Earlier this week, I was going through my normal monthly routine of updating a spreadsheet with my net worth as of August 1st. This is a quick process that usually takes less than 30 minutes a month to do, but one that I find incredibly valuable.
If you are not yet tracking your net worth, you should really consider doing so. Net Worth is in simple terms, the sum total of everything you own minus the debts that you owe. In business terms, Net Worth = Assets – Liabilities.
Why is this worth tracking?
Your Net Worth is a convenient tracking mechanism for your overall financial performance. When people discuss finances, you will find they either discuss income or net worth. They might call net worth “wealth” or something similar, but the basic concept is the same. What you’ll find though is that your net worth is a much better tool for determining how you are doing financially than your income. Many people have a high income but never do well at increasing their net worth. The people who do this will not be able to grow wealthy over time, simply because they are measuring the wrong thing. There is a very simple phrase in management which plays a role in this: “What gets measured, gets managed.” This quote is attributed to multiple people, but the one I have read it from most recently is Peter Drucker. The idea is that if you measure something as a means of discussing performance, you are likely to improve your perceived performance by focusing on what you are measuring. Let’s look at two different cases.
Let’s imagine we have a fictional person named Larry. Larry wants to become rich, and so he decides to focus on increasing his income over time. He sees income as the route to wealth. He decides to do everything he can to grow his income. At the age of 25 he has an income of $30,000 per year. By the age of 40, he is making $150,000. His employer auto-enrolls him in a 401k where he deposits 5% of his income into the 401k each year. Larry assumes that is enough, and so he let’s his growth in income manage his investments for him.
Taking a look at his progress over time, he’s likely to see himself as a financial success. He’s managed to increase his income five fold. This is a great accomplishment. However, he isn’t actually wealthy. Wealth is determined not by what you make but by what you keep. If Larry is like the average American, his net worth would have hardly increased over this 15 year time frame. After 15 years his total net worth is $109,851. He might be making $150,000 a year, but he’s spending 95% of it. He still depends upon his job to provide for all of his basic needs, and he will be in big trouble should he ever lose his job. This is because after 15 years of savings, his 401k is not even enough to cover a full year of his living expenses.
Measuring Net Worth
We have another fictional person named Jane. Jane also wants to become rich, but unlike Larry, she understands that the most important way to do that is to save money steadily over time. Jane decides to do everything she can to grow her net worth. In order to measure her progress over time, she decides to tabulate her net worth figure each month. This provides reassurance that she is making progress, and she can see the number get larger over time. Jane also begins at the age of 25 with an income of $30,000 per year. However, unlike Larry who saved only 5% of his money, Jane focuses on saving 20% of her income each month. That starts out at $6,000 a year in the first year and grows each year as she invests the money and her income increases. Let’s jump ahead to when Jane reaches the age of 40. Jane’s income is now $90,000 a year. It’s only 3x the income she had at 25 and not $150,000 like Larry, but she is in a much better financial situation.
By continuing to save 20% of her income every year, and putting that money to work in the stock market through tax-deferred accounts her net worth has grown significantly. If she started with a net worth of $0 at age 25, by the age of 40, she would have a net worth of $341,603. This is almost 4x her current salary at the end of the time frame. This means she has the ability to cover a bulk of her living expenses for years if she were to ever lose her job. So, even though Jane has made less money than Larry over the course of the past 15 years, she is in a vastly better situation than Larry. Larry makes over 1.5x what Jane does, but has less than one-third of the investment portfolio, and will likely never catch up to Jane.
The most valuable aspect of your finances that you can focus on if you want to be rich, is to save money and track your performance. By tracking your performance you can gain valuable encouragement as you see the improvement over time. This will help because saving money is difficult. It isn’t easy to choose to spend less than you make, when everyone in your social circles is doing the exact opposite. However, it will pay off in the long run and set you apart to be much wealthier over time.
My personal method is to take 30 minutes on the 1st of every month and plug in the account values for my bank accounts, investments, and major physical assets. I limit the assets to anything worth at least as much as a vehicle. I don’t worry about anything less, as it isn’t worth my time to add. The main key is to focus on liquid investments, or things that you could sell for a large amount of money if ever needed. Then, I add up all of my liabilities, such as loans, outstanding checks, outstanding rent or mortgage payments. While there are some fluctuations due to the performance of my investments, it is encouraging to see the net worth amount go up each month. Even if it is a small amount.
I even encourage you to try this if you expect your net worth is negative. There is nothing wrong with a negative net worth. Your financial net worth, does not have any meaning on your worth as a person. Everyone starts from somewhere, and it is very common nowadays to enter the workforce with a negative net worth from student loans, car loans, and credit card debt. Even paying off these debts will increase your net worth. As you cross key milestones, such as a positive net worth, or $10,000 or $100,000 or $1,000,000 you can then celebrate these achievements.
The first time might take a while, but it doesn’t take long once you have established a system. You’ll be glad you did, when you can look back years from now and see how your hard work has paid off.