So last week I talked about assets and liabilities. If you didn’t catch that, go and read that first.
Its important to know about these two things, because they are going to help you with the next part of the discovering the health of your finances equation – YOUR NET WORTH.
If liabilities are your pulse and blood pressure, net worth is whether you’re alive or dead. Quite simply – this is the overall reflection of how well you are doing financially. It is the most basic thing you can track that will instantly tell you how healthy your money is.
You Have Been Warned
I warn you, it may not be a pretty number. Mine has been sub-zero for ages. This is because of two things – the debt I owe (student loan/credit cards etc) and the lack of savings/investments I have. The point I’m making is that now I KNOW about my net worth, I can DO THINGS to improve it. In the last year alone I’ve more than halved the negative number, and I project that by the end of 2018 I will be over and above “0”.
I’m going to show you how you can do the same.
What is net worth?
Your net worth is an overall indicator of how well you are doing financially. So now we have looked at the definitions of assets and liabilities, we can work out your net worth.
This is simply:
The total number of assets you own (remember the house you live in is not included) MINUS (-) the total number of liabilities you own (remember your house is not included here either).
So £10,000 in a pension account – £15,000 credit card debt = net worth = -£5000
Why is knowing this essential? This shows you how healthy your finances are.
If you have a negative number, then you need to make some changes to how you manage money in order to at least get to “0”. What this number is telling you is that you have more money going out than you have coming in, and you have little to no savings (and/or a lot of debt). It seems obvious, but not many people know this.
As teenagers, before going to university, or buying a car for example, our net worth would have been “0” or maybe even a little positive if you had a savings account. Unfortunately, as we get older, we take on more debt for things we want. As I went through medical school, my net worth plummeted to a very negative number, because I suddenly owed the Student Loans Company a lot of money just for the privilege of going to medical school.
Don’t get me wrong, this degree has served me well, and it continues to do so, but I have to recognise it for what it is – a liability because it is detracting away from my income every month. Yes, it has enabled me to earn a higher salary (so on the scheme of liabilities, it’s a good one to have), but it detracts all the same. If you went to uni to do a rubbish degree that you now do nothing with, was it worth it?
That’s why going to uni is not necessarily the right thing to do for everyone.
Don’t let this put you off going to uni though (or put your kids off uni). Student loans can be the stepping stone someone needs to become more educated, and therefore be more open to higher salaries, a better social status, and many long term benefits like learning to live on their own, confidence, a knowledge of the wider world and many more opportunities besides. All I ask is that this is well thought out, and that all options have been explored before throwing future money at a uni degree. If you can set up a savings account for your child now, with the intention of this money going to their education, then even better.
So where should you be at your stage of life?
There are quite a few ideas on the internet, and in books like “The Millionaire Next Door”, but I like this adapted version found at www.thesimpledollar.com
(Your Age – the age when you started work +3) times by your income per year (pretax and not including inheritances)
then divide by 10
So mine is:
(32-(24+3)) x £48,000 / 10 = £24,000
Is it there yet? – er, no, but I’m closer to it than I was two years ago, because I’m actively doing things about it and changing my financial situation month by month.
Lets break it down. Until you start earning a salary, there’s no contribution to your net worth, so factor out the first 18-24 years of your life (I graduated medical school at 24).
You’ll also have to allow a few years for your money to adjust once you start earning- so add on around 3 years for when your net worth could have started to be above 0. Your number might be 25 or 21 – it just depends what age you were when you started earning money. I have some catching up to do, so don’t worry if you realise you do too!
Then multiply this by your average pre-tax income (that’s ALL money you bring in – including property and businesses), and divide by 10. Why 10? In theory, your net worth should increase every year by at least 10%. It still makes my brain hurt when I think about it too hard, so just accept for now that your assets/net worth should improve by 10% every year, and you’ll be doing ok!
You might be confused about why your salary is used in this “where you should be” equation, and when we do our calculation at the top of the post (A-L=N), the salary is not something we include (assets are physical things like stocks and shares/property/savings/pensions/businesses etc). The reason for this is because your “estimated net worth” relies on the assumption that you have SAVED some of your money somewhere (savings account/investments etc). In other words, the more you earn, the more you can save and therefore increase your net worth.
So what’s the good news?
Your net worth will probably grow faster than this as you get older – this is due to a sexy phenomenon known as compounding! This makes your investments grow faster with time (pure savings do not, but we’ll come onto this another time). If I made sure that I turned some of my money into good investments, my net worth might grow by 20%+ every year. 20% = 100/5, so you could divide the sum by 5 instead and have a new higher target for yourself.
(32-27) x £48,000 / 5 = £48,000
So as long as my net worth lies somewhere between £24,000-£48,000 while I’m 32, I know I’m doing ok. Don’t panic if you are nowhere near to where you apparently “should be”. I certainly am not, but I know it won’t be like that for much longer. MOST people are in the negative, and will only reach “0” or above when they retire (because they should have paid off their mortgage and other debts by then, especially if they sell their house and downsize).
Scarily, some never get there at all. But now you know how to calculate this number, and why its important to know, you can do things about it.
Bottom line: pay down debt and increase your assets. That’s the key to having a healthy financial life. Seems obvious, but now you have the numbers to back up this statement.
So how will you use this number?
The estimated net worth calculation shows how much money you are bringing in on an annual basis. The higher the net worth, the higher the income, and therefore the more money you have potentially to put into physical assets. When you do this yourself at home, you don’t include your salary as an asset – it has to be translated into something else in order to become an asset, such as an investment property or savings in a stocks and shares account. If you have been skimping on the savings, then your net worth will be LESS than expected.
You could be earning £100,000 per year – but if you haven’t put money into a pension, or savings, or investments, and you have loads of liabilities, you will have a very low net worth. Conversely, you could be earning £30,000, but have no debt and loads of savings, and pay into a pension, and have a buy to let property. Your net worth will be fantastic!
So the way I would look at it is this:
What kind of life do you want? And when do you want it by?
If your goal is to be a multimillionaire with a yacht, security staff and a private island, then your net worth needs to be much bigger than the person who wants a cottage in the country, chickens and a dog called Doug. If you want to retire in comfort (and early), and your net worth is currently negative or 0, then what do you need to put in place so that money comes in from other sources? For example, do you have a pension that you regularly pay into? How big does the pot need to be, and at what age can you start claiming from it? How long will it last once you do retire?
What training do you need? Property? Stocks and Shares Investments? Its certainly a big undertaking and I’m not going to lie to you – it will take a lot of effort on your part to turn this around! If you want it badly enough though, you’ll do what it takes. You don’t have to want to be a glamazon with an entourage like Kim Kardashian or Victoria Beckham (but its ok if you do!). You may just want to know that your retirement and your family are cared for in the future (this is also ok!). Whatever it is, my advice is to pick just one or two areas (such as investing in property or index trackers) that you’re interested in first and learn as much as you can and actually buy some investments in these areas before moving on to something new and shiny.
The first step is knowing how much money per year (and therefore per month) you need so you can achieve whatever lifestyle goal you set your mind to. Let yourself dream about what you would like, and then go out there to make it happen, starting with your money! (Because whether you like it or not, money will help you do whatever you want if you have enough of it) If you want to help others through charity work, help yourself FIRST!
The amount you therefore need is entirely dependent on what you want in life
Well done for getting to the end – I know that was a long post, but I think it is an important lesson to learn.
Let me know in the comments what you discover. Remember – don’t beat yourself up if its not what you were expecting. You have the ability to do something about it now! If you want help with improving your net worth, come over to my Private FREE Facebook Page!
Good luck, and keep working towards your amazing financial goals.
Until next time,