Your Net Worth Statement: the financial equivalent of a Swiss Army knife
November 11, 2013
There are lots of financial writers, advisors and experts that all tell us we need to complete a Net Worth Statement. And while some of them even tell us why we should do it (to find out where you are financially today!), they never really explain how we should use it to help guide our financial decisions.
It’s really too bad because your Net Worth Statement is more than just a static photograph of your financial situation. It can actually help you get a grip on various aspects of your financial life if used properly. Just think of it as your financial Swiss Army knife.
- It’s an important planning tool to help you keep score. Yup, that’s right. It helps you keep track of whether you’re winning or losing. Are you richer than you were last year? Your Net Worth Statement shows how rich you are today, and gives you the ability to track your progress toward your long-term financial goals. For example, if your objective is to analyze your retirement plan, you’ll want to know the present value of your investments and track their future values. At the same time it will let you see your outstanding debts decreasing each year (ideally!).
- It can help you with financial emergencies. Financial emergencies happen – losing a job, getting injured at work, getting really sick, etc. So, your Net Worth Statement tells you where your money is, which is especially useful when emergencies hit. For example, are your assets tied up in real estate with nothing in the bank? Unfortunately this is sadly the case for a lot of households. So, if that’s what your Net Worth Statement is telling you, then you might want to make some changes and start to build up that emergency fund.
- It exposes the good, the bad, and the ugly. Ideally you want to see your net worth increasing each year. But when you have both investments and debts, it’s not always clear whether you’re spending and improving life-style is due to a growing net worth and income or an increasing amount of debt. In other words, while borrowing to spend can make you feel wealthier, it can actually make you poorer. Your Net Worth Statement never lies. It will capture your real financial picture with all your true blemishes – the good, the bad, and the ugly.
- It will prepare you for your banker. Sooner or later we all find ourselves heading off for a meeting with the bank about that loan we need. And he/she is going to ask … What’s your net worth? It’s also a common question on most college financial aid program forms. So be prepared.
- It’s also useful for insurance purposes. To repeat, ideally most of your assets are going up in value. Updating and reviewing your Net Worth Statement on a regular basis will help you to maintain adequate insurance coverage of those assets. For example, what is the current value of your home and its contents? Do you have enough insurance to cover its replacement? Your Net Worth Statement can help ensure your insurance needs are up to date.
- It’s necessary for certain investments. In some instances there are certain types of investments that are best suited for high net worth, sophisticated individuals where the investment industry requires that investors demonstrate a minimum net worth before they are permitted to invest. In these circumstances, a Net Worth Statement is essential to get you in the door.
Net worth goals
For most of us, the most basic goal in our financial lives is to be richer tomorrow than we are today and to live a comfortable retirement. And to accomplish this most basic goal, the character of our Net Worth Statement will change as our assets increase in value and our debts decline and (hopefully!) disappear.
As you review your Net Worth Statement each year, here are a few net worth goals to keep in mind:
- Include cash on hand. Your net worth should include assets that can be easily used to help cover both your planned expenses (i.e. RRSP, RESP, TFSA contributions, new roof, car purchase, etc.) and unplanned expenses (job loss, car repairs, etc.). Do you have enough money readily available to cover both these types of expenses?
- Weigh investment assets. Identify which of your assets will increase in value (typically real estate, financial investments, private businesses, etc.) and which assets will not (typically, cars, boats, trailers, etc.). Your goal should be to minimize those assets that decline or depreciate in value.
- Minimize consumption assets. Try to minimize the amount you spend on assets that will diminish in financial value over time. These assets are typically the toys and luxuries we buy on a whim. Before you buy, look at alternatives such as renting or chartering that new toy boat or trailer.
- Review your liabilities: There are many different types of borrowing and many different reasons for borrowing – some good and some not so good. Borrowing to pay for your day-to-day expenses (i.e. clothes, gasoline, dining out, etc.) may indicate you’re living beyond your means. Each year ask yourself as you look over your Net Worth Statement, do you owe less this year than you did last year? Ultimately, your goal should be to reduce your debts and eventually (!) be debt free.
Measuring your financial success: it’s different for everyone
What should your net worth be at any specific point in time? We all just want to know … at my age, am I winning or losing? Just give me a Yes or No!
Unfortunately, there’s no standardized chart for you to refer to when checking your net worth success or failure. Each of us is unique with unique family resources, financial goals, expectations, etc. For example, a 45-year old with a family will have a different net worth than someone without kids, or someone who’s landed an inheritance.
The main thing to remember is that your net worth should look like it’s growing in value, allowing for chapters in your life that can be expensive or include financial emergencies that we talked about. As we said before, think of your Net Worth Statement as your financial Swiss Army knife. Keep it around and use it to stay focused on your financial goals no matter what stage of life you find yourself in.
(This article was first published by Troy Media)
Read the next article in the series - Budgeting: a team sport
Read the 1st article in the series - 76% of Canadians must be idiots when it comes to saving and planning for retirement!