Episode 72 - Net Worth – how and why

Remember back in your school days where every few weeks you’d have a test, then at the end of the year there would be an exam. I have kids in high school now and I can tell you the framework hasn’t changed.

So why all this measurement? It’s all about assessing progress.

If you get a test result back and it’s 8/20, you know you’ve got to pull your finger out before the year-end exam rolls around. In the absence of that test result you may have floated along thinking you had that topic well covered.

And the exam serves to confirm that you’ve learnt enough of the material to progress on to the next stage of learning. Without that assessment of progress, students could move up to concepts of higher complexity, without the foundational knowledge required for it to make sense.

The take away here is that if you want to improve on something you first need to know your starting position, then you measure at regular intervals to monitor progress. The feedback this monitoring provides is essential to enable you to know where to focus, and course correct as needed.

In a personal finance context, the way you do this by determining your Net Worth. So in this episode we’re going to look at how you get that done, and then how you can use this measurement to propel you towards Financial Autonomy and the choices in life that you deserve.

 

Let’s start with the how. It’s really pretty easy.

Step 1 – list all of your assets, with their dollar values next to them. So your car, money in the bank, retirement savings, home etc. I wouldn’t bother going down to things like furniture and jewellery, which are pretty hard to value and possibly unsellable anyhow.

Now add up the value of all of your assets.

Step 2 – do the same thing for all of your debts – credit cards, mortgage, car loan, etc.

Once again, add up the total.

Step 3 – Subtract the total debt number from your total asset number. The result is your Net Worth.

 

Net Worth calculation example:

ASSETS

 

Home

$825,000

Car

$13,000

Superannuation

$135,000

Money in bank

$6,800

Shares

$14,000

   

TOTAL ASSETS

$993,800

   

DEBTS

 

Mortgage

$640,000

Credit card

$2,300

   

TOTAL DEBTS

$642,300

   

NET WORTH (ASSETS - DEBTS)

$351,500

 

The first thing to establish is that your Net Worth number is a positive one. This means you have more assets than debts. If you do come up with a negative number, then your goal becomes crystal clear – get that negative down, and move to a positive net worth position. This will mean getting debt paid down. A negative net worth means you’ve borrowed to spend, but that spending hasn’t produced any assets. So the money has gone on clothes or travel for instance.

For most people, you will get a positive Net Worth number. So what’s next? Well in isolation, it’s just an interesting number. But where the Net Worth calculation becomes useful, is in how it changes over time. There is no particular ideal number (so long as it’s positive). Happiness comes from achieving your particular goals and the financial requirements of your goals are unique.

(Just a slight aside, understanding the Net Worth you need to achieve your goals is determined through financial modelling. This is something we do for most of our clients, so if you need help with this bit, visit the Work with Paul page to find out more.)

So recalculate your Net Worth number at regular intervals – at least once a year, and then compare it to your previous results. You will be able to see in one clear and concise number the progress you’ve made in building your financial resources.

Monitoring this progress in your Net Worth can have several benefits.

I think the most important is providing you with feedback that you are making progress. Building wealth is a slog and it takes time. Often your main focus is paying down debt, which doesn’t come with a lot of fireworks type celebrations. But if you calculate your Net Worth number every 3 months, and can see it rising steadily, you’re getting the positive feedback, which will help you stick with your plan.

Monitoring progress will also allow for course corrections. Some people have home loan facilities where they put all of their living costs on a credit card, and all their wage goes onto their mortgage. Then once a month, the credit card is paid off via a deduction from the mortgage. Now the people that sell these packages can show how it delivers a great result over time through savings on interest on the home loan. But I’ve seen plenty of people who actually end up making no progress in building wealth, because there’s no brakes on their spending, the credit card just magically gets repaid, but what they miss is that their home loan doesn’t go down like it should. Sometimes it even goes up.

Now if you monitored your Net Worth every 3 or 6 months, you’d fairly quickly recognise that this scheme isn’t working for you. However most people don’t notice for years because they only get a home loan statement 6 monthly at best, and quite possibly don’t open it anyway.

You can also build milestones into your Net Worth monitoring. Let’s say your big goal was around retirement, and you’ve determined that in order to retire, you needed a Net Worth of $2million. Well breaking through the $1million mark is certainly a good reason for a celebration. And you could of course pick other points along the way to celebrate and recognise your progress.

Calculating your Net Worth on a regular basis is an essential foundation stone in achieving your financial autonomy goals. So get cracking!