The past few days I’ve spoken about Net Worth and budgeting a lot. The general idea with this has been to introduce the concept of them going hand in hand for one’s financial freedom. You really cannot build your net worth without budgeting but at the same time if you budget without really paying attention to your net worth, you’ll be left in the dark as to your true progress. You can look at it like this: budgeting is where you fight the battles but net worth is the reward for winning the war.
Calculating your net worth is a fairly easy thing to do. If you’re familiar at all with accounting or if you ever check out the balance sheet of a company before you invest in it (which you shouldalwaysdo by the way) then you’ll know exactly where I’m coming from. All we’re talking about here is a balance sheet for your household:
If you look at the above you’ll see that you can create this spreadsheet easily in Excel or in Google Drive. If you don’t want to do it manually you can always use your Mint.com account to review it, although it’s always helpful to do it yourself and really see what you’re working with. What you’re looking to do is figure out what exactly you have in Assets and Liabilities (debt!). The assets side is easy enough: what do you have in your bank accounts, your 401K and other retirement and investment accounts. You should also count the value of your rapidly depreciating car (arguably the item that will drop the most on a month to month basis) and the value of your home, if you have purchased a house. When trying to value your house I would use both Zillow.com and Cyberhomes.com to get an estimate and then take the average of the two. As a note to this, always try to get the estimate around the same time of the month for consistency. I always shoot for the end of each month to give me the best picture of my net worth.
For your liabilities and debt, put your car loans, student loans, home loans, credit cards, accounts payable, deferred taxes and anything else you’ll have to pay over here. This side sucks. But we’ve got to deal with it and recognizing that it sucks is probably one of the first steps to actually reducing it.
Once you’ve put everything into your spreadsheet, just subtract your liabilities from your assets and boom, net worth! Or in my case, negative net worth. But now that you have your net worth, what does it mean? Obviously if it’s negative like mine, you’ve got your work cut out for you. And while a positive net worth is a great goal you still need to have an eventual goal to get past the average net worth for your age and salary bracket. It’s here that I turn to Doctors Thomas Stanley and William Danko, authors of the New York Times Best Seller The Millionaire Next Door. This book is considered one of the most eye opening personal finance books out there because it proved that many millionaires are just frugal, hard working people who save and invest their money wisely. Another idea that came from their research (because their book is based on dozens of studies over a two decade period) is a formula to calculate the average Net Worth by age and salary. Their formula reads as such:
(Pretax Annual Income X Your Age)/ 10 = Average Net Worth
This formula can give us a true number to work towards each year. For example, my number is just a bit over $160K. So, I’m only about $175K off from meeting the average for my age and salary group. Doing this should give you a true goal to work towards with your Net worth and your budgeting.
If you have any other ideas or thoughts on Net Worth and how you can use it to improve your personal finance situation, leave a comment or send me an email!