Many people focus on how much they earn or the assets they own, but true financial stability comes from your Net Worth.
Why Net Worth Matters More Than Just Income
1. Income Alone Doesn’t Build Wealth
Don't get me wrong, but a six-figure salary in a stable job is a dream come true. However, if consumption (spending) exceeds income by even $1 you're on your way to struggle town.
2. Net Worth Reflects Financial Security
A Net Worth of significant proportion provides a safety net where you may be without a job. Owning growth assets and holding minimal debt beats a high paycheck any day.
3. Assets Generate Self-Sustaining Wealth - Income Doesn’t (Without Action & Discipline)
So What is Net Worth
Simply put, all of your valuables less all your debt.
Net Worth = (Home Value – Outstanding Mortgage)
+ (Car Value – Car Loan)
+ (Savings + Stocks/Bonds + Other Investments)
– (Credit Card Debt + Personal Loans)
+ (Value of Jewelry/Collectables + Other Saleable Items)
+ Superannuation
Now some of these you may wish to ignore, like household items, as you’re unlikely to ever sell them, but in theory you could have a garage sale tomorrow!
Are all components of Net worth equal
Well no. You're best off focusing on appreciating assets. Things like cars, that have a high current value but ultimately lose value over time, are worth including in your calculation for the unlikely scenario that everything went belly up tomorrow. But take note, they aren’t the thing you want to accumulate more of.
How to Increase Your Net Worth
A. Spend less than you earn
This is the absolute minimum requirement. Not a complex topic, but not exactly easy to do without planning.
You can gamble to increase Net Worth, by going into debt, but this brings a level of short term risk most people will find unappealing. And, at the end of the day, you will need surplus income to maintain this debt.
B. Prioritise Saving & Investing
- Keep a moderate level of savings to ensure you never risk having to go into debt, say should you get stuck without income between jobs. Common advice is 3 months worth of expenses. A home loan offset account is a good option for most, both saving you interest expense and providing peace of mind.
- Make a plan to invest. How much, how frequently, and what type of asset/s. And don't forget to diversify.
- Execute on the plan. Most important! Without this it's just good intentions. Part of that plan should include a projection of your future Net Worth, say at retirement age, to ensure you don’t underinvest.
C. Evolve Your Plan as Your Income Grows
When you get a pay rise, don't allow your spending to consume the extra without a thought. Adjust your plan to enable your extra cash to also be extra Net Worth.
D. Reduce Debt & Liabilities
Reduce the highest interest debt first, usually credit cards, then personal or car loans. Avoid afterpay type services, as these drive bad habits and can result in hefty interest expense. Before you pay off your home loan reflect on the opportunity cost of reducing this debt vs the investment growth opportunities. There is value to feeling financially free without a home loan hanging over your finances but make a choice (or get some financial advice), as a 6% pa interest rate home loan saving is ultimately not as valuable as a long term 8% pa stock market return.
E. Enjoy life but be clear about your goals and spend accordingly
You may have enough income to purchase a second car today, but don't forget the future impact of this spend. Yearly rego fees and insurance take significant cash before you even leave the garage. Then there is the loss in value when it comes time to sell. And don't forget the interest expense on the loan (or the missed interest income you would now have if you had invested the money instead). These potentially unnecessary costs add up quick.
Examples of Net Worth Trumping Income
Let's say you have always lived below your means (spent less than your income) but the max you ever earnt was $60k pa (after tax). You likely have some savings, are on top of your mortgage payments, have everything you absolutely need and much, but not all, of the things that you want. After 30 years your mortgage is paid off and you also managed to invest that $10k pa in the stock market. You therefore spent a total of $1.5m over 30 years, however at 7% pa returns from that $300k invested your Net Worth increased by almost $1,000,000.
Alternatively, you earn $150k, rent a sweet house in the city, finance a flashy new car every couple of years, constantly max out your 3 credit cards and save a grand total of $0 each year. You still manage to pay off your mortgage over 30 years, as part of the $4.5m income you have received. You saved and invested $0, so your Net Worth has increased by the same amount, nought.
| Focus on Net Worth | Focus on Income | |
|---|---|---|
| Spent Over 30 Years | $1,500,000 | $4,500,000 |
| Saved/Invested Over 30 Years | $300,000 | $0 |
| Change in Net Worth in 30 Years | $1,000,000 | $0 |
Net worth Trumps Income!
Final Thoughts
Income alone is not the way to lasting financial security. Net Worth is the real measure of wealth. And the ultimate simplicity is, Spend less than you earn & Invest what you save! Not much in life is more simple.
This blog provides educational information only and does not constitute financial advice. Seek independent financial guidance before making decisions. The author is not responsible for any losses from reliance on this content.
Comments
Post a Comment