Why Your Net Worth Is Not the Most Important Number
In personal finance, a lot of attention is paid to your own capital , and for good reason – this is, in fact, your financial statement. You can calculate your net worth or statement of financial position by subtracting your total debt from your total assets.
Some experts say a different number could better measure your finances. Nick Maggiulli, chief operating officer of Ritholtz Wealth Management and blogger Of Dollars and Data , argues that your net worth does not reflect how you achieved your current financial position.
While two net worth may be the same number, they may not be equal. For example, Maggiulli says there is a big difference between someone who inherited most of their $ 1 million fortune and someone who saved and invested to achieve the same goal.
Lifetime Wealth Ratio
Rather than focusing on your net worth, Maggiulli offers a look at your lifetime wealth ratio, Personal Finance Blogger’s Concept J. Budgeting money is sexy .
Here’s how to calculate your lifetime wealth ratio:
Lifetime Wealth Ratio = Net Worth / Total Lifetime Income
As a reminder, you can calculate your net worth as follows:
Net Worth = Total Assets – Total Liabilities
You can see your total lifetime income on the Social Security website . After creating your account and logging in, click on the income entry in the right column. There is a cap on Social Security earnings, so you must add up Medicare taxable income (right column) to get your total lifetime income.
The next step is to divide your net worth by your total lifetime earnings. This percentage shows how much of your income you have turned into wealth. J. Money uses the following ratings to measure your progress:
- 0% -10% – Meh
- 10% -25% – Cooking!
- 25-50% – You’re on fire, baby! Give me your number!
- 50-100% – Marry me.
- 100% -1,000% – How do I get into your will?
While the ratings may be far from scientific, Maggiulli claims it can be better than just your net worth. The Lifetime Wealth Ratio takes into account your ability to save and invest, but it is far from ideal. This ratio can be skewed for young people who do not have much time to grow their assets. He may also be biased against people with higher incomes who can save but pay more taxes.
The group that benefits the least from this ratio are the consistently low income groups. When you spend nearly all of your income on basic services, it can be very difficult to save money and get rich.
The balance of wealth and discipline
Given the above constraints, the lifelong wealth ratio has several serious disadvantages. To make up for these shortcomings, Maggiulli suggests using a different number: the ratio of wealth and discipline. This is identical to the lifetime wealth ratio, but eliminates the need to spend annually.
The reason is that everyone should be spending money on the basics . Maggiulli argues that we must exclude the necessary costs from the ratio because you have no way to save or invest that money. He believes that you should only count the money that you could save and invest.
Here’s how to calculate the Wealth and Discipline Ratio:
Disciplinary Welfare Ratio = Net Worth / (Total Lifetime Income – Lifetime Major Costs)
It is not easy to calculate your basic lifetime expenses, but you can calculate the annual basic expenses (rent, food, utilities, transportation, etc.) for your family in every city you have lived in. While there is no perfect balance between wealth and discipline, Maggiulli says that balance may still provide some insight. For example, if you are closer to a 10% ratio there may be room for improvement, and a 100% ratio may mean you are not spending enough.