Know your net worth - It's important!

Think about this; if you were lost in the forest, the first thing you would want to know is where you are, so then you know which way to walk to reach the exit. If you don’t know your location, which way would you walk? For how long do you need to walk? Do you have enough time to reach the exit before nightfall? Well, we can use the same analogy with your money. You need to know how much wealth you have today in order to know what to do next, and to determine as to whether you are on track to reach your retirement goals in time…

Of course, if we all had $10 million we wouldn’t need to create this post. With that kind of money we would safely assume you have enough financial wealth to take care of your needs when you decide to hang up your work boots.

But alas, very few of us have such wealth, so we need to pay attention to our net wealth. And just as important is tracking it, year after year, to ensure that you stay on the right journey to get to that future financial destination at the right time.

Your net worth is how you start to see the results of your actions. Day after day, week after week, and year after year, we make hundreds of financial decisions. Many of these decisions we don’t even think about. The decisions you make with your money and the subsequent actions you take, all go towards determining, and creating your overall financial net worth.

As you build up your rainy day money, your net worth will increase. As you pay more off your mortgage, your net worth will increase. All the investments inside and outside of super moving up and down will be reflected in your net worth.

Net worth is simply a reflection of your assets minus your debts. It is the difference between what you own and what you owe. Therefore, it captures all of your financial efforts in one place. It’s a bit scary to think that your net worth is what you have to show for every day you’ve ever turned up to work!

Know the difference between income and wealth

Hopefully, you’ve already picked this up from the Wages to Wealth program, but we want to bring it up again as it is one of the most poorly understood factors in financial success. Your net worth isn’t about your income - your income doesn’t even factor into your net worth. Your net worth is about how much of your income you’ve been able to turn into wealth. Your income is the fuel that can help create wealth.

You could be earning $1 million a year, but if it’s all being spent you have a high income and no wealth. It’s your wealth that will determine what you will be able to afford to pay yourself later in life, i.e., when you retire. And that’s why the decisions you are making with your income right now will determine what your life looks like many years from now.

Tracking your net worth over time is an easy way to show how far you’ve come.

Your financial freedom number

Now that you have a bit of an understanding as to why your net worth is important and how it differs from the income you earn, it’s time to get an idea as to your financial freedom number. Your financial freedom number is the estimated amount of money (wealth) that you envisage needing to generate an income that would suffice to allow you to replace your employment income. For many of you, this income would need to address your day-to-day living costs, but there may no longer be a mortgage to repay, nor kids to feed as they have just maybe flown the coop.

There are two ways we suggest you work out your number. The first is to immerse yourself into Module 2 of the Wages to Wealth program where we cover this in depth.

The second is to use the “rule of 25”. The Rule of 25 estimates how much money you need by multiplying your desired annual income by 25. Here’s an example; Someone decides they’d be comfortable with an income of $50,000 per year, so we multiply the $50,000 x 25 which equals $1.25 million.

The rule of 25 assumes you'll be able to generate an annual real return of 4% per year (i.e. 4% above inflation [with inflation estimated at 3% per annum]). The best thing about this calculation (other than being quick and easy) is the fact it anticipates your net worth is not depleted over time by your income needs. This means your financial wealth can potentially be passed on to your loved ones.

We strongly encourage all of you to think about the day-to-day money decisions you’re making and how each of these collectively, over many years, will determine your net worth and when you may reach your financial freedom number.

Cheers,

Dan and Dave