Actions of a Lifetime (1)

One person's economic actions over their whole life … and beyond

Purely in economic terms, what effect does one person’s life have on everyone else?

The One Lesson tells us that to find the answer, we should look at how people’s decisions and actions over the person’s life affect everyone’s raw net worth¹.

In this article (part 1), let’s think about every action involving a person called Bob over his whole life, and consider their effect on his own RNW. In part 2, we’ll consider their effect on the combined RNW of everyone else who’s ever lived. I’ll call that group of everyone else “etc.”.

Suppose this particular Bob was born 150 years ago in 1875, and died 60 years ago in 1965 after a long and happy life. Let’s look at his assets, liabilities and RNW over his lifetime.

Childhood

When Bob was born, he didn’t own anything, wasn’t owed anything, and didn’t owe anything.

Bob as a baby with an empty balance sheet

In the diagram, we see Bob has no assets (nothing on the left of the balance sheet) and no liabilities (nothing on the right), and so his RNW is 0.

When he was young, his parents gave him some tangible assets which he then owned: toys, clothes, and a violin. These all made his RNW ↑.

(L) Bob is given toys, clothes and a violin; (R) his resulting balance sheet

The left of the diagram shows these (existing) tangible assets being transferred from the rest of the world to Bob. The right of the diagram shows his new balance sheet, where he now has 3 assets. Since his RNW is his assets minus his liabilities, his new RNW is just the assets he’s been given.

Bob’s parents gave him some other tangible assets which he could consume, like paper, pencils and food. These made his RNW ↑ at first:

(L) Bob is given paper, pencil and food; (R) his resulting balance sheet

But consuming them made his RNW ↓ again.

(L) Bob consumes the paper, pencil and food; (R) his resulting balance sheet

His parents opened a savings account at a bank for him, and relatives paid in £30 as birthday presents.

(L) Bob is given £30; (R) his resulting balance sheet

Bob has a new asset: he’s owed £30 by the bank. So his RNW ↑ by £30.

Before adulthood, he didn’t have any liabilities (i.e. he didn’t owe anything). I’m not a lawyer, but I believe it’s normal that nobody can be indebted until they become an adult². This makes sense, because it protects younger people who may not understand the seriousness of what they’re agreeing to.³

Adulthood

Once he became an adult, he was free to engage in any of the 7 types of economic action, and he continually gained and lost both assets and liabilities as a result.

• Actions which made his assets ↑ or liabilities ↓ made his RNW ↑.

• Actions which made his assets ↓ or liabilities ↑ made his RNW ↓.

For example, here is Bob buying his first car on credit (i.e. instead of paying for it immediately, he promises to pay the dealer later).

(L) Bob buys a car on credit for £200; (R) his resulting balance sheet

Notice that Bob now has a £200 liability, and the RNW section of his balance sheet shows that his RNW has increased by the car, and decreased by £200. (+ £30 - £200 = - £170).

When thinking about this phase of Bob’s life, remember that the only assets or liabilities he can lose are ones he’d previously gained. You can’t lose something you don’t have. So over his life, assets and liabilities are added, and some (probably most) of them are later removed. Here he gives away his old stacking rings toy to his nephew:

(L) Bob gives his old toy to a nephew; (R) his resulting balance sheet

When he died in 1965, he still had some assets and liabilities. What happened next?

Probate

In the UK, when someone dies, a process called probate starts: one or more people are appointed as executors to clear up the person’s balance sheet. The idea is to end up with no assets or liabilities. (I assume there must be something similar in other countries).

There are two major steps to probate:

1. Settling any remaining debts.

2. Distributing what’s left (if anything).

First, the executors need to find what the person who died owed, and whether they had enough assets left to be able to pay these liabilities — either by handing over the assets directly, or exchanging some of the assets for what the person actually owed. (Normally this means selling some of the assets to get money to pay the debts).

In Bob’s case, he owed his neighbour, Charlotte, a bag of sugar, and he also owed Alice £300. He had an unopened bag of sugar in his kitchen cupboard, but only £100 in his bank account. However, he also had his car which the executors believed could be sold for £1,600. It looked as though there should be no problem with paying the debts.

Bob’s balance sheet when he died

After advertising the car for sale, the highest bid they received was £1,400 from Dom, so they accepted that.

(L) Executors sell Bob’s car for £1,400; (R) his resulting balance sheet

Now they could simply hand over what Bob owed. They gave the bag of sugar to Charlotte and £300 to Alice. This left the violin, £1,200 and no debts.

With no remaining debts, the executors moved to the second major step of probate — distributing the remaining assets. Bob’s will⁴ contained instructions to share any money equally between Eve and Frank, split equally. He also left the violin to Frank. So the executors gave £600 to Eve, and £600 plus the violin to Frank. The balance sheet was now empty.

That’s an overview of a simple probate process, but sometimes it works slightly differently. There are 3 possibilities when trying to settle the dead person’s debts:

1. All the debts are successfully paid, and there are still some assets left over, which get distributed, as we just saw.

2. The person’s assets were exactly the right amount to pay all of the person’s debts. (This is very unlikely!)

3. There weren’t enough assets to pay all of the person’s debts.

We saw that in case 1, after distribution, there are no assets or liabilities remaining.

In case 2, the executors’ job is finished as soon as the debts are all paid.

For case 3, some or all of the remaining liabilities have to be written off — like in bankruptcy. Laws determine how the assets are shared between the creditors, but at least some of them will get less than they were promised, and at the same time, the dead person’s liabilities are removed from their balance sheet. If Bob had only had £100 in assets, but had owed £300 to Alice, the executors would have transferred the £100 to her, but she would have had to write off the whole £300, leaving Bob with no assets or liabilities.

(L) Balance sheet at death; (C) executors pay Alice £100, but she must write off £300; (R) final balance sheet

So in all 3 cases, at the end of probate, the balance sheet is clear of all assets and liabilities, just like it was when the person was born. The person’s final lingering economic ties with the rest of the world have been cut, and their assets and liabilities don’t ever change again.

Summary

Over a person’s lifetime, they gain a number of assets and liabilities, many of which they subsequently lose one way or another. After their death, the probate process results in any remaining assets and liabilities being lost via paying any remaining debts and distributing any remaining assets, leaving them once again with an empty balance sheet. Over their life and probate process, the change in their assets, liabilities and RNW is exactly 0.

As we’ll see next time, this helps us to know the effect of their life on the rest of the world’s RNW.

Spoiler alert: it’s not 0!

1. Someone’s raw net worth (RNW) is what they own plus what they’re owed minus what they owe (i.e. their assets minus their liabilities). It is a “heterogeneous” sum/difference, which just means that things of different types are added and subtracted, not monetary “values” which have been assigned to them. If the idea is new to you, this article explains it with examples.

2. Or at least courts of law won’t enforce the payment of debts which were taken on before the person became an adult. They can still pay voluntarily.

3. Assuming this is right, it’s impossible for a minor to be insolvent, because that can only happen if you owe something which you neither have nor can acquire by trading your existing assets. Obviously if you can’t owe anything at all, you can’t be insolvent.

4. A will contains instructions for how to distribute any remaining assets after all the debts are paid. If someone dies intestate (i.e. without having written a will) laws determine who gets what.