Net Worth = Assets - Liabilities
Pretty straight forward stuff here.
Add up the present value of the following categories to find the present value of your assets:
Then Subtract the above "asset" amount by what you owe, or your liabilities:
Net Worth (at time of calculation) = Assets (present value) - Outstanding Liabilities
Net Worth Is Timestamped
In other words, it is snapshot. It is unique to when you calculate it.
Consider a 10% increase in equities, or a hit on local real estate by 15% this year. That will dramatically effect your inputs into the net worth equation.
Just because you got to a point where your net worth crosses a certain threshold does not mean you will stay there forever.
The present value of your net worth is very transient. It is based on both individual behavior and market behavior.
Finally saved enough to cross into six-figure net worth, then went out and purchased a speed boat... guess what... you can likely say goodbye to that six-figure net worth. Why? Because you purchased a depreciating asset (unless you can find another dummy to pay as much or more than you originally paid for it).
The purchase of depreciating asset is nearly as bad as any other liabilities. There present value will most likely be much higher than their future value. When you purchase that speed boat for $100k and sell it down the road for $40k (if you're lucky), you have lost $60k of net worth in the process of owning that boat. What's worse, if you would have instead invested that $100k in a low cost index fund for the 10 years, instead of owning the boat, you could have $215,892 in 10 years assuming an 8% annual return (take a little more off for taxes on long-term gains of course). In reality, that makes the purchase of a boat, otherwise held for 10 years, a total cost of $175,892 - the loss of $60k in value of the boat over 10 years plus the loss of investment income of $100k invested over 10 years assuming 8% return.
So What "Should" I Be Worth?
My favorite simple equation for determining how much you "should" be worth is based on annual income and your age. It comes directly from the book The Millionaire Next Door by Thomas Stanley.
Expected Net Worth = (Age x Pre-tax Annual Household Income)/10
I really like how this equation actually provides an excellent reflection of your spending vs. accumulating behavior to date.
Essentially, if you make $600,000 a year and you are 50 years old, with a present net worth of $450,000, you are actually a fairly poor accumulator of wealth. Per Stanley's equation, you should be worth $3 million!
Tell us what you think in the comments below. Are you worth what you should be? Are you now motivated to save and invest even more than you already have?!
Earn Big. Make More Money. Be More Valuable. Or...
Many advocate of financial freedom discuss earning more, making more, creating more.
We need to draw a hard line between making more and accumulating more. There is a huge difference between the making and accumulating if one is not frugal and thrifty.
If you would make more and spend more, you would be a poor accumulator of wealth. On the other hand, if you were able to make more and save more, you would be a good accumulator of wealth.
Increasing your net worth is simple. It requires that you become a good accumulator of wealth. It does not mean that you earn a high income and spend everything you make because despite your facade of high social status, you are essentially poor from a net worth perspective.
Word of caution, more income is not always better. You could certainly be a good accumulator of wealth and not have a high income, especially if you practice frugality.
Here are some questions to ask yourself surrounding the concept of more income:
If we are always focused on productivity and output, we may miss the very things that are right in front of us. Further, many activities listed above (exercise, sleep, nutrition, meditation, cognitive challenges) are actually scientifically proven to improve BDNF and neuroplasticity thus making our brains even more productive.
Does More INCOME Always Equal More Freedom?
Short answer: no.
Let us dig in a little further however. More money, more problems -- or Mo' money, Mo' problems for those so culturally inclined -- is a lasting adage because it holds a fair weight of truth behind it. We highlighted above that earning more money can potentially lead to increased psychological, and occasionally physical, stress.
Another axiom worth mentioning is work smarter not harder. Sometimes this is true however, if you are sitting on your ass making minimum wage and living above your means with debt and empty accounts, I would certainly worry about how hard I am working. At baseline, most people work relatively "hard". I use it in quotations because the average individual works hard because they are extremely inefficient and fail to recognize their lack of overall work density (defined as amount of productive output per unit of time).
For those of you working hard with very low rates of actual work density, it is time to focus on efficiency and work flow. For practical purposes, consider the Pomodoro technique pioneered by Francesco Cirillo in the 80's.
Why Do People Say "Money Doesn't Buy Happiness"?
Admittedly, most people who say this either have no money and pretend to be happy or they have money and still are not happy. I propose that you do not have to be either of the aforementioned individuals to believe in the above statement.
Further, may I suggest a revision of the above statement to:
"Buying More Things Doesn't Buy Happiness" - Dr. Jon
The typical belief is that we need to have "nice things" and buy more stuff to display a high social status to prove to others how wealthy we are. My proposal is that displaying a high social status almost always equates to lower net worth.
If you use your higher income to purchase more depreciating assets, and in turn those depreciating assets have other built in costs (maintenance, insurance, accessories, etc.) then it will actually reduce your overall net worth.
Besides, consider how displaying high social status to others actually reduces your true net worth visible to the only real person that matters... YOU!
So How Does Less Income Lead To More Success?
For what it teaches you. For what it permits you to do that you otherwise couldn't.
If your six-figure job requires ruthless hours late into the night and throughout the weekend, inclusive of holidays and allows a measly week for vacation, then I would say your trading your entire life for your income. Sounds to me like a shit trade.
There are certainly ways to make more money with less stress, but those opportunities are few and far between. More stress traded for more money is almost always the deal. Think of the promotion to manager - now you have more employees to manage. Fighting for days off. Always putting in sick leave. Poor performance and lack of motivation. Managing is nearly synonymous to "babysitting adults".
What about the successful business owner who sits in his backyard while earning $10k a month from his business? Where were you the first 35 years he was rolling around on the floor like one of the employees? All you see now is the snapshot of what he has become due to all his time spent, holidays missed, birthdays not attended. All so that he can enjoy the "twilight years" of his life.
My ultimate proposal is that we improve and optimize our efficiency. Researchers indicates that happiness plateaus at an annual income around $70,000/yr. I do not mind people working diligently to attain this point, but you need to enjoy life and enjoy what you do.
Do not be beholden to your job. If you are going to participate in periods of life with higher income and higher stress, please do so wisely by accumulating, saving, and investing your increased earnings, not spending it all away!
Less income will but a greater emphasis on frugality and thriftiness. Think of how much of an advantage it would be if you learned how to raise a family with a wife and three kids while earning a household income of $45,000. I do believe that too little annual income can also have adverse effects.
If you are frugal, disciplined, and value-oriented, focus on the following:
Frugality Is The ANSWER
Becoming more resourceful with less is a great way to combat the added stressors and negative energy associated with worrying about spending more, displaying higher social status, and long nights in the office just to earn enough to "cover" the mortgage on your over-purchased home.
I encourage you to see if there is more to life than money in the respect that money can only buy certain things, most of which derive very little happiness.
There are plenty of things that move the needle on happiness that are free:
Those are few of many. Perhaps your best life is about a balance between what you do to generate income and what you do to define THE REST OF YOUR LIFE. Spend too much time generating income and it will define you completely and, from my experience, MOST people do not want to be defined by their jobs.
Let us know your thoughts below in the comments section. Are there any other free activities that you really enjoy to share with the frugal community?
What Is "Investing" and How Can I Participate?
First things first, if you want to build wealth and you aren't 7 feet tall with a sweet jump-shot or a square-jawed Hollywood big shot, you need to invest.
"Invest in what?" you might ask.
Anything you anticipate will hold increased future value.
I will admit, a great majority of the time--probably 90 to 95% of the time--when you hear about investing it revolves around either the stock market or real estate.
A distant third to the stock market and real estate is likely small business investment or entrepreneurship.
Technically, you can invest in anything. Not all investments are not created equal.
Hey, just because a pile of empty cigarette cartons presently holds little to no value, there is no guarantee that it will never hold value. Who knows, all you need is one person willing and able to purchase those empty boxes at a premium and you may be closer to financial independence than you realize.
The reason the above cigarette carton scheme this is a terrible investment example is because these cartons hold no present value and likely will hold no future value either.
If you purchase something and you do not reasonably expect it to be worth more in the future than it is at your purchase price, then you are probably making a poor investment.
Please, don't let me stop you from purchasing a dump-truck of empty cigarette cartons however.
If You Know You Need to Invest For Wealth, Where Does One Start?
Educate yourself. Read, study, and immerse yourself in money management, investing, and personal finance.
I am not saying be the next Warren Buffet and read financial statements all day for the next 80 years, but educating yourself would be a good place to start.
The two most common investment options, both with fairly small barriers to entry, are investing in the stock market or real estate.
How Do You Invest in the Stock Market?
You actually have many options. The primary options are through any of the following accounts:
So investing in the stock market is pretty simple. If you are interested in investing outside of retirement accounts, you can check out either Fidelity or Vanguard (or any other brokerage -- just make sure they are low cost to maintain an account).
If you want the simples investing strategy, look no further than index funds. Pick whatever you want but I personally use these:
You can definitely invest yourself and you will find that you will save a ton of money on expenses this way.
It's pretty simple, if you are younger, consider having at least 75% in stocks and 25% or less in bonds. As you get older, you want to adjust to less stocks and more bonds.
If you have any trouble figuring out how to purchase stocks/index funds, just call their toll-free number and ask how to purchase these in your account.
If You Started Investing In The Stock Market, What's Next?
"Set it and forget it".
My preference is to just keep adding money, whenever I am able, over time to the same funds that I originally purchased. My plan is to do this year after year until I am ready to start withdrawing this money which will be when I no longer need to work for money and can live off investment income.
Please, do not worry about timing the market. Do not worry about crashes. Do not worry about corrections. Just invest in low cost index funds for life and allow your money to compound over time.
Do not listen to any snake oil salesmen who can tell you they have "insider information". Guess what, they don't. Their "pick of the week" and "insider information" has never historically proven to be accurate. Consider that almost every single long term investment advisor has failed to even match the returns of the S&P 500. That's why I choose to invest in index funds to allow me to match the S&P 500 thereby beating 95% of all professional investment advisors.
What About Real Estate?
I have not personally began investing in real estate as of 2020, but I expect that to change over time.
One of the best real estate investment books I have read is How to Buy and Sell Real Estate for Financial Freedom by James and JW Hicks.
The two most common real estate investment strategies are:
These two strategies oppose one another greatly. Long-term rental strategies are geared for those looking for many years of residual rental income and who do not mind either managing the properties themselves or paying somebody else to do it.
"Fix and Flip" is exactly what it sounds like. Buy a crappy place for cheap, fix it up either yourself or with low cost contractors, and sell it for a profit after factoring in expenses to fix it up.
Regardless of how you start investing, whether it be real estate, stocks, or otherwise, you need to get your money working for you as early in life as possible.
If you are hoping to land the $500,000 salary or win the lottery I hate to break it to you, chances are you never will. Please let me know when you do and I will be the first to congratulate your windfall.
The most assured way to generate signficant long-term wealth is saving and investing. Boring? Maybe. But you can laugh your way to the bank someday when you are counting all the zeros behind a big number in your investment accounts.
Dr. Jon is a physical therapist by day, and a dedicated frugalist by night, deeply enthralled in the thrill of "pinching pennies" and investing the margin.