Thanks to some very savvy readers, I have hone an updated the most popular post of all time on Gen Y Wealth. This post was originally written on August 7, 2009.
The NBA owners knew exactly what they were getting into. Ten years ago, the NBA season started about 4 months late.
Why? The owners went on strike. No games were played, which meant no paychecks for the players.
In the end, it was a very smart move by owners. They knew exactly what they wanted and how to get it.
The players union was trying to hide a giant secret. After making millions of dollars a year, some players had spent it all. They lived paycheck to paycheck just like most people today.
The owners were smart. They knew the longer they held out, the easier negotiations would get.
It took only a few months for the players union to cave in to the demands of the owners.
Switching To A Net Worth Mindset
It’s not what you make it’s what you keep. If you make a million and spend a million in a month, you might have had a lot of fun, but your financial situation doesn’t improve.
Luckily, there is a pretty simple calculation to see how much you have kept, called your net worth.
The most standard way of calculating your net worth is:
Net Worth = Assets – Liabilities
Net Worth vs. Net Wealth
Your net worth is a fairly simple equation. However, for a better snapshot of your personal finances, take it one step farther by dividing your net worth by your average daily expenditures. Let’s call this your net wealth.
Net Wealth = (Assets – Liabilities) / (average monthly expenses/30)
Your net wealth is the best way to get a clear picture of your personal finances. The NBA players above, might of had an above average net worth for sometime, but they had a below average net wealth.
Formula for Calculating Net Worth and Net Wealth
There are plenty of ways to automate calculation of your net worth. Sites like Mint can do this calculation fairly quickly.
If you don’t wish to give all your financial information to one company, I created a net wealth template in Google docs that you can use.
The first step is to add up your assets. (If you’re not signed up for online access at your banks, now is the time)
Your assets column should contain:
- Money Market Funds
- Non-Retirement Investments
- Real Estate
- Anything else that has value and are willing to sell
Note: I don’t find it very important to include every asset. You can easily go overboard and include your furniture, appliances, jewelry, clothes, collections…etc to your assets column. Include only those things that you’re willing to sell. For example, I could easily include my wedding ring and Michael Jordan card collection but they have no value since I have no plan to sell them. Also, there are good reasons why you might not want to include real estate.
Next step, add up your liabilities:
- Credit Cards
- Car Loans
- Student Loans
- Home Loans
- Any other debts
Now take your assets minus liabilities. You have arrived at your net worth. You’re not done yet.
On the bottom of the page, there are four more important rows:
- Percent change = ((Old-New)/Old) x 100
- Average monthly expenses
- Average daily expenses = Average monthly expenses / 30
- Net Wealth = Net Worth/Average Daily Expenses
The Benefits Of Calculating Net Worth and Net Wealth
One of my favorite personal finance authors is none other than Benjamin Franklin. One quote of his explains the fundamentals of personal finance in only a few words, “”There are two ways to increase your wealth. Increase your means or decrease your wants. The best is to do both at the same time.”
It’s easy to get yourself cut up in the amount of information available on personal finance. You can read for hours and hours and still be confused about what action to take next.
I find it easier just to grasp principles. If you’re able to grasp the principles, personal finance is pretty simple.
Having a net wealth mindset is one of the few principles to personal finance. If you were to calculate your net wealth each month, you know exactly where you’re at and a better idea of where you’re going.
Formula for Calculating Net Worth and Net Wealth| One More Thing
One hidden benefit to calculating your net wealth, that you will start to see after a few months of data, is how interest on debts makes it very hard to increase your net wealth. If you made a mortgage payment for $1000, with $750 going to interest and $250 to principal, your net wealth actually decreases. You have $750 going out of the asset column and it only reduces your liabilities by $250. Just one more reason to hate debt.
Update April 13, 2010
Thank you to Mike who pointed out that you shouldn’t bother calculating your net wealth if your liabilities are greater than your assets. Technically, your net wealth would increase as your monthly expenses increased. Not good.
Another reader, Jacob, pointed out that he:
“I use a similar gauge except I divide by monthly expenses * 300. In this case, if you wealth > 1, you are financially independent.