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The Most Important Number
The most important number when it comes to personal finance isn’t how much you’re going to need to retire or the current rate of inflation or how well the Dow Jones Industrial Average or the S&P 500 did last year. Those numbers are important in various ways, don’t get me wrong, but they don’t completely express the state of your personal finances.
Instead, the most important number for your personal finances is your net worth. That’s the one number that matters more than anything else in terms of tracking your financial progress. Assuming you are of working age and have some form of income, your goal should always be to increase your net worth – each month, each year, and each decade.
What Is Net Worth?
In simplest terms, your net worth is the total of all of your assets minus the total of all of your debts. It represents the money you’d have left if you paid off all of your debts right this moment.
Calculating your net worth is easy. All you do is make two lists. One list has all of your accounts that have money in them – like your savings account, your checking account, your 401(k), your Roth IRA, and so on – and any assets you have that have significant value, like your home, your automobiles, any collectibles you might have, and so on. For each item on that list, list the current value of that item. The second list is just a list of all of your debts and, for each item on that list, write down the current level of that debt.
Add up each list, then subtract the total debts from the total assets. That’s your net worth. If you’re familiar with using spreadsheet programs, they’re basically designed for these kinds of calculations.
I encourage you to calculate this regularly. I currently do it on a quarterly basis. In the past, I’ve done it on a monthly basis. I keep my past calculations stored away on my computer on a spreadsheet file, and I use a spreadsheet when recalculating my net worth every three months.
Why do it regularly? Much of the value in calculating one’s net worth is so that you can compare it to how you were doing in the past.
Sometimes people have a negative net worth – and that’s okay. Recent college graduates who leave school with a pile of student loans will have a negative net worth. Sometimes, people who are just starting to really figure out their finances after a period of drastic overspending will have a negative net worth. Don’t get too worried about it. What really matters is that your net worth goes up over time.
Why Is It Important?
There are several reasons why I put one’s net worth as perhaps the most important single financial number for each person.
1. It provides a very clear and simple picture of your financial state in one number.
It’s amazing how just one number – and the history of that number over time – can tell you so much about how you spend your time and your money.
The number itself tells you exactly how much you’d have if you emptied out all of your accounts, liquidated everything, paid off all of your debts, and accumulated that cash in one spot. A friend of mine says it’s her “run away money” that she would be able to get if she just got fed up with everything, which is certainly a colorful way to illustrate it.
Over time, the change in that number means even more. It indicates positive (and potentially negative) financial growth in your life. It shows you how far you’ve come when you look back at earlier numbers. It can also show you the impact of the changes you’ve made in your life… though it can be a little “noisy” since everything in your life impacts that number.
2. Moves you can make that improve your net worth are almost always good ones.
In general, if a financial move is a good idea, it’s going to have a positive impact on your net worth.
If you’re frugal, your net worth will go up. That happens because you’re leaving more money in your checking account instead of spending it on things that have very little or no cash value (like travel or food or stuff you can’t resell without taking a big loss).
If you work hard and make more money, your net worth will go up. Again, that’s because you’re putting more right into your checking account.
If you pay down debt, your net worth will go up. This is more of a “gradual” improvement, however, because what you’re doing is just eliminating interest payments, which means more money stays in your checking account.
If you invest your money, your net worth will usually go up. Your investments will increase in value and return dividends, both of which bolster your net worth.
3. Similarly, moves that decrease your net worth are almost always bad ones in terms of your finances.
If you make a move that decreases your net worth, it’s generally a poor financial move. That’s not perfectly true, of course, because spending money on the basic necessities of life like food and hygiene and clothing cause your net worth to decrease and that’s not really a mistake, but most other moves that bring about a net worth drop are.
If you spend your money on something that you just consume or can’t re-sell, your net worth goes down. Again, if it’s for basic necessities, that’s something you have to do, but many expenses in life aren’t just basic necessities.
If you go into debt, your net worth (usually) goes down. Note that I said usually, because there are rare situations where debt can actually increase your net worth, but the vast majority of consumer debt just hurts you.
If you “lend” money to your deadbeat brother who will never repay you, your net worth goes down. Loaning money to people who won’t repay you is the same as watching it blow away in the wind. Never loan money to family – it’s one of my core financial rules.
4. It’s a great way to measure your own financial progress over time – and that progress is really the only financial progress that matters.
To me, this is the biggest reason why net worth is incredibly valuable. It allows you to compare your current state to your past state.
Let’s say, right now, you calculate your net worth. Then, in three months, you calculate it again. Right there, just by comparing those two numbers, you can check your financial progress over the course of those three months.
There’s no lying or telling yourself that you’re doing well. There’s no misdirection or hiding mistakes. Assuming you calculate your net worth honestly, it’ll tell you the honest truth about how you’re doing, good or bad.
I love comparing my net worth year over year, just to see how things have progressed. I also like doing a few interesting calculations with it, as I’ll discuss below.
5. It puts the focus on your own behavior, as the only person you have to claim victory over is yourself.
Human competition is natural. We do it instinctively all the time whether we directly notice it or not.
That competition often gets us in financial trouble. When we see someone else having something, we want to have that “something,” too.
If you maintain a history of your net worth, you already have a shining example of someone to compete against – your past self. Instead of worrying about keeping up with the Joneses and their shiny new car, you can worry about beating your net worth from last year or last quarter. Even better, you can focus on trouncing that old net worth number.
That record gives you competition, and many of us thrive on competition. This is a great kind of competition, too, as it points us on a very healthy financial trajectory.
Putting Things in “Net Worth Perspective”
One of the biggest mental shifts I’ve made during my financial turnaround was to start putting all of my finances into what I call “net worth perspective.” One major part of how I judge the expenses in my life is in terms of how they’ll affect my net worth. It’s also a part of how I judge the ways I spend my time and my energy.
Here are six simple calculations that I use, based upon my net worth, to get a better picture of how I’m spending my time.
Assets Alone and Debts Alone
Sometimes, a really good year for your investments can cover up the fact that you let your debt situation get a little out of control. Or, perhaps you threw everything into your debt payoffs but didn’t even bother to refill that emergency fund after you tapped it for a car repair.
Looking at just your assets or just your debts can reveal these things, especially when you compare them year over year.
Normally, your assets should be going up. If they’re not, that’s a sign that you need to investigate and figure out why things went down and if you need to do anything about it (probably, you do).
At the same time, your debts should be going down over the course of a quarter or a year. If they’re not, then you have another problem that you need to be looking into and figuring out why things aren’t getting better.
These aren’t indications of disaster, but they can be signs that things are out of whack and potentially heading toward a disastrous situation. Consider it an “early warning sign.”
Years to Debt Freedom
This is a valuable calculation to make if you still have debts and want to someday be free from personal debt.
Take the total value of your debts at the start of the year and the total value of your debts at the end of the year. Subtract the end value from the start value, then divide your end value by this new number. That will tell you how many years you should expect to have to spend until you’re completely free of debt.
For example, let’s say your total debt at the start of the year was $200,000 and at the end of the year it was $175,000. That’s great progress! Now, subtract $175,000 from $200,000 and you get $25,000 – that’s how much debt you paid off this year. Divide $175,000 – the debt you have now – by $25,000 – the debt you’re paying off per year – and you get a result of 7 years. That’s how long it will be, at your current pace, until you’re free from debt.
I used this number as a strong motivator during my years of working toward debt freedom. My goal each year was to lower that number by two. So, at the end of one year, I might calculate that I had 6 years left until debt freedom. My goal by the end of the next year would be to reduce that number to 4 years until debt freedom. It was that kind of lightning focus that led us to total debt freedom – including our mortgage – in 2011.
Net Worth Improvement Per Hour of Work
Let’s say, over the course of a year, I see that my net worth has increased by $20,000. However, over that same year, I’ve worked about 50 hours a week for about 50 weeks. That means I’ve worked 2,500 hours this year.
By doing some simple division, I can see that I’ve only improved my net worth by $8 for every hour I’ve spent working in this past year. Every hour I’ve spent working on a tough project or holed up reading emails instead of working, I’ve only retained $8 for that effort.
Basically, the more hours I work, the lower this number goes. The less careful I am with my money, the lower this number goes. I can only make it go up year over year if I work and spend smarter.
This is actually the number I most want to increase these days. If I am truly working to build a better financial future for myself while also being engaged with my loved ones and closest friends and personal interests, then I want this number to be as high as possible. Each hour I work needs to be a smart, undistracted, and productive hour. Each dollar I spend needs to be a wise dollar spent.
Years to Destination
This calculation requires both your income and the amount you actually spend each year, both of which are essentially parts of your net worth calculation.
Let’s say I make $50,000 a year, but I know that I actually save $20,000 of that, so my actual expenses are $30,000 a year. I also know that one can live on their investments for a very long time – likely far longer than you’ll live – if you only withdraw 4% of your balance each year, because your investment growth should cover that plus inflation.
Given those two numbers, you just divide $30,000 by 0.04 to get how high your net worth would have to be for you to retire – in this case, $750,000. Now, that number isn’t perfect. It’s actually on the low side because it includes things like the value of your home, which you would never realistically sell, so I usually add to that number the value of any assets I wouldn’t sell in retirement, like my home and my car. This leaves me somewhere close to $1 million.
The next thing I do is figure out how much my net worth changed in the past year. Let’s say it went from $200,000 to $225,000 – an increase of $25,000. I then subtract my current net worth from my target net worth – subtracting $225,000 from $1 million – to determine how much more I need to save. That’s $775,000. I divide that by how much I’m increasing each year – $25,000 – and I see that it’s going to take 31 years at this current rate to get to where I want to be.
I want that number to be lower – as low as possible, in fact, so I use this number as inspiration to move toward my dreams. I want that number to drop by as much as possible each year.
The Value of Your Working Life
This is a number I use to remind myself of how little I actually earn for the time I’ve worked in my life.
Basically, I do a rough calculation of the number of hours I’ve worked in my adult life, starting at my college graduation. You can do this by multiplying the number of years you’ve been actively employed by 2,000, which is how many hours you’d work if you worked 40 hours a week for 50 weeks per year, and adjusting according to your own experiences. I came up with a number in the 25,000 range.
Given that, let’s say my current net worth is $100,000. That would mean that for every hour I’ve worked in my adult life, I’ve only got $4 to show for it in this world. That’s it.
This really is a painful realization of how wasteful I’ve been with my money. All of the rest of my income beyond the $4 per hour mark has just vanished into the ether, on stuff with little or no value and on memories that are mostly forgotten. That’s a big legacy of wasted resources, a legacy I have no interest whatsoever in continuing.
That $4 an hour rate is a call to do better. I want my working life to have produced significant value for me, far beyond minimum wage. $4 an hour means that there’s a long way to go and, as we saw with the discussion of net worth above, there’s a lot of ways to improve things.
Time to get to work.
Acceleration, or Improving Your Improvement
Let’s say that in 2010, I calculated my net worth and it was $100,000. In 2011, I calculated it again and it was $115,000. In 2012, I calculated it again and it was $135,000.
So, from 2010 to 2011, my net worth improved by $15,000 and from 2011 to 2012, it improved by $20,000.
In other words, in the second year, my net worth improvement increased by $5,000.
I view that kind of change as incredibly valuable. I refer to it as net worth “acceleration,” because, much like real world acceleration, the more you accelerate, the faster you go.
Let’s say I make it a goal to maintain that $5,000 a year net worth acceleration. That would mean from 2012 to 2013, I would want my net worth to improve by $25,000 – the $20,000 increase of 2011 to 2012 plus the $5,000 in “net worth acceleration.” I’d want to finish that year at $160,000.
How does one “accelerate” their net worth? The best way is to improve your income without acquiring new debts or expenses. If you can increase your pay without increasing your standard of living, it’s very likely that you will experience some degree of net worth acceleration.
The main purpose of figuring your net worth and putting that number through these kinds of numerical gymnastics is so that you can look at your life from a lot of different angles.
You can look at your goals. You can identify areas of needed improvement. You can identify potential problems. You can see the forward progress you’ve made, as well as the great distance you still have to go. You can see methods for making the changes you want happen faster and faster.
All it takes is a piece of paper, a pencil, and some time to run the numbers. It also takes some real time and thought to recognize what those numbers mean.
Sometimes, they can be uplifting and show you how far you’ve really come and how you really are marching toward your big dreams. Sometimes, they can show you how you’re making missteps and really demonstrate how far you still have to go.
Both are valuable. Both are incredibly useful. And both start with the simple calculation of your net worth.
It may just be one number, but it represents a great deal of our financial state in one simple form.