I have been searching the web for months, looking for ways to measure my financial progress, and have come up pretty empty handed. By merely looking at my peers and neighbors there is no doubt we are far ahead of the curve. On the other hand, when compared to some people in the financial forums I visit, it’s obvious that they have much more than we do. It is enough to make me question how well we are really doing.
To try and answer this, I started a wide search looking for where we should be and, more importantly, how to measure our financial progress. I guess with time and wisdom we all realize the answer to this question is dependent on many factors, and is different for everyone. But I did want to share some of what I have learned in the process.
First and foremost, to measure your net worth, you need to determine what your net worth is. Basically, add up all of your assets (bank accounts, investments, retirement, value of your home and cars) and subtract all of your debts (mortgage, student loans, credit card debt, etc.). This number is your net worth. For some of us, particularly those of us just starting out, this number may even be negative. Here is a simple worksheet to see where you stand.
One important thing to consider is the liquidity of your net worth. Cash should be easily accessible and FDIC insured, overall the most liquid asset available. Investments and/or retirement funds should be easy enough to sell and get at, but could be subject to taxes and penalties, and more importantly, are more subject to market fluctuations. Cars, on the other end of the spectrum, depreciate faster and could take time to sell. I would consider a home one of the most illiquid of assets since it can take great time to sell and cash out. Technically you can include household goods like furniture and electronic equipment in your net worth statement, but I don’t even bother due to the extreme depreciation and illiquidity of these goods. I generally tend to realistically value my assets at how much I could sell them for in a pinch, to get a more realistic idea of my more liquid net worth. Assets like cars and homes should be evaluated annually.
Like many of us these days, I have a large amount of home equity which completely skews my net worth, and yet we have put so much money into our house it really skews our measure of wealth to completely discount our home. To compromise I just keep 2 net worth schedules to chart our progress. One includes our current home value, for an overall picture of our current net worth. But I keep a separate net worth schedule to measure our current progress, and the best way I have found is to include the purchase price of our house as an asset. Therefore we can show the mortgage payments as progress in our net worth, but the overall numbers don’t get skewed by large fluctuations in the housing market, which have little to do with our forward progress. If our house were to ever plummet to less than we paid for it, it would be something to reconsider, but in the meantime the normal market fluctuations have little bearing on our current progress. I just throw this out because we will all have unique situations which will take extra consideration when measuring our true net worth.
Next, I have good news for those of us with little, or negative net worth. I have personally found little value in current measures of net worth. At face value it does little more than to show where you are, as it is merely a statement of where you are at in one point of time. I think the negative to this is it can get some of us on the higher end to relax more than we probably should, and some of us on the lower end to just want to give up. When you are analyzing the progress of a corporation you don’t just look at the balance sheet; it is just a piece of the big picture. You really want to see the income statement and continuing profitability and progress, as well. Everyone’s balance sheet (or net worth) is going to start out pretty ugly in the beginning. Our ability and commitment to improve our net worth with time is far more important than where we stand today.
I find most of the traditional net worth measures around the web show that most young people will find great impossibility of doing well, and most of the older population will easily have a high net worth. This is because net worth, like compound savings, has a long growth curve that takes time to build. Since I am more interested in forward progress, I have taken to analyzing any measure of net worth in terms of where I “should be” now, where I “should be” in 10 years, and figuring the difference divided by 10 is how my net worth should progress annually for the next 10 years. I generally find that being young I am way behind where I should be, by many measures, but that I can easily surpass the progress expected in the future. I also find if I consider where I “should be” at retirement age with some of these measures, the result is way off from my own retirement calculations. Let me show by example.
In Stanley’s book “The Millionaire Mind,” an important financial measure is your Expected Net Worth. If you are significantly ahead you are doing great, and if significantly behind you have a lot of catching up to do. The formula for expected net worth is as follows:
Age x .112 x Total Annual Income = Expected Net Worth
Note: This measure is very similar to the one used by Stanley and Danko in the book, “The Millionaire Next Door.”
Doing this calculation, assuming you are 30 and have an annual wage of $75,000, your Expected Net Worth would be around $252k. This is supposed to be an average measure of wealth. How many 30-year-olds do you know who have such a high net worth? Of course the problem is at that age you probably haven’t made such a high wage for very many years either. Now assume the same wage and take an age of 40 (10 years down the road). Your Expected Net Worth should be about $336k at age 40. $336k minus $252k equals $84k. Divide by 10 and that means your net worth should increase by about $8.4k per year to stay on track. You probably have far more catching up to do, but in the end, with time, you have less work to do to keep up with net worth progress. I find that with most net worth comparisons, so it goes, since we have a much bigger curve to work against in the early years. However, the interesting thing in this measure is if you took a wage of $75,000 and assumed an age of 65 (assumed retirement age) your net worth would only be “expected” to be $546k at age 65. I understand that with inflation that your wage should be much higher at age 65, but all the same, does $546k sound like a particularly grand goal for someone 65, today? Will that even cover living expenses in retirement? Is someone who is retired with $1 million really that far ahead of the curve in today’s world? Of course, I guess this leads to the reason I have been trying so hard to find a good, true measure of where we really should be today. These measures of wealth leave a lot to be desired.
Just as I was about to give up in finding some more realistic answers to where we should be, I did find some more interesting measures of net worth and financial progress around the web. One extremely interesting I article I found was here.
There are two extremely interesting points in this article that I don’t see mentioned in other net worth measures. First, your net worth should be measured in terms of your annual spending, instead of your annual income. If you save half of your income, it really makes little sense to determine your wealth based on your income, if you can live on much less. The opposite holds true, if you spend significantly more than you make. This immediately drew me to this measure since we ourselves put such a significant amount aside to retirement, and we don’t expect to have to live on in retirement. However, doing these calculations in terms of your income, instead of spending, will give you a much more aggressive net worth goal to consider, and since this is a more conservative stance, I don’t think it is a bad idea to look at it from an income perspective. But for many, it does make more sense to plan based on your spending levels. If you are aiming for early retirement, this could be a good measure to see how on track you are, since you are more likely to save a significant amount of your income. Secondly, this article has a little table that shows numerically where you should be on the curve at different points in your life. I think they have done a good job of quantifying for the younger crowd where we should be, and showing that our net worth should increase considerably as we age.
Going through the same calculations with this chart, net worth merely needs to be $75k today at age 30, for someone making $75k annually (going aggressive or an assumption that spending equals wages), or $1.5 million if the same person was 72 today and retired (both ends seem reasonable). This is a moving target though as basically the gist is that we should have 20 times our annual expenses saved when we hit retirement at age 72. But in today’s dollars it seems reasonable, and no doubt your expenses will be significantly greater in 40 years. Also, according to this model, by age 40, with the example above, net assets should be about $260k, or they should be increasing around $18.5k/year in the meantime. All of this seems very reasonable. Of course what really caught my eye as a simple measure of progress was the statement, “Between the ages of 40 and 60 your net worth should increase by one unit of your annual spending every two years.” I found this as a very simple goal to set today, though I am only 30. It is uncertain if we will reach this goal personally, this year, but there is no doubt that by the time we are 40 we should be easily progressing forward at this clip. I finally feel that I have some easy to quantify, and worthy goals, and some more immediate measure of our progress moving forward. My retirement goal is extremely high, but when you factor inflation and all the uncertainty of the next 40 years, it really needs to be. This measure of net worth seems to make the most sense to me, fitting in with the more long-term goals we have already set. More importantly, it makes sense to many of us on both ends of the spectrum, and even in between.
In the meantime I have taken to keeping track in an excel spreadsheet of our net worth progress moving forward. For me, it really helps me to look at the big picture, and track our progress. I found in the past I would get too caught up in little pieces, like how much cash or debt we had. Looking at the big picture puts everything into much better perspective. I think a monthly comparison is probably overkill, as regular market fluctuations and monthly setbacks could be frustrating. But for now it has worked out extremely well, and I would recommend that everyone set some goals and measure their progress moving forward, at least on an annual basis. Reviewing on a monthly basis can be a wonderful tool as well, as long as you don’t get too caught up in little setbacks.
Finally, I think the most interesting article I found about our true measure of wealth was an article at Punny Money. I just had to share because this was such an excellent piece, that argues that income potential, quality of life, health, and many other factors bear heavily on your total measure of wealth. Punny Money even started a series on trying to quantify all of these measures of wealth, which is to-date incomplete. But even so, I think maybe a good lesson in all this is wealth and progress is not easily quantifiable, so don’t get caught up in the numbers. But if you realize that you can use these tools and measures to set goals and monitor progress, it can be of great reward to do so all the same.