Creating a balance sheet (Part 3)

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While I think few would argue that paying off debts is a good thing, there is a better way to accurately see the big picture of your finances. It is called your NET WORTH.

And no it is not just a number that rich people talk about at cocktail parties. It is what financially saavy people use to track their progress.

The simple definition of it is:

Assets(stuff you own) – Liabilities(debts) = Net Worth

It is simple to calculate and I will get to that shortly, but first…

Creating a balance sheet - part 3

Why Net Worth rather than just debt?

Your Net Worth is more encouraging

The primary reason for using your Net Worth as a gauge of your financial progress rather than the amount of debt you have is because it is more encouraging. When you look at your amount of debt to track progress you are only seeing the fruit of paying down those debts. On the other hand, your Net Worth increases for every good financial decision you make.

For example, you can increase your Net Worth with the following actions:

Paying off credit cards or car loans
Paying more towards your mortgage
Buying property
Funding a Roth IRA
Getting your employer’s match on your 401(k)
Building an emergency fund
Buying index funds, mutual funds, or dividend paying stocks
Or even just not spending as much money

There are many more things you can do to increase your Net Worth, but these are some of the bigger and more common ones.

Your Net Worth changes how you think about buying decisions

The second reason I prefer to use my Net Worth to track my progress is because I have found it helps change how I think about my buying decisions.

One of the most valuable financial lessons I have learned can be summed up in two words: buy assets. What I mean by that is you should spend more of your money on things that will keep cash in your pocket. So they should at the very least:

maintain their value
but better yet increase in value
and the best would be increase in value and provide you income as well.

On the other hand you should avoid buying things that are going to take cash from your pocket. Coincidentally, these are most of the things most of us spend our money on. When you buy clothes, food, electronics, decorations, cars, entertainment, you are (generally) using cash to for something that is going down in value and therefore decreasing your Net Worth. Examples of this would be:

Spending $200 on new clothes
A $50 steak dinner
Getting the new iPhone
Going to the Yankees game
A brand new BMW

Think about how much you could sell each of these for 2 years from now. Each one of them is a depreciating asset, so 2 years later they would not be worth what you paid for it, if anything at all. But if you had spent it on…

Buying property
Funding a Roth IRA
Getting your employer’s match on your 401(k)
Building an emergency fund
Buying index funds, mutual funds, or dividend paying stocks

You would have a much better chance that it would be worth at least what you paid, and it would more than likely be worth more than you paid for it.

Obviously there is more to life than Net Worth, and you can never avoid spending money on depreciating assets, but you can avoid spending ALL of your money on depreciating assets. This is the key to why many people never get ahead financially. They spend all of their money on stuff that goes down in value. Once you start buying things that increase in value, you begin building a snowball that just grows larger and larger, faster and faster.

I don’t want to get the cart ahead of the horse, so lets get back to our Net Worth. The reason I mentioned this is because I want you to be thinking about the end result of each buying decision. None of the things listed above are necessarily wrong, but they should be thought about and decided upon rather than just reacting to what you “feel like doing”. Your Net Worth will reflect each buying decision that you make – good or bad.

How to calculate your Net Worth

This shouldn’t take more than a hour if you have never done it before. When you update it in the future it will take even less time than that. I have created a template from my own balance sheet that you can use if you would like. You can download it here.

1. Get a spreadsheet

First off, you can do this on paper if you really want to, but I suggest Excel, Google docs, Open Office, or really any kind of spreadsheet will do.

2. Total your assets

List every asset you can think of. Anything that you could realistically sell. For the purposes of sanity and simplicity I don’t bother with items under about $500. Yea, I am sure I could find someone on Ebay to buy my socks, but I am just looking for a general picture. So I just lump together all these smaller items as one line called “Misc items” and take a conservative guess of what they could be sold for.

So your house, cars, retirement accounts, stocks, savings accounts, checking accounts, emergency fund, jewelry, and anything else similar would fall in this category.

To get real estate values you can use Zillow to get a decent estimate of what your home may be worth. For automobiles you can check out Kelley Blue Book to see what they could be sold for. For all your checking, savings, investment accounts you can either check the balances online, or just use your last statement.

Once you have them all listed with the estimated selling/liquidation value you can total them up.

3. Total your liabilities

A few lines below the Assets total, we are going to now list every debt you have. Mortgages, credit cards, student loans, they all apply. Do the same as above checking balances on each one and then total your debts to get your liability total.

4. Subtract them

Now you can subtract your liability total from your asset total and viola! You have your Net Worth. Date it and save it.

Now what?

When I first calculated my Net Worth, it was -$13,843.84. Which was eye-opening to me. I knew I had a bunch of debt, but didn’t realize how below par I was. Regardless of what you number is, just look at it as the starting point. It is from this point that it will become larger.
After we had been working at it for one year it was up to $746! We were so excited to have a positive Net Worth! Even if it was only $746. As we kept on working on it, it has just continued to grow.

I normally update mine about two times a year. But if you are working really hard at it and need to see the encouragement of it increasing, do it more! As in just about anything, you are either moving forward, or you are going backwards. If you are increasing your assets by making good buying decisions or minimizing debts your net worth will be growing.

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