Why you shouldn’t (and should) care about your net worth?

The other day I read an article written by a respected personal finance blogger at Fulltimefinance.com about why you should not pay too much attention to your net worth.

The whole thesis of the blog was centred on the fact that your net worth is a number that fluctuates daily as a result of factors that are outside of your control – the stock market, the housing market, the political environment and even the real environment! Just yesterday the S&P 500 index witnessed its worst drop in over 2 years. Consequently rather than concentrating all of your energy on a single number that you have little control over, it is far better to develop good financial habits.
Here are my thoughts:
  • Net worth is a number you should pay attention to but not be obsessed with.
  • Focusing on income and expenditures is a far better way to spend your energy.
  • Concentrating on the streams, value and quality of each income will add significant benefit to your journey to financial freedom.
Before we proceed, just thought I’d quickly define net worth:
Your currently net worth = the value of everything you own currently (assets) – the value of everything you owe currently (liabilities).
It is therefore a snapshot of your personal financial worth (accountants call it balance sheet) at a given point.

1. Net worth is a number you should pay attention to but not be obsessed with

I agree wholeheartedly with the central thesis behind the article: your net worth is often outside of your control. This is something I have had deep experience with as my personal net worth fluctuates daily and it isn’t uncommon to see swings in the £10,000 mark on a daily basis. If I were to focus on every change in that figure then I would literally go nuts.
Because a significant portion of my net worth is in stocks, which represent ownership in companies. Stocks have a different value every second during the trading hours. Another portion of my wealth is in ownership of real estates, whose value also changes monthly due to market conditions.
Both of these examples are conditions which I have zero control over and hence I don’t even bother knowing as the act of knowing adds zero benefit to my own utility. Consequently I do not focus on my net worth in the short-term.
That is not to say I don’t pay attention to my net worth.
I pay tremendous attention to these 2 factors: my liabilities and the long-term trend of my net worth.
I know how much I owe very well. I know the exact size of my mortgage, my current credit card balance and my loans. I know its duration, its key terms as well as the monthly payment amounts. In fact, I view anything that takes money out of my bank account as a liability and scrutinise them regularly. This is because liability is the single biggest obstacle to financial freedom. Most people would obtain financial freedom rapidly if they didn’t have these liabilities. As Sun Tzu wrote in the Art of War: know your friends well, yours enemies better. That’s why I pay extreme attention to my liabilities.
The second thing I track at the start of every year is the value of my net worth, which I then compare that against the values for the past 5 years. I do that by using a technique called “mark to market”, which is a fancy way of saying take the latest market valuation of all of your assets and liabilities.
My interest lies in how each component of my net worth (i.e. real estate, stocks, alternative investments) changes over time and their respective contribution to the rise or fall in my net worth. This technique allows me to identify assets that may be under-performing and thus warrant further investigation.

2. Focusing on income and expenditures is a far better way to spend your energy

Instead of my net worth, my focus lies on my income and expenditure as they are the key drivers to financial freedom.
Financial freedom is when my monthly income exceeds my monthly expenditure by at least 20% for a sustainable period of time (6 months or more).
Every month, I make a list and then categorise all of my monthly incomes and outgoings (e.g. credit card debt, salary). I then compare its values against previous months to identify deviations. I also interrogate the rationale behind every expenditure and whether a cheaper substitute can be obtained elsewhere (e.g. utility provider, remortgage services), in order to ensure I always get the highest value for my money.

3. Concentrating on the streams, value and quality of each income

Something which I dedicate an even larger proportion of my time to is income, because the scope for expenditure reduction is limited to 100% whereas the potential for income increase is unlimited.
I look at 3 key components of the income metrics: streams of income, value of income and the quality of each income stream.

Streams of income

This is also known as sources of income, which looks at how many different sources does your income originate from. Most people unfortunately only have a single source, which is from their employer, in the form of wage or salary.
Personally I think this is extremely risky as you effectively have only one fee paying client if you were a business. No prudent businessmen would commit to such similarity and why should you? My fellow blogger Apathy Ends has written an extreme accurate (yet cynical) article about the power of employers hold over you. Highly recommended.
I develop as many income streams as possible through side hustling, property investing and buying dividend-paying blue chip stocks, because I truly believe that you are the master of your own destiny and when the next economic downturn comes, it is only you who can and will take care of yourself and your family.

Value of income

I examine the value of each of my income streams carefully. Currently my salary still occupies a significant portion of my overall income, which isn’t the ideal place to be as employment is often most vulnerable to economic recession.
My target as stated in by WealthyBy40 Challenge is to have my non-employment based income significantly exceed salary. Ideally these different sources of non-employment income will be in equal portion, thereby eliminating concentrated risk spots.

Quality of income

Not all incomes are created equally. They normally fall into 3 categories:
  • Active: income that you have to put in work for in order to generate (e.g. salary, my consulting side gig)
  • Quasi passive: income where you can put in some initial legwork and then it starts to flow in without significant active work (e.g. rent).
  • Passive: income that flows in without much or any work (e.g. dividend).
Currently the majority of my income streams still rest in the active category. My target is to transition them onto the quasi passive and passive routes. Consequently most of my effort outside of work is dedicated to realising this goal.

Wrap up

I think net worth is definitely a number that is good to be aware of and monitor in the long-term. However there is zero need to sweat over it in the short term. Instead I focus my energy on ensuring:
  • My expenditure is well below my income
  • Saving and investing as much of the excess as possible
  • Multiply my income streams
  • Increasing the value and quality of each income stream
Do you know your net worth? Do you actively track it? What are your thoughts? Please comment away.