Thriving Millionaires

By Eric

Spend a few minutes browsing the internet for personal finance advise, articles, blogs, stories, etc, and you’ll come across a litany of metrics and measures to gauge your personal finances. Certain people tout one measure to be the be-all-end-all. Others are focused on measuring everything and running every possible computation on the data. Most fall somewhere in between those two.

Truthfully, there isn’t a “right” answer to the best metrics and/or what you should be measuring. Like most things in the personal finance realm, it comes down to your personal situation and individual goals.

Because it does (and should) vary from person to person, the list and explanations below aren’t my recommendation for what you should be measuring – but rather my top three and the reasons why. If you find yourself in agreement, all the better, but know that you may find other metrics that work better for you and your situation.

Metric #1: Net Worth

Net Worth tops my list because of its ability to show progress over time. Being the data nerd that I am, I have an Excel workbook that tracks our net worth over the course of about 5 years. There is something fundamentally satisfying to me about watching our net worth grow over time and remembering all the effort and sacrifice (along with some luck) that went into helping that number increase.

For those who don’t know, net worth is defined as your total assets (cash, investments, property, etc) minus your total liabilities (debt, mortgage, etc). For context, below is the median net worth by age grouping according to the Federal Reserve (note – I am using median because the average tends to be skewed by a small percentage of individuals with very high net worth).

Under 35: $11,000

35-44: $59,800

45-54: $124,200

55-64: $187,300

65-75: $224,000

I share these numbers not because I think they are a resounding accomplishment and should be treated as targets (frankly, I think they are a little low, but that speaks to the need for people to focus more on their personal finances), but rather because it provides a general benchmark for comparison.

Personally, we pay no attention to where we stand vs the median or average for our age group, but instead focus on two things relative to our net worth:

1. Net worth growth over time and vs the same time period in the previous year.
2. Current net worth vs where we hope our net worth will be at the end of each year.

Each year we have a net worth target for where we want to be on December 31st. We track our progress towards that goal by pulling our net worth out of Intuit’s Mint and adding the data points to the previously mentioned Excel file.

Because net worth is, in my opinion, the best measure of overall financial health and standing, you can increase your net worth by either adding to your total assets or reducing your total debt.

Some of the best ways we’ve found to increase assets are to spend less than we make and invest the difference. It may sound simple, but having a budget that ensures you are investing money each month into a 401k, IRA, brokerage account or even a savings account will allow you to grow your assets over time. This plays into my second favorite metric, Monthly Net Income, which I’ll speak to below.

Reducing your debt can be done in a number of ways, but generally will depend on the type of debt that you currently have. Working to pay off credit card debt, student loans, car loans, and mortgages will allow you to reduce your liabilities and increase your overall net worth.

The balance between working to grow your assets and reduce your liabilities is unique to each situation and each individual – but taking the time to inspect your personal finances and make a plan is the key component regardless of where you stand today.

It is important to note that net worth won’t always move in the positive direction. Market downturns, declines in home values, unexpected expenses that cause you to dip into your emergency fund or savings can all move your net worth downward. That is completely fine and, actually, expected. The purpose of net worth should be momentum over time, specifically with a long-term view.

Metric #2: Monthly Net Income

Monthly Net Income is my second favorite measurement in the personal finance realm because it allows to take a long-term metric like net worth and bring it to a monthly number. This makes progress towards increasing net worth feel more doable on a monthly basis and you can easily move the needle on this by adjust your budget.

I measure monthly net income as total income less total expenditures. For example, if you make $5,000 per month and your total monthly expenses add to $4,500, your monthly net income would be $500. Finding ways to increase your income or reduce your expenses by $200 each month (or $100 in each bucket), would increase your monthly net income to $700.

This net income per month will find its place in your net worth calculation. Even with no returns or savings on interest factored into the equation, $500 per month of net income will increase your net worth by $6,000 per year. If you can find a way to expand this monthly net income to $700 as per the example above, your net worth will increase by $8,400 per year. Assuming you begin working at 24 and start with a net worth of zero, by the time you reach 34, you would have a net worth of $84,000 – again, this assumes no returns at all. With an assumed 7% return per year, this net worth would be closer to $116,000. When you compare that to the median net worth in the “Under 35” bucket above of $11,000, you can see that you would be setting yourself up for long-term financial success.

Our goal is to find ways to increase our monthly net income over time and invest the difference in a variety of ways. When I receive a raise at work, our income number goes up. Provided we can hold our expenses flat, that increases our monthly net income which we can then put the difference to work via increased contributions to our 401ks or IRAs or simply by buying stocks/ETFs via our brokerage accounts.

Metric #3: Annual Passive Income

I can admit my bias, I like dividends. I view interest and dividends as truly passive income. This is money that, while it requires capital to generate, requires no work on my part. I don’t have to invest time to generate this cash flow, which is the integral rule by which I measure our annual passive income.

For reference, I add up all the dividends paid to us in a year plus all the interest generated from savings accounts/CDs to get to a total annual passive income number.

I like measuring annual passive income because it allows me to change my perspective on the amount of cash we are able to generate completely passively. Let’s say for example you have $100,000 of invested funds in the market with a dividend payout of 2.5% and $10,000 in a savings account earning 1.0% interest. In this example you would earn $2,600 per year in passive income. The perspective I take on this is that this money can pay for ordinary expenses in your life, rendering them functionally “free”.

From the example above, if your mortgage payment is $1,300, your annual passive income pays for 2 months of your mortgage each year. Or, viewed differently, if your cell phone bill is $150 per month and your internet bill is $70 per month, your annual passive income pays for your cell phone and internet for the entire year.

Certainly this measure requires a substantial amount of money to be invest and earning dividends and/or having money in high-yield savings accounts or CDs, but even with a more modest sum, shifting your perspective on how those payments work for you can be beneficial.

For purposes of an example on a smaller scale, let’s say you have $12,000 in your investment accounts earning the same 2.5% dividend yield and $3,000 in your savings account earning the 1.0% mentioned before. This situation would still provide $330 per year in truly passive income. That would allow you to pay for your internet for nearly half of the following year completely free. As you build your invested base over time, you can get to a point where you can cover your entire annual internet bill.

For me, this metric is all about perspective. But by shifting your perspective on the dividends and interest you earn, you can feel better about your personal finance situation.

Patrick’s Thoughts:

In today’s response, I really want to focus on Net Worth. I think all of the metrics that Eric talks about above are incredibly important to track. On top of that, most Americans don’t do a good job measuring them. Why is it that everyone is so focused on gross income as a measure of financial success? We’ve seen the movie stars who make hundreds of millions of dollars and then go bankrupt. The old joke is that consumption often keeps up with income, so not including that consumption in your financial metrics will give you a false sense of security.

So why is Net Worth so important? When Forbes publishes its annual list of billionaires, this is the number they care about. The reason for its importance is it’s the primary metric that matters. You could have billions of dollars’ worth of assets, but if you have even more in liabilities, do you really have anything? The fact of the matter is you don’t. Now some people might take this as your primary goal should be to have no liabilities. That’s the wrong way to look at it. The goal is to take actions that increase your net worth, and often times, more liabilities lead to more assets and an acceleration in the difference between the two

So what do I mean by that? Take real estate as an example. Let’s say you go ahead and get a mortgage to buy a second house. Ideally, the purchase of this house doesn’t have a net impact on your net worth. You acquire a $250,000 asset and take out a $200,000 mortgage on it. The impact on your net worth is zero, because the $50,000 in cash you had before now takes the form of equity in the house. The benefit for you hear is the future increase in your net worth. If you’re able to rent out the house, you can have someone paying your mortgage for you, which adds to your net worth every month as you slowly pay down principal. In a lot of cases, you will make some profit on the rental further accelerating growth.  All this isn’t possible if you aren’t willing to increase your liabilities.

The house example only works because a house is generally an appreciating asset. Taking out liabilities on an appreciating asset is a tremendous way to build net worth. The same could be said for other investments in stocks or different retirement accounts. Data shows that real estate generally is the best appreciating asset you can own, but the important thing is to not have too many depreciating liabilities, as those will contribute negatively to your net worth.

Tracking your net worth doesn’t need to be a hard activity at all. You should understand the impact every decision you make has on your net worth. Even at the grocery store, when you’re purchasing food items, you should be thinking about it. The people that are the best at any activity are ones that are constantly studying and tracking the impact their decisions have on their performance. The more you can be focused on your net worth, the more success you will have. As you track the impact different decisions have, you will be able to determine what are the best ways to increase your net worth.

Now this doesn’t mean you totally avoid all consumption that doesn’t increase your net worth. That just isn’t possible. What it does mean though is that you need to change your mindset for how you view income and consumption. It’s this mindset that will lead you to make the  most important decisions and avoid the worst. Like anything, if you go to the extreme with it, you may find yourself not living as enjoyable life as you want, but like anything in life, the important thing is to get the big decisions right.

A friend of mine told me a story about a real estate agent who worked with a couple high-powered attorneys. They had a $2.5 million house they were trying to sell and easily made $400-500K a year each. This is the type of couple that many of us would think has their financial plan together. Even with all their success, they weren’t even able to write a $10,000 check. Don’t be like this couple. Start tracking your net worth and making decisions to increase it over time with smart investments.