 pesos per month and always pays the entire balance on time.

Given the information above, what is Pepe's net worth?

Try this out first. I will post my solution in the comments section next week. :)

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