Calculating Your Financial Report Card!
Today we look at Net Worth - Your Financial Report Card!
The underlying premise behind “net worth” is the question: What would I be worth if I were to sell everything I own and paid off all of my debts. Its not very realistic – no one is actually going to do this; however, it is an extremely useful tool for measuring financial progress. When first starting out, this number is likely to be negative – for those of us with student loans, net worth can be very negative. But over time the negative should become neutral and then positive. As we approach retirement, our net worth represents our nest egg.
While calculating your net worth is a simple process, it does require that you gather a lot of financial information. Once you have all this information, keep it in a secure place and update it annually. What will you need? Well you will need to know your assets and liabilities.
First, you will want to have information on large non-liquid assets these include:
- Equity in your home (market value – mortgage)
- Value of you car (if there is a loan, we will account for it below)
- Equity in your practice (if any)
Second gather statements for your liquid assets. Including:
- Checking accounts
- Savings accounts
- Brokerage accounts
- Retirement accounts (IRA, 401K, etc)
- 529 college savings
Third, consider any personal items of significant value
- Antiques / collectables of known value
Lastly, add up the value of all the non-liquid, liquid and personal items and this is your “total assets.”
First, you will want to have information on large outstanding loans
- Student loan debt*
- Car loan
Then find you smaller debts:
- Credit cards
Now add up all your liabilities to arrive at “total liabilities”
To calculate your net worth, simply subtract the total liabilities from the total assets. Remember, that “net worth” is nothing more than a snapshot of your financial situation at one point in time. To be truly meaningful, you need to look at trends over a period of years. What should be your goal? Well generally, we want to see our net worth trending upward year after year so that by the time we reach retirement, our net worth is at least equal to our projected retirement savings. People have over the years proposed target net worth formulas against which to measure your progress. lets take a look.
One commonly quoted target net worth formula looks like this:
- Target Net Worth = [Your Age - 25] x [Gross Annual Income ÷ 5].
So a 30 year old making $100,000 would want their Net worth be about $100,000. The problem with this calculation is that it’s not really designed for veterinarians who accumulate more debt and delay income earning much longer than other professions.
“The Millionaire Next Door” by Stanley and Danko makes for an interesting read. Essentially, the authors interviewed “Millionaires” and discovered that they aren’t whom you would expect. They weren’t doctors and lawyers. These folks spend too much of their money maintaining a certain “life style.” The real millionaires are people who are self-employed small business owners or work in unglamorous professions. They don't drive German cars, own an expensive watches or live in glamorous homes. In short they are “thrifty” common folk. In their book they came up with the following formula for target net worth, which looks like this:
- Target Net Worth =[Your Age x Gross Annual Income] /10
So using this formula, a 30 year old making $100,000, would expect a net worth of about $300,000. This is MUCH higher than the previous formula because Stanley and Danko are assuming you want to be “wealthy” not just doing well. Problems with this formula are the same as above. Very few veterinarians have a net worth of $300k 5 years out of school! The authors actually spend a lot of time describing what they call UAWs (Under Accumulators of Wealth) and those who they consider PAWs (Prodigious Accumulator of Wealth). Its an interesting read and I do recommend it, I’m just not certain its directly applicable to veterinarians.
The White Coat Investor is an interesting book and a website. They are authored by Dr. Jim Dahle and let me start by saying he is a very financially savvy author. At times some of his writings could be interpreted as sexist or judgmental. In addition, it seems like his conservative Mormon views sometimes color his recommendations. That said, he does offer some very sound financial advice. Because physicians, like veterinarians, spend much time in school accumulating student debt he proposed the following net worth formula for physicians:
- Target Net Worth = [Salary x Years in Practice x 0.3] -$200,000
So for our 30 year old veterinarian who graduated 5 years ago, and is making $100,000 we would expect a net worth of -$50,000. While this is probably closer to reality, this formula has never actually been validated for physicians nor veterinarians.
Which formula do I recommend? None actually. While they all provide interesting information, I think the best use of net worth is follow it from year to year and measure you progress. Focus on paying down your mortgage and student debt while growing your savings. And it goes with out saying, don’t carry a balance on your credit cards! I prefer to focus on these items, especially making sure I’m on track with savings, than worry about someone else’s definition of wealth!
* Student debt will require some discussion. If you are on a standard repayment plan then just put your outstanding balance here. If you are on income based plan it’s more complicated. Do this: Go to the Federal Student Aid Repayment Estimator and figure out what you will pay over the life of the loan and the amount that will be forgiven. Add what you will pay to the expected tax on the amount forgiven and this is your “Student Loan debt.” For more detailed discussion, please see here and here.