Most people interested in personal finance have a goal to build wealth so they can have options, whether it’s travelling, switching careers, or simply retirement. In making that happen, it’s important to focus on income — earning more. But Financial Samurai makes a solid argument about why net worth might deserve more of your focus.
Currency picture from Shutterstock
He writes:
It’s all fine and dandy to have a $20,000 a month income. But if they have got no assets to speak of, there’s a high chance that not only will their income go away one day, they will end up back to square one because people have a tendency to spend everything they earn. Growing your net worth requires a higher level of financial acumen than growing your income.
Basically, it’s great to have a six-figure job, but not focusing on net worth could destine you to work at that job forever. Here are a few of the reasons why Financial Samurai says net worth trumps income:
- You’re taxed on income, not net worth: The government is (generally) interested in how much you make, not how much you have.
- A different wealth mindset: While income focuses on your being a “worker bee”, net worth focuses on your own investments.
- A higher level of security: You feel more secure about your financial situation.
Of course, this isn’t to say that income isn’t important. It is, and, in fact, net worth and high income usually go hand in hand. His point is simply that it makes more sense to focus on how much you have than how much you make. And this focus can be helpful when planning for financial goals.
Check out the full article for more detail.
Focus On Building Net Worth Even More Than Growing Income [Financial Samurai]
Comments
10 responses to “Why Net Worth Matters More Than Income”
ProTip: When you reach retirement, your net worth matters a lot. If you are a high net-worth individual, you will find all your ‘poor ‘ friends get all sorts of taxpayer sponsored handouts. You will get none.
If you are going to work your guts out and save your entire life to build a high net-worth, make sure you do it well enough that you get a better income from your assets (for 40 years), than you would’ve if you had enjoyed life and spent a little more in your youth, and ended up on the pension 10 years earlier.
Or, spend the money on a good accountant so that net worth isn’t counted by the ATO as yours.
And for us dumb dumbs. What is net worth and what does it extend to? My car? My computer?
Good question.
Forget the car and computer, you cannot readily cash them.
Keep your eyes on cash, bank deposits, saleable investments – minus liabilities/obligations.
First things first with me, Kill the 26K Debt I have….
http://en.wikipedia.org/wiki/Net_worth
Everything you own minus everything you owe.
I would include non-liquid assets (I’d argue a house is less liquid than a car or a computer and not including real estate in a calculation of net worth would be absurd) however you need to keep in mind the nature of your assets depending on the purpose of the exercise.
Whether you want to quantify your tshirt collection is up to you but I think for most people that level of accuracy is not worth the cost of analysis.
Net worth does extend to your car and computer, however you wouldn’t want to base your net worth goals on such things as they are depreciating assets (ie they reduce in value over time, generate no income and are costly to maintain and operate). Ideally you want to focus on assets which appreciate over time and generate an income. For example cash in a high interest bank account, while it depreciates due to inflation over time, generates income through interest, which in the long run is generally more than inflation. A diversified share portfolio generally appreciates in the long run and provides income through dividend payments. As the article correctly points out, you want to have a sufficient level of income generating assets, that will offset the loss of income when you stop working.
This is a well thought out reply by kesawi, so keep it in mind as you put together a financial plan.
A few basics to add:
Do a budget on spending and make sure your expenditure is lower that your income.
Put your savings to work to grow them via fixed interest or shares if you don’t have much,
property or housing if you have more.
Keep in mind capital gains tax when you sell (shares can be split over a number of years but property can’t).
Study up on franked dividends and negative gearing.
Income is always essential. Net worth is the Insurance.
Net worth is the total of your assets, minus the total of your debts.
So, if you had $900 in the bank, $100 in cash, and a debt of $26k, your net worth would be $1k-$26k, which is -$25k.
@pbgala is right – it’s probably not worth counting assets that you wouldn’t sell (e.g. if you need your car to get to work), or that aren’t worth selling (e.g. if your computer would only sell for a couple of hundred).
When you’re just starting out financially, net worth is a useful way of measuring your progress and creating goals. Currently, you’re at about -$26k, and you’re aiming to get to $0. Once you get there, you might set another goal, like “get to $5k one year from now”.
loosers
I’m sorry but this article and the one it references – total bullshit.
Income and net worth are not mutually exclusive. The only way you can build net wealth is by saving and investing. Both of them require you to spend less than you earn. The more you earn, the more potential to save.
Superannuation is a good example of this. If you focus on improving you income, you’ll also improve your super contributions, and build your net worth. Superannuation contributions on $20,000 per month is equal to $18,783 per year in contributions.
What is even more idiotic is that it’s completely bloody obvious. When you retire you don’t have an income so you need to build enough income producing assets to replace it.
The only exception to above is some massive inheritance or winning the lottery or some game show. Is this article suggesting people go after these?