What Is Special About Net Worth and Why Winners Track Theirs
- June 24, 2018
- by Michael
Net worth isn’t just for rich people to “keep score” in an endless game of getting more. It is a key indicator of everyone’s financial health. Income, job title, and especially what car a person drives are superficial measures of financial success. If you are serious about meeting your financial goals it is essential to understand and track your net worth. After all it is what you save and how you make that savings work for you that really matters.
Here are a few reasons net worth is so important.
Net Worth Shows Progress… or Lack Thereof
If your income doesn’t change from one year to the next, it would be easy to think that you’re not making any financial progress. That is not necessarily true. Think about the following circumstances:
- Your income stays the same, but you’re saving 50% of your income—so your net worth is growing with each year. Hooray! Your making a lot of progress towards retirement and financial stability.
- Your incomes stays the same, and it’s not enough to cover your spending, so you start racking up credit card debt. This is reflected in a decrease in your net worth… and is a huge red flag that you need to either decrease spending, increase income or both.
- Your income is the same, and your net worth is also the same as last year. This is like treading water, and it shows that you need to either decrease spending, increase income or both.
In any of these cases, tracking your income would not give you the same information about your financial situation as tracking your net worth does.
Net Worth Is Brutally Honest
Just as tracking your net worth can show you whether or not you’re making progress, tallying up your net worth can be an eye-opening exercise, in both a good and bad way. It can help you identify problematic areas in your personal finance habits as well as help you appreciate things you’re doing right. Here are some examples:
- Especially for young people, retirement accounts can seem very theoretical. Seeing how your retirement account adds to your net worth can help the money feel more concrete and also motivate you to continue making contributions.
- Seeing how your debt negatively affects your net worth—perhaps even making your net worth negative—can highlight how important it is to pay off debt of all kinds.
High Net Worth = Financial Security
The higher your net worth, the easier it will be for you to weather unexpected events, whether it’s a dip in the stock market, a serious illness or a job loss. There is an intangible peace of mind that comes with knowing random negative shocks are above the waterline of your ship and won’t sink you.
Consider that people an even modest net worth are likely not going to be forced to take a low-paying job out of desperation. This leads to a virtuous cycle of getting a higher income, which in turn can help net worth grow even more.
High Net Worth = More Choices
Having options in life is a form of success unto itself. Arguably having the ability to choose what you want to do when is ultimate way of measuring happiness. The ability to hold out for the best deal or to be okay passing on a bad deal is a luxury only those with sufficient net worth get to enjoy.
High Net Worth = Financial Independence
There’s a difference between your entire net worth and your “investable” net worth, which refers to the money you can invest and potentially live off of. Things like equity in your home or your car are technically part of your total net worth, but you can’t easily sell a small sliver of it to pay your bills… So focusing on investments and how they are allocated is important to attaining financial independence.
How financial independence works in a nutshell for a typical early retirement scenario:
Once your investable net worth gets to be about 25 times your expenses, you have reached the finish line! You are now financially independent, which means you can retire early… or just have the peace of mind that you don’t need to earn money anymore.
The 25x figure reflects a 4% safe withdrawal ratio which the famous Trinity study first uncovered. Our retirement withdrawal calculator lets you play with the numbers in detail given your own scenario.
Generally speaking the more money you have and the less you spend, the lower your risk is of going broke some day. If your retirement time frame is 40 years and you were to spend 10% of your investments each year there would be a higher chance of going broke compared to a person who only withdrawals 1% each year. In fact the person who takes out just 1% is more likely to die super rich, leaving the majority of the money they started with in retirement (if not many times more) to their estate when they die. The 4% withdrawal rate is a happy medium designed to avoid going broke while still allowing a good amount of spending.
For example, let’s say you want to live on $60k per year. You’d need 25 * 60,000 = $1,500,000, assuming a 4% safe withdrawal ratio. But let’s also say you’ll be getting $18k per year from social security, and $9k per year from a pension. That brings the money you need to withdraw from your portfolio down to just $33k per year, and 25 * 33,000 = $825,000. Keep in mind the 4% withdrawal rate is not a law of nature and could be wrong since historical returns do not guarantee future performance.
$1.5M or even $825,000 may sound like a lot, but if you get comfortable with investing, automate your savings, and keep investment expenses low you can get there. And if you can reduce your spending by sticking to a budget, you’ll get there even quicker. If you are interested in retiring early see our post on FIRE which stands for financial independence retire early.
Tracking Net Worth
If you don’t have the right tools, figuring out net worth can be overwhelming, especially if you have complex investments, other assets and debt.
A DIY spreadsheet is a good place to start but can be annoying to keep updated.
That’s why the staff at Wealth Meta created the Net Worth Dashboard, a tool to scratch our own itch when it comes to monitoring net worth.
The Net Worth Dashboard gives you an easy way to figure out your net worth and track it. The Net Worth Dashboard shows you how your assets are distributed, both across accounts and more importantly across investment types like stocks, bonds, real estate, etc. This makes it easy to know if the reality of your portfolio agrees with your investment priorities so you can ensure your net worth is on the right trajectory and you have your risk level dialed in.