I was wrong for a very long time. I dismissed a financial metric that financial planners have been using since financial planning was created. I still can't decide if I completely misunderstood the metric, or if I eventually started viewing the metric in a completely different way. The metric was first introduced to me as a tool to measure wealth, but it's more than that to me now. As you will see in a moment, the metric is much more powerful for people who are actually struggling.
I believe Charles Dickens said it best in Bleak House. I'm kidding. I never read Bleak House. Net worth is the greatest metric in all the financial world. It's a powerful, misunderstood tool that can drive wealth higher, and better yet, pull desperate people out of the doldrums of debt.
Why is net worth such a great measure? Simply put, it measures various financial activity in a very complex way. If you monitor your net worth, you will be able to see the impact of making debt payments, saving money, investing money, and you can even watch your investments' market performance or simple appreciation. Net worth is obtained by subtracting your current debts from your current assets. As you know, assets are things such as real estate, savings and investments. And debts are...debts.
Let's take a look at a couple of different examples to help us better understand this. First up, let's examine the financial life of local pop sensation, Dustin Tendersnake:
As you can clearly see, Dustin's net worth is $280,000. If Dustin takes care of business and makes some prudent financial decisions, then he can make some shockingly good financial progress. For instance, if Dustin pays his mortgage (12 month's of principal payments for a total of $13,000), puts money into his 401k ($10,000 deferred from his paycheck and $5,000 matched from his employer), saves into his savings account ($1,000 per month), and pays on his student loans (12 month's worth of principal payments for a total of $2,000), then his net worth will increase by $31,000 in 2013. And that doesn't even include the possible market appreciation of his home and/or return on his 401k. By measuring his net worth, Dustin learned that he moved the financial needle by $31,000, or 11% of his net worth at the beginning of the year.
Let's now examine the financial life of local football phenom and UGG enthusiast, Dawn Grady:
Dawn is depressed. Her powderpuff football team just lost an important game, and her financial life is pretty UGGly. Dawn NEVER looks at her debts. They stress her out. "What's the point?" she often says to her self. Dawn decides to measure her activity for one year. Here's what she does. She works hard to pay down her credit cards by $8,000. And she pays down $1,000 on her student loans. Additionally, she starts contributing to her company's 401k, up to the match. Thus, she deposits $1,200 and the company matches $1,200. On December 31st, 2013, Dawn does the math and realizes that she just increased her net worth by $11,400, or a 21% increase. Sure, Dawn now has a net worth of -$43,100, but she made AMAZING progress. And better yet, she's enthused. She's been working really hard on making financial changes, but she always felt like she was running in place. She clearly isn't running her place. She improved her situation by 20%! That's phenomenal.
Can you imagine eating well, exercising regularly, feeling crappy about your fitness progress, yet never weighing yourself to see if you are getting any results? Yeah, it happens all the time. When you don't measure your net worth, you miss the opportunity to reward your progress and hard work. Paying down debt can feel mundane, but it isn't. In fact, if you paid down $10,000 worth of debt, it has the same effect on your net worth as if you were to save $10,000. In both cases it's a net worth increase of $10,000.
Do you want to start viewing your debt pay down process differently? Then start measuring your net worth. The only debt I personally have is my mortgage, but I love figuring my net worth so I can measure the impact of my mortgage principal payments. I sincerely celebrate each mortgage payment, and so should you! The possibilities are endless, when net worth is your goto metric. Take for instance the story of Mr. Ihave Lotsamoney.
Mr. Ihave Lotsamoney had lots of money. He was CONSUMED with monitoring his portfolio's performance on a daily basis. Like many people, Ihave lost sight of reality. He was so concerned with how well his broker was doing, he neglected to put any more of his income toward his investment portfolio. Instead, he chose to spend wildly because he had a $500,000 portfolio. Frankly, his portfolio was struggling. He lost 1% or $5,000 this year. The crazy thing is that Ihave was completely wasting $2,500 per month on really stupid stuff. Really stupid stuff. If Ihave had monitored and utilized the net worth metric correctly, he would have increased his contributions to his portfolio by $30,000, despite his $5,000 loss. Not only would his net worth have increased, but he would have hypothetically purchased more investments, at a lower price, thus insuring more profit, once the portfolio turned around.
I love using net worth to reinvigorate individuals who've already amassed great wealth, yet have fallen on apathetic times. I love using net worth to reinvigorate individuals who've dug themselves such a deep hole that they can't muster the intestine fortitude to glance at their actual debt levels. I love using net worth to show anyone and everyone that purposeful financial decision-making will always lead to progress. Net worth is the greatest financial metric, in all the financial world.