Before getting into the details of what net worth is and why it’s critical for achieving FI, is important to take a step back and understand Key Performance Indicators and the role they play in providing important information to not only determine but explain our progress towards meeting our individual goals. Many people hear the term and get confused about it. At work we use KPIs all the time; however, I’ve seen cases where the most basic rules for establishing KPIs are not honored which have led to miscommunication, poor performance and ultimately goals being missed.
What is a Key Performance Indicator?
A KPI is a quantifiable measure used to evaluate the success of an individual or a company in achieving its strategic objectives. According to Investopedia, KPIs can also be called Key Success Indicators or KSIs and are also used to gauge performance over time. A KPI has to be quantitative, practical, directional, actionable and must have a specific timeframe associated with it.
So far it sounds simple right?, but anyone who’s attempted to agree on the right KPI can tell you that determining what factors matter isn’t always straightforward. Some individuals and companies spend months tracking metrics that turn out to have little or no impact on actual results.
So why am I writing all this stuff about KPIs?… well, because it matters. If the ultimate goal is to achieve FI, how will you know if you’re focused and headed in the right direction? how will you know if you need to make adjustments? how will you hold yourself accountable when your plan is deviating from its course or not working as well as you thought it should? that’s right you need a tracking mechanism to measure progress. What gets measured gets managed and the one I’d like to strongly suggest using is net worth.
What is Net Worth?
Net worth is the value of all your assets minus the value of all your outstanding liabilities. Simply put is the difference between what you own and what you owe. If your assets outweigh your liabilities you obviously have a positive net worth which means you’re awesome. If your liabilities are larger, then your net worth will be negative. Don’t worry, you’re still awesome but you’ve got work to do.
Figuring your net worth is not only a critical first step in financial planning, it is also THE one and only KPI that will truly allow you to keep track of your progress toward achieving financial independence. You’ll find it will also come in handy in many financial situations. For example:
- Applying for a mortgage may require a statement of net worth
- Certain high-risk investment may require that you have a minimum net worth of say $1 million or more
Starting the process is pretty straightforward, you need to gather all your financial records: banks, brokerage, credit card statements, loans, tax forms, retirement savings records and personal property valuations. Once you have all these documents handy all you have to do is add and subtract and voila!. Excel has worked really well for me, it easy to use, simple and manageable.
Believe it or not, I didn’t know what my net worth was until 2015. I figured it had to be positive based on my understanding of what my assets and liabilities were. In those days life was pretty simple. We were renting, had two cars fully paid off, checking accounts, savings accounts, and a 401k. That was it!. Despite the simplicity, it wasn’t easy for me to say what the number was at any given time or know if it was going up, down or staying flat.
Today, life is a little less simple but it’s for the right reasons. As a result, I’m now using tools like Mint and Personal Capital that facilitate data gathering, aggregation, and consolidation. Using these tools has improved efficiencies significantly and the best part is you have free access to their websites as well as mobile apps for on-demand analyses. Do you wanna know my net worth?, let me grab my cell phone and I’ll tell you in less than 1 minute.
As I mentioned, I can check my net worth whenever I want but some suggest doing a regular revision perhaps on an annual basis to help you assess the progress you’re making in building a strong financial base. Nowadays, I check my net worth more than I probably should but that’s OK, I’d rather do that than be completely passive about it.
So what can you do to increase your net worth?, well you have three options: 1) Increase your assets or 2) decrease your liabilities
Increasing your assets
What I’m about to say sounds so simple yet it is difficult for a lot of folks … “you have to learn to live within your means and spend less than you earn“. This will provide you with opportunities for saving, investing and enjoying the beautiful miracle of compounding. In addition, you could generate other sources of income such as dividends from stock/bonds or rental properties. Currently my sources of income in order of highest to lowest include:
- Salary – from full-time job
- Rental properties – 3 properties
- Dividends – taxable accounts
- Interest – peer to peer lending
Yeah, yeah, I know, we all wanna have additional sources of income but if you’re like me and work full time then you know that’s easier said than done. However, you can still do creative things such as selling stuff you don’t need using craigslist, letgo or OfferUP while making a little profit. Some people take this option to the next level but I’m not that intense which is perfectly fine.
But what else can you do? …. have your head about the phrase “pay yourself first“? if not, don’t worry this is a topic that deserves its own post but for now, let’s just say it implies saving and investing (for the most part leveraging automation) before you do anything else with your income. Below is a simple example:
I love paying myself first and you should love it as well. It’s an amazing vehicle to boost your wealth and overall increase your net worth.
Decreasing your liabilities
Do you think our society encourages saving and delaying gratification?, heck NO!. It’s completely the opposite. You don’t even have to leave your house to find yourself dealing with people knocking on your door offering something that I can guarantee you don’t need. That’s just the reality we live in and you just need to be prepared to deal with it.
OK I get it, we have to spend money because otherwise, we wouldn’t survive but I’m of the belief that when it comes to liabilities there’s a preferred list I’m comfortable settling on. Some of them we might get to scratch off but some will remain for some time. So what does that list look like?
- Primary residence mortgage
- Property taxes of primary residence
That’s it!. I wish my house was paid off but it doesn’t make a lot of sense at the moment given the low interest I was able to get when we bought it.
Some of you might be even in a better spot if you’re renting so theoretically you shouldn’t have any liabilities. Furthermore, if you’re being smart about paying yourself first then you should be well on your way to financial freedom seeing your net worth grow dramatically every time you look at it.
- Net worth is the KPI I recommend for monitoring and tracking your progress toward achieving FI.
- Gather all the information of your assets and liabilities and estimate what your net worth is today.
- Use tools like Mint and Personal Capital
- Increase your assets by paying yourself first
- Work on reducing your liabilities as much as possible
Until next time … JJ