Your Net Worth is a Stronger Planning Tool Than Your Budget
Why is it that when you apply for a loan, they don’t look at your budget? Rather, the lender looks at your debt to income ratio and your net worth statement. No lender cares about your budget. What they really want to know is how much you have and how much income you bring in annually. You can adjust your spending habits, but your net worth reveals how well you have been able to build your wealth.
So, what exactly is this “net worth” anyway? Simply put, it is the total of everything you own (all your assets) minus everything you owe (all your debt.)
Obsessively tracking your budget isn’t good for your health. Creating a budget or, ‘Money Flow,’ can help you build your net worth by paying down certain debts or contributing more to retirement or savings. However, your ‘Money Flow’ doesn’t show you the big, long term picture that you need to see. That’s where your net worth statement comes into play.
Remember, it’s not what you make but how much you keep that is key here.
I’ve seen it time and time again: Some people make well above six-figure salaries, yet have a negative net worth. However, I have clients that make far less but have been able to accumulate a net worth of over triple their income.
Consider these four simple steps to determine your net worth and make long-term financial decisions:
1. Create a one-page, simply-stated document. Regardless of how many assets or lines of debt you have, you can create a net worth statement on just one page. That is all it should be. The only reason you would have a two-page net worth statement is if you have an overabundance of line items. I’ve worked with hundreds of clients in various financial states and have yet to see a two-page net worth statement.
- Add up all your assets, or what you own, including collectibles, cars, etc., and subtract all the debt you owe. This is how you calculate your net worth in simplest terms.
- Each time you check the amount, verify whether the total net worth is better than it was the last time you checked it. It sounds simple, but why would you want to make your financials any more complicated?
- More advanced programs, like the one I prefer to use with my clients called Blueleaf, will show exactly what impacted net worth, not just an updated amount.
2. Organize your finances to easily input and view. Creating your net worth statement requires taking stock of what you own: Gather all of your most recent financial statements -- dating at most 3 months old -- and include certain valuable assets for which you don’t typically have statements. This may include the value of your cars, collectible items, or jewelry. It may sound laborious, but it forces you to face your financial reality and get organized.
With technology being so advanced nowadays, it is best to download an app to your phone or tablet that’ll aggregate all of your accounts, including your loans, into one central place. It will update all account balances automatically so that you will always get a picture of your wealth in real time whenever you check it.
Also, in the case of more extreme circumstances, this planning makes the management of your estate much easier for your executor and your loved ones. They won’t have to scramble around to figure out what you have and owe.
3. Be strategic about balancing your accounts. Your net worth statement should include such line items as the balance in your checking accounts, savings, and retirement accounts. It also shows how much debt you have relative to your assets.
The net worth statement is the primary tool I use with every client because it helps plan for both short-term and long-term goals. For example, the client may need to minimize the number of accounts they own to simplify things. It can also pinpoint on a higher level what the most urgent issues are to address first, such as paying off debt if it is significantly more than the assets.
4. Use this tool for future planning. If you want to buy a house, you will need to provide all of your financial statements to your lender. In taking the time to put together your net worth statement ahead of meeting with a lender, you have cut down the mortgage application process. Your net worth statement serves as a checklist which makes the application process more fluid and transparent for everyone involved.
The net worth statement makes the financial planning process easier by capturing in one place what areas need the most immediate attention and facilitates in prioritizing goals.
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