When was the last time you did your financial health check?
Most people are not sure how to manage their finances because they are not taught in schools, or at home. Money may have been a taboo subject in the family or it has always led to argument between the parents, resulting in limited exposure to financial knowledge.
The fact that most high schools and colleges do not provide sufficient financial education to teach personal finance does not help either.
Some people are fortunate enough to learn the keys to financial success at home, from knowledgeable friends that are keen to share, or are willing to read up multiple personal finance books to acquire the knowledge to perform a proper financial health analysis.
While some other may never discover the key to financial success, or learn them the hard way — by making a number of costly mistakes along the way.
The more financial errors you commit, the more money leaves your pocket and out of your life. To make things worst, costly mistakes make you feel like you are not in control of your money, leading to stress and anxiety when it comes to managing money.
It all stems from not being able to master your finance.
Developing good financial habits
Regardless of your income, you can make your every dollar stretch further if you practice good financial habits and avoid costly mistakes. In fact, the lower your income, the more important it is for you to make the most out of your income and savings because you don’t have the next fat paycheck to fall back on.
From this point onward, please avoid making financial mistakes or overlook the wealth building strategies that will be discussed throughout the steps.
When taking into account your financial health, you should keep track of your overall financial situation, which includes reviewing your income, spending, savings, future goals, and insurance.
If you are like most people, you have either never done it before or you did so a long time ago that it probably is wise to reevaluate your financial health.
When you go through this step, try not to dwell on your financial “problems”. Instead view them for what they really are – various opportunities to improve your financial situation and ditch bad financial habits.
The more improvement you can identify, the greater the potential you may have to build real and long-lasting wealth, and at the same time accomplish your financial and personal goals.
What is my net worth?
Determining your financial net worth doesn’t have to be complicated
Your financial net worth is like a barometer to your personal financial health. It shows you at a glance how much you actually own and indicates your capacity to accomplish major financial goals such as buying a home, raising kids, retiring, and withstanding a major, unexpected expense or loss of income.
If you are able to set up a solid system around your net worth, which we will guide you through the rest of the steps, you will be able to accomplish your life goals and withstand any crisis. For starter, we do not need a complicated financial health calculator. Just follow through the steps and you will be in good shape.
With that said, your net worth is your financial assets minus your financial liabilities:
Financial Assets – Financial Liabilities = Net Worth
Adding Up Your Financial Assets
To define financial asset — an asset is real money, investment or property that you can convert into your currency to buy things now or in the future.
They generally include money in your bank, stocks, bonds, mutual fund accounts, retirement accounts (including those with your employer), business and real estate that you own.
What about my personal residence? Is it an asset? We generally don’t recommend including your home in the calculation unless you plan to sell it off someday or live off the money you have now tied up in the equity (by taking out a reverse mortgage).
If you plan to eventually tap into the equity (the difference between the market value of your home minus any debt owed on the property), you can add that portion of the equity that you expect to use to your list of assets.
Assets can also include your future expected income: for example social security benefits and pension payments (if applicable). However, these assets are usually in the form of monthly payments instead of a lump sum.
We will explain in a moment how to tally these financial benefits into your financial assets.
Consumer items such as your car, stereo, laptop and iPhone DO NOT count as financial assets. You may be tempted to add these to the list but you cannot live off them unless you sell them.
Therefore, ignore your personal possessions unless you plan to sell them off in the near future.
Subtracting Your Financial Liabilities
In order to get your financial net worth, you must subtract your financial liabilities from your assets. Liabilities include loans and debts that you still owe, such as any consumer credit including credit card loan, auto loan, student loan, payday loan, medical loan, and any other personal loans.
In short, to figure out your liabilities, include money that you have borrowed and have to pay back. At this stage, you do not need to include the interests that are attached to your loans. We will deal with the interests in the following steps. Just focus on principal amount that you need to pay back.
Include mortgage debt on your home in your liability checklist only if you include the value of your home in your asset list. Add in the debt owed on any other real estate that you own (because you count the value of investment real estate as an asset).
Example of Net Worth Calculation
|IRAs (Roths & SEP)||$35,000.00|
|Home Value (Market Value)||$300,000.00|
Note: As a shortcut, multiply the benefits (social security or employer’s pension) you will collect monthly in retirement by 240 (12 months per year times 20 years) and add the amount into your assets.
|Credit Card Loan||-$8,000.00|
Congratulations! You have just determined your financial net worth. If your net worth is negative or less than half your annual income, do take notice. But if you have just started working, having a low net worth is normal and don’t be too concerned.
However, don’t get depressed if you are not where you want to be yet, because it will only get better from now on. You are here because you want to improve your finance, and you will succeed if you stick to it.
In the subsequent steps, we will help you create your long term financial plan that would eventually lead you to financial freedom.
This article is one of 6-step series “Achieve financial freedom in 5 years time“.