David writes in:
As per your suggestion I have been tracking my net worth over the past year and it has gone upward (good!) in an almost perfectly straight line (bad!). Based on your articles and my own intuition, shouldn’t it be accelerating and going upward in a parabola shape?
Assuming that there is no change in a person’s spending or professional income and assuming that they are spending less than they earn and doing something productive with it, then over a long period of time, yes, that person’s net worth should start to accelerate. As that person pays off debt, he or she will be able to devote more and more money each month to paying off the balance of debts and less and less to paying off interest. Eventually, that debt is gone and that money goes toward investments, which start to grow on their own as the returns on your investments are reinvested and begin to earn on their own…
That’s not happening in David’s case, though. Why not?
Without knowing more about David’s story, I can’t 100% diagnose exactly what’s happening, but there are usually a few things going on when a person is expecting their net worth to grow rapidly and it’s not.
Let’s see if we can figure out what’s going on with David’s story, and perhaps, along the way, uncover how anyone can accelerate their net worth growth.
Are You Calculating Net Worth Correctly?
Calculating net worth is really simple. All you do is add up the value of all of your assets – your home, your cars, your valuable possessions, the balances of your checking and savings and investment accounts – and subtract from that the amount of all of your debts – your student loans, your mortgage, your car loans, and so on. Easy enough, right?
The trick, of course, is making sure that you’re covering everything in this calculation and calculating them accurately. For example, if you own your own home, getting an accurate read on the value of that building can be tricky. You can rely on tools like Zillow to give you an estimate, but it’s imperfect. The same goes for your car – it’s a ballpark estimate at best and your car is constantly depreciating to boot.
My solution? I simply calculate my net worth once every three months, attempting to get a fresh new estimate on our home value and the value of our cars. I’ve been doing this for more than ten years, and aside from a couple of bumpy quarters, we’ve always beaten the previous quarter, often matching the percentage growth of the previous quarter.
Are You Still Spending Less Than You Earn?
If you’re sure that you’re calculating your net worth correctly, you need to move on to some bigger questions, like whether or not you’re still spending less than you earn. If your net worth is only going up at a slow rate – or going down – then the culprit is likely that you’re spending almost as much as you bring in (or more).
If you want your net worth to grow, you have to be spending less than you earn. If you want it to grow at any sort of impressive rate, you have to be spending a lot less than you earn. There’s no magic trick. There’s no secret. If you want to build wealth – and net worth is about as good of a measure of personal wealth as there is – you have to spend substantially less than you earn.
Figure out what you’re spending If you’re not sure whether you’re actually doing that or not… well, you’ve uncovered the first big problem! Sit down for a moment and figure out exactly how much income you brought home in the last month, then look at your bank statements and your credit card statements and see how much you’re spending over that same period. If those numbers are pretty close to each other, your net worth isn’t going to be growing very quickly at all.
The truth is that if you want to see big long-term changes in your financial state, you’re going to have to do something different than that. There are a lot of approaches to this age old problem.
Start a budget. Budgeting can be a pretty intimidating thing for most people, as it involves having to categorize all of the spending that you do and then use that data to set healthy spending targets for all of the different spending areas in your life. Thankfully, there are a number of apps out there that make this easy.
My favorite for years has been You Need a Budget 4th Edition, which does a splendid job of helping people enter expenses categorize them, and then use those results to make a useful spending plan for the month to come. They also offer a cloud-based version.
Another option is Mint, which does a good job of syncing with all of your accounts and providing a singular view of your finances, but often incorporates “offers” into your financial views that can guide you to some less-than-optimal spending choices. Ignore those and Mint is a great tool.
Quicken is the “grandaddy” of these types of software packages and is probably the most feature-rich of the lot.
I don’t have a strong recommendation among them aside from saying that You Need a Budget has always met my needs well when I outgrew my own homemade do-it-yourself spreadsheet.
Put a strong cap on your non-essential spending. Once you’ve assembled a budget using your real spending data, the key thing that it provides for you is some guidance on where your money is actually going. In truth, it tends to go into two areas – essential spending and non-essential spending. Most of your cuts are going to come from the non-essential side, and it won’t be easy.
This is where frugality pops in. Frugality is all about getting the maximum value for your dollar, no matter how or where you use it. When you start putting caps on your spending, you’ll have to start looking for more effective ways to get the things you enjoy in life. Try exploring store brand versions of the things you ordinarily buy. Seek out free and low cost hobbies, particularly alternate versions of the things you already do, like checking out books from the library instead of using the bookstore.
What About Your Income?
If you look at the question of “spending less than you earn” from the other side of the coin, you’ll recognize that your income also plays a vital role in things. The more you earn, after all, the easier it becomes to spend less than you’re bringing in and the easier it is to have a nice gap between the two numbers. If you increase your income without increasing your spending, suddenly you have a lot more money with which to pay down debts and invest for the future and your net worth is going to take off like a rocket ship.
Of course, improving your income isn’t as easy as flipping a switch. There are really two ways to improve your income: improve your hourly rate for the time you’re currently working or work more hours.
Improving your hourly rate This centers around moving forward in your current career, whether that comes in the form of a raise at your current job, a promotion in your current workplace, or a new job entirely. Each of those opportunities requires a different path.
Getting a raise If you have a few good performance reviews in your pocket and you can point to projects that you helped bring to a successful conclusion, you’re probably ready for this step. If not, work on really nailing a performance review or two.
Once you have a clear paper trail of success, sit down with your supervisor and work out a plan that will lead you to getting a significant raise beyond merely your typical annual cost of living raise. In many workplaces, this might take the form of an extra jump in a standardized pay grid, for example. Don’t go in with the approach that this raise should just be handed to you – instead, look for what you can do to make this raise easily justifiable for your boss, as he or she is likely to have to justify it to their boss, too. This plan might involve more education, another good performance review, or some other standard that you and your supervisor can agree upon.
Getting a promotion This varies quite a lot depending on the internal mechanisms for promotion in your workplace, but you need to make it your objective to make sure you hit every requirement needed for that promotion. This is something you can start on today – identify the promotion you want and start hammering out the things you need to have to move into that better position.
Getting a new job This centers around two things: bolstering your resume so that you appear to be a good candidate for the job you desire and building relationships with people who might be able to help you get that new job. Start by looking at job listings for the type of job you’d like to have and then make it your goal to perfectly match those requirements. At the same time, start building relationships with other people in your field, both in your current workplace and in your city or local area. Are there any professional groups or professional meetings you can start attending and getting involved with?
The other alternative, of course, is to work more hours, whether that takes the form of a part time job or a side hustle. Both paths lead toward more income, but at the cost of hours that you could be spending on other things.
Has Your Spending Level Changed?
If your net worth is staying level as you’re paying down debt, then there must be some sort of change going on in your spending habits elsewhere. What exactly are you doing with your money?
One of the biggest temptations that people face as they move through their financial lives is handling lifestyle inflation. When you have a few extra dollars in your checking account, it’s so easy to just spend it on something on the spur of the moment – a cup of coffee, a little treat, a meal at a restaurant.
The trick, of course, is that if you do it once or twice or three times in short order, it goes from being a treat to being a normal routine. Your day starts with that $5 latte. Going out to eat or grabbing takeout becomes the norm, rather than making a simple meal at home.
At that point, the more expensive routine becomes the normal routine and the baseline cost of your life just went up.
If you find that you’re barely making ends meet, especially after just receiving a raise, look for instances of lifestyle inflation. What things do you do routinely that you didn’t do a few years ago? What things do you do routinely that have a less expensive alternative? What things do you buy routinely that have a less expensive alternative?
Explore those alternatives. Look for ways to wind back the clock on your lifestyle inflation. Try eliminating, cutting back on, or finding alternatives for those things you’ve uncovered. You may just find that they’re not really contributing all that much to your life, but they are contributing to your financial difficulties.
Are You Doing Something Smart with the Excess?
Another reason that your net worth might not be accelerating is that you’re not doing anything smart with the difference between what you earn and what you spend. If that money is just sitting in a checking account somewhere, it’s not going to help you accelerate the growth of your net worth. Instead, try these approaches.
Maintain a reasonably sized emergency fund. You should have some cash set aside for emergencies, but it should be just a reasonable amount – somewhere around one month of living expenses for your family for each dependent you have. Having this cash on hand will greatly minimize the negative impact on your finances from unexpected events.
Pay off your debts in a reasonable and logical fashion. The most sensible approach to paying off your debts is to make minimum payments on all of your debts, then the largest possible extra payment on whichever debt has the highest interest rate. This will ensure that you’re minimizing the amount of interest you owe next month.
Once you have your high interest debts (everything over 10% interest) paid off, start contributing to your other goals. Put some money aside for retirement each paycheck, whether in the 401(k) or 403(b) plan at work or in your own Roth IRA. Don’t get overly stressed about what particular investment to choose – just choose the Target Retirement Fund closest to the year in which you’ll turn 65. That’s easy enough.
The best part? The money you put aside for retirement will slowly accelerate as the investments earn a dividend and then that dividend is rolled right back into the investment, meaning next time it’ll earn a little more dividend… and then a little more… and then a little more!
If you make those moves in order without accumulating any new debt, you’ll find that your net worth should be accelerating in the right direction.
Are You Doing All of These Things Consistently?
The true key to financial success isn’t doing all of these things once. It’s doing all of these things consistently over an extended period of time – years and decades. Spend less than you earn. Invest the difference by building up an emergency fund, then paying off high interest debt, then investing for the future. If you’re doing that over and over again, every quarter, every year, every decade, your net worth will accelerate.
The key is consistency. Automate as much of this as you can. Set up an automatic contribution to your emergency fund. Set up an automatic contribution to your 401(k) or 403(b) or Roth IRA. Pay as many of your bills as automatically as you can. Set aside some money automatically into your savings each month so that you’ll make a big extra payment on your highest interest debt. The key is to never give yourself a chance to make a dumb spending move.
You can carry that thinking forward into moves like cutting up your credit card (or at least hiding it away), deleting your credit card number from online accounts, and choosing to simply avoid places where you might spend money during your leisure time.
Taken together, those steps will automatically ensure that you’re spending less money and putting those extra dollars into smarter places.
The individual steps needed to make your net worth take off like a rocket aren’t hard. The trick is actually making them happen in your life, and doing lots of them at once. It’s the people who manage to succeed at pulling off several of those simple steps at once that manage to see great results when it comes to their net worth, and they begin to quickly see the kind of acceleration promised by the power of compound interest.
You’ll see it for yourself with just a little more focus on making smart choices with your spending and then putting that extra money aside for your future.