Once you’ve mastered tracking your spending, another actionable step for getting your financial house in order is to track your net worth. What’s the fun in reducing your spending, increasing your earnings, and investing the difference if you can’t see your progress? Right?
Assets vs Liabilities
One way to think about net worth is to place what you own or owe into 1 of 2 categories, assets and liabilities. Assets are things that pay you money, while liabilities are things that cost you money. When your assets are greater than your liabilities, you have a positive net worth and vice versa.
Regardless of whether you’re in the black or in the red, knowing this information is incredibly valuable. If your net worth is positive, you know the systems you have in place are working. At this stage, an important question to ask yourself is, “Can my income-generating processes be better-optimized?” Just because you have a positive net worth, doesn’t mean your investing process can’t be improved upon.
Avoid “Resulting” When Analyzing Your Portfolio
Looking at a positive net worth and thinking that your investment philosophy is without flaw could be an example of what author, Annie Duke, in her book,Thinking in Bets, calls “resulting.” [1] This occurs when one looks at the result of a process, as opposed to the process itself, to determine if the process is good or bad.
An example of this is someone who becomes a millionaire because he won the lottery. Spending $50 each week on lottery tickets is a flawed process for achieving financial well-being, despite the positive outcome of winning the lottery and subsequently becoming a millionaire. Although the outcome for this gentleman was a good one, this process wouldn’t be advisable for most people.
A Negative Net Worth Needs a Financial Overhaul
If your net worth is negative and you find yourself accelerating toward an even worse situation, you know there’s a serious problem. The good news is, you’ve taken the first step toward correcting this problem by actually acknowledging that it exists.
At this point, it is time to start thinking about actionable steps to reverse this trajectory. This might occur by cutting out your frivolous expenses, selling your expensive car, moving to a more modest home, getting a second job, asking your adult children who are still living at home to pay rent, etc. No matter what approach you decide, the key is to make a plan and take action.
The Holy Grail: Financial Independence
A few financial ninjas are in the position where the income generated by their assets earn more than what they spend on their liabilities. These people make money by doing nothing–as their assets are doing all the work passively. This places them into the Holy Grail of financial categories known as Financial Independence or (FI).
When a person is FI, they no longer work because they have to, they work because they want to. Earning money is no longer a necessity, it’s a bonus. Not only is their net worth positive, it is distributed in such a way that their assets can support them into perpetuity. FI buys you your freedom–the freedom to do what you want, when you want to, on your terms. I’ll take that over a boat any day.
Net Worth Apps
So how can we develop a habit of tracking our net worth so we too can reach FI? This can easily be accomplished by using a free app like Personal Capital. If Mint reigns supreme when tracking your spending, Personal Capital takes the gold when tracking net worth. It’s easy to use, has a fantastic user interface, and basically requires the same info that you’ve already logged into Mint.
Tracking your net worth on a weekly, monthly, and annual basis will allow you to make sure your financial goals are being reached. If you consistently fall short, you are now armed with the data needed to make the necessary adjustments. Remember, these adjustments aren’t hard to make as there are only 3 variables to consider:
Earn more
Spend less
Learn how to better invest the difference
Optimizing your ability to pull these three levers on a regular basis will undoubtedly send your net worth in a more positive trajectory. Since variables 1 and 3 are a bit tricky to refine, I suggest starting out with variable 2 as spending less is an actionable step that can be implemented right away.
Remember the winning formula for a positive net worth has always been and will always be:
Earn More + Spend Less + Invest the Difference = Financial Well-being
I wished we learned that in Math class!
How about you? What methods have worked well for you when tracking your net worth?`
References:
Duke, A. (2019). Thinking in Bets: Making Smarter Decisions when You Don't Have All the Facts. Portfolio.