Net Worth is a pretty easy concept for people to wrap their minds around.
What Net Worth Theoretically Is
Your Net Worth is the amount left over after you sell non-essential things and you pay off any debts you owe.
A lot of people would say that you just sell everything, but that gives a really distorted picture of what’s really going on and leads people to make stupid decisions.
I don’t really want to go into why only non-essentials get sold, please just accept it. You aren’t going to sell your toothpaste, your soap, your cars, your house, or anything else you use every day when doing these calculations.
If there are amounts owed attached to anything you use every day, you are still required to pay those off as part of the calculations.
Just list off things you can sell and how much you get for them under an assets column and things you have to pay off under a liabilities column and then do some adding and subtracting.
- 401k = 10,000
- Cash = 5,000
- Home Loan = 300,000
- Student Loans = 50,000
- Car Loans = 30,000
Total net worth in this scenario is -365,000.
This is not an example of somebody that has a high net worth.
Sigh, there is definitely going to be an objection here. If you have a house that is worth 400,000 more than you still owe on it, you are going to claim your net worth is positive.
Until that gain is locked in, you aren’t. If you sell it and take the extra 400,000 and put it in stocks and get another home loan for 300,000 then I will let you count yourself as having a positive net worth. Not before then. Until then, you shouldn’t count your net worth as positive either.
What Is Net Worth, Really?
In a more real sense, Net Worth is your ability to buy time.
Either your own time, how long you can live into the future without having to do any more work for money, or somebody else’s time, how long you can pay other people to work to your benefit.
If you owe a huge amount on a house and it isn’t sold and you don’t have the cash on hand, then you aren’t going to be sailing off into the sunset. You are tied down by your loans until you have the cash in hand to pay them off.
If you have 400k equity in your house, that isn’t paying your bills. You aren’t able to live off that without working. You never know, you might not be able to sell your house and all that equity you think you have might be imaginary. When you sell your house, that’s when it is counted, not before.
Why Should I Care About Net Worth?
Statistically, you are somewhat likely to get to a point during your working years where you have to care about it. If you get disabled and have to stop working for a while, your ability to buy time becomes quite important. For women, this might mean pregnancy. A lot of women end up taking unpaid time off from work due to pregnancy and child rearing. Men can take extended unpaid time off from work for child related stuff too.
It could also mean that you get injured or sick and you need time to recover.
It could also mean you get sick and there just plain is no recovery. Then there is retirement. You could have to live the rest of your life based on your current net worth.
Pay Your Future Self
Every month, do it.
What I am rather fond of suggesting is that you should try to keep your expenses pretty low so that you have some decent cash in your bank account at the end of the month and then spend at least half on increasing your net worth.
People really like their ability to live it up now. They want to have an amount every month they can waste on improving their current standard of living. The above plan gives them that.
The biggest thing that takes away from that is having high fixed expenses. Borrowing for cars and houses cuts inordinately into how much you have left over after you have made all your minimum payments and it causes you to build net worth really slowly.
Where your net worth really starts going up is when you invest out of your free cash flow, the amount after expenses are paid.
The secret of people that are really rich is that they are investing heavily out of their free cash flow. That means they have free cash flow, they are making significantly more than they are spending on bills. They are taking that overage and getting interest on it.
Anyone that wants to be rich should try to do just that. To make significantly more than they spend to survive and to invest a large percentage of the difference between what they make and what they spend.
Where You Really Want To Be
The best place to end up has this description:
- You have a large amount invested
- Those investments are paying you in cash
- The amount you are getting paid on your investments is significantly more than your expenses
If that is the case, you can buy yourself infinite time.
You CAN get there too. This is a realistic goal for most people. It does require sacrifice, though. Only a few people can live like a king and still get there. Many more can live reasonably and get there, if they choose to.
You almost definitely can’t get there without putting at least 1000/m to your net worth. Not unless you want to move to a 3rd world country for your retirement. The cost of living in first world countries is just too high.
You most likely need to be putting more like 2000/m to your net worth if you want to pull this off in a first world country. Only a very small percentage of people can pull this off while living like kings throughout their working years.
The more you put in and the earlier you do it, the more you get luck on your side in terms of having better than average investment gains and getting to the end point sooner or at all.