If you feel that you need to improve in a particular area of your life, one strategy that is virtually guaranteed to help you improve if you apply it consistently is to keep score. Think of a metric that you think would be appropriate in measuring the results that you are looking for. Make it something that is not too difficult to measure, and make it something that will let you know very specifically where you stand. One common metric that comes to most people’s minds as they get older is their weight or their waist size. Many people focus on their golf handicaps. Others focus on their salaries. The number of metrics that you could come up with is virtually unlimited.
“If you don’t know where you are going, you might wind up someplace else.”
– Yogi Berra –
Here are 4 reasons that keeping score is so important:
1) It keeps you honest. When you keep track of some objective metric, you can’t fool yourself. The numbers don’t lie. Your current position or results are right there in front of you.
2) It provides feedback. By noticing how your score changes, you will know if what you are doing is working. You can also experiment with different strategies and notice the impact that it has on your results.
3) It can be very motivational. Because keeping score shows the progress you are making towards your goal, it motivates you to get even better. Every pound that you lose provides motivation to lose yet another pound. This is also one reason that video games can be so addicting. You are always trying to get to a higher level or a higher score. Tetris, anyone?
4) It focuses your attention. There is an old saying in business that “Whatever gets measured gets done.” The reason is because the very fact that it is being measured implies that it is important and needs to be paid attention to.
When it comes to finances, a very common financial metric is income. Most people know how much money they make. Unfortunately, this financial metric is inadequate. There are plenty of stories of people earning huge incomes right before going into bankruptcy and losing everything. Don’t confuse having a high income with being wealthy.
“Not everything that counts can be counted, and not everything that can be counted counts.”
– Albert Einstein –
If wealth is one of your goals, then obviously it makes sense to measure your wealth. The way to measure your wealth is by calculating your net worth. If you do this, you will probably be in rare company. My guess is that less than 1% of the population could tell you what their net worth is. Many people don’t even know what “net worth” means or how to measure it. This is unfortunate, because if most people knew how little progress they were making financially, they would be much more motivated to take action to improve their situation.
What is net worth?
Net worth can be calculated simply:
Net Worth = Assets – Liabilities
or in other words
Net Worth = What you own – What you owe
Your assets include your cash (checking accounts, savings accounts, etc.), brokerage accounts, mutual funds, house, cars, business, possessions, etc.
Your liabilities include your credit card balances, car loan, mortgage, home equity loan, or other loans.
Essentially, your net worth is the value of what you would have left over if you paid off everything that you owe. It is the bottom line of your personal balance sheet. It is a snapshot of your financial condition at a point in time. The change in your net worth is a great measure of your progress towards becoming wealthy.
Net worth is a great metric to track because it represents the sum total of all your decisions up until now. All of the income you earned and all the money you spent brought you to your present financial condition. By reviewing the change in your net worth consistently, you will know if you are spending too much relative to your income or if you can afford to spend more and still achieve your goals. There is no one right answer on how to become wealthy (or on how much wealth to accumulate). Some people will prefer to work harder and try to focus on earning a higher income. Others will prefer to decrease their spending. Some people will do both. The decision about the best course of action is very personal and depends on your values.
Your assignment
Your mission – should you choose to accept it – is to begin calculating your net worth on a monthly basis. First, make a list of your assets. Personally, I recommend ignoring any asset that depreciates (i.e. declines) in value, such as cars, clothes, electronics, etc. The conservative treatment of depreciable assets is to treat them as if they have zero value. There are two basic reasons that I treat depreciable assets this way: 1) it is easier because I don’t have to track assets that are just going to become nearly worthless anyway, and 2) I don’t want to fool myself into thinking that I am better off financially than I really am. For example, adding my car to my net worth will make my net worth look better right now, but it won’t help my net worth in the long run. Buying a significant amount of depreciable assets is a great way to make sure that you are never wealthy.
After you have listed your assets, gather up your statements (bank statements, brokerage statements, etc.), and enter the values for those assets. If you own a house, I would either use what you paid for it, the assessment value for tax purposes, or some conservative valuation for it. Don’t fool yourself into thinking you are doing better than you really are by entering in a high value. If you own a business, enter a value for that as well (it’s beyond the scope of this post to go into how to value a business).
Next, make a list of all of your liabilities (i.e. everything you owe). Gather up your statements, and enter values for all of your liabilities. Finally, calculate your net worth by subtracting the value of your liabilities from the value of your assets.
How does it look? This exercise can be a real eye-opener. Most people have no clue where they stand financially. If you are not happy with where you are, that’s okay. Accept where you are as an okay place to be for now. Don’t beat yourself up. Just focus on improving your net worth consistently from month to month. Pretty soon you will be anxious to calculate your net worth to see how you did for the month.
“Life is like riding a bicycle. To keep your balance, you must keep moving.”
– Albert Einstein –
Good luck!
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