Here's Why Your FI Number Is Not Your Net Worth

Home equity looks nice on paper; investible assets can cover your living expenses.

Zillow tells me that my estimated home equity is $800,000.

Seeing an estimate like that might make you feel pretty good. After all, that’s quite a nice boost to net worth.

But what does the large sum of equity in a home mean to your goal of financial independence (FI)?

It turns out that equity in your primary residence doesn’t mean much when reaching FI. There’s a big difference between net worth and your FI number.

Net Worth

Your net worth is the calculation of all your assets minus all your liabilities. This includes everything you own, house, car(s), collectibles, cash, savings, investments, etc.

Some of the items you own are less liquid than others. Your car and primary residence are examples. If you can live without a car, you can sell it and create a liquid asset. However, turning your primary residence into a liquid asset is much more challenging.

You still need a roof over your head.

Equity in your home and other hard-to-liquidate assets add to your net worth, but these funds are not easily accessible.

Your FI Number

If you follow the FIRE community, you are likely familiar with a financial independence (FI) number. Using the 4% rule, your living expense is multiplied by 25.

If your expenses are $50,000 annually, your FI number is $1.25M.

The number represents the investible assets required to sustain your living expenses for 30 years or more.

Investible assets are can be liquidated quickly. These include cash, stocks, bonds, etc.

Equity in your primary residence is not an investible asset.

Challenges with Net Worth Imbalance

Financial blogger the Financial Samurai states that your primary residence’s ideal percentage net worth is no more than 30%.

Given that ratio, the net worth of someone with $800,000 home equity should be at least $2.6M.

The problem is that most people have far more than 30% of their net worth tied up in their house. The skyrocketing housing prices have boosted existing homeowner equity.

Net worth is rising for these homeowners. However, their investible assets are not growing.

An argument to invest instead of paying off a mortgage early

Every dollar of equity you grow boosts your net worth. For some, paying off a mortgage early provides comfort and makes them sleep better at night.

Every dollar of equity you grow in your house is another dollar that is hard to liquidate. These dollars cannot easily be invested and cannot be counted on to provide for your future living expenses.

When you focus on investing extra income instead of paying down your mortgage, you boost your investible assets and close the gap on your FI number.

Many people in the FIRE community believe in paying off a mortgage in full. One prominent member, Carl Jensen from Mile High FI and 1500 Days, believes in the value of carrying a mortgage, even in retirement. He is a strong believer in investing instead of paying off mortgages.

Boosting your investible assets can help shift the net worth ratio away from home equity. This will give you more flexibility and enable you to cover living expenses with your investments.

What about a HELOC?

You can convert home equity into investible assets using a Home Equity Line of Credit (HELOC). The practice is fairly common for real estate investors. A HELOC makes it much easier to put your home to work.

However, you are borrowing against the value of the structure that provides the roof over your head.

Many people effectively use HELOCs to build additional wealth. I’m not here to tell you not to use one.

There are risks that you need to be aware of, though. A housing crash can wipe out your equity and put you upside down on your primary residence. The Great Recession of 2008 wiped out home equity and devastated homeowners who were upside down.

All indications in 2022 do not point to a housing crash like in 2008. However, rising interest rates are likely to slow the meteoric growth in the sector.

Focus on your FI Number over Net Worth

To reach financial independence, you must focus on your FI number more than your net worth. Equity in your home is nice, and it may help you someday. However, investible assets are what you need to reach FI.

Sock away additional income in investments instead of paying down your mortgage to help balance the ratio of your home’s equity to your net worth.

The higher the ratio of investible assets in your net worth, the more relevant the number is to your financial independence.

You can use a HELOC to access your home equity and put the money to use. This practice has some dangers, but many real estate investors successfully use HELOCs to create wealth. If you choose this path, ensure you understand the risks of leveraging the roof over your head.

Your FI number is critical if you are on a journey to financial independence. While it may feel nice to see that Zillow estimates you have a large sum of home equity, investible assets are the essential component of your success.