Updated: Feb 21, 2021
If you do not measure the right data point, it is very hard to succeed. Think of it like a skier. For a skier, there are races where the goal is to get down the mountain as quickly as possible, events where you’re scored on tricks performed, and style/form demonstrated. Following this logic, if you enter a race, expending your time completing tricks and jumps, you may have done some incredible things, but, you won’t ultimately be successful. The race isn’t measuring tricks, your focus was off when it comes to what would lead to your success. Finance is very similar to this metaphor. In finance, we need to focus on what ultimately drives success, and then measure against that, instead of some arbitrary measure not linked to the ultimate goal.
In financial terms, the most common example is people focusing strictly on growing their paycheck but not measuring and actively growing their net worth. This is why we discuss the “Net Worth Mentality” often, income typically measures how extravagantly you can live today while net worth measures how secure and prosperous you can be in your future. Frankly, I’m not concerned if my clients are able to drive the nicest cars or eat out for every single meal, these things usually don’t contribute to their financial or personal well-being (and may even detract from it). What does concern me is if clients will be able to prosper as they advance in age, rid their lives of the stress associated with insufficient financial resources, send their children to college, etc. For this reason, we adopt the Net Worth Mentality, actively track, and strive to grow our net worth.
Knowing this, there’s a logical intersection between income and net worth. It’s crucial to determine, track, and growing how much of your income goes towards increasing your net worth. We’ll call that the “Net Worth Growth Percentage.” This percentage is determined by how much we contribute to retirement accounts, save towards specific goals, pay off the principal on loans on appreciating assets, or any other financial move that increases our assets or decreases our liabilities. It’s worth noting that we don’t include paying off debt on consumer loans or depreciating assets because they typically lose value as quickly or more quickly than the principal pay down.
For further reference, consider the simplified monthly Income Statement for Taylor and Adam found below under Attachment 1 & 2. While Taylor makes significantly less income than Adam, she is contributing almost 19% of her gross income towards her 401(k), keeping her monthly expenses lower, and avoiding significant debt on depreciating assets and consumer goods. Adam, on the other hand, is only contributing up to the 6% match on his W-2 income into his 401(k), carries more credit card debt, and took out a loan on a new truck. Not only is Taylor growing her net worth at a larger dollar amount per month, but the percentage of her income that translates to net worth growth is also a whopping 40.37% compared to only 22.28% for Adam. To put things in perspective, even 22% is a relatively strong number, and Adam benefits greatly from the principal paydown of his two mortgages and student loan, however, Taylor is really setting herself up well by turning over 40% of her monthly income directly into net worth growth.
Now, pull up your most recent financial records. If your percentage is below 20%, you really do need to make some saving/spending changes if you’d like to be successful financially. If you’re between 20-40%, you’re off to a great start but there is room to go. And, if you’re in excess of 40%, you should see rapid growth in one of the most critical financial indicators, your net worth. Even still, if you find yourself in that highest percentage bracket, why not actively work to grow the percentage even more! It is for that reason that we calculate, track, and actively work to grow client’s Net Worth Growth Percentage as part of our ongoing financial planning service, because it really can be one of the most important indicators for financial success.