For many of us, 2020 has been a year to forget. While many have suffered financially, most are in better shape than we feared amid the market crash in March. But how do you check your financial vital signs to determine your fiscal health? You need to understand your net worth and annual spending.
You probably know how much you earn a year. If you’re a homeowner, you have a reasonable guess of your home’s value thanks to the magic of Zillow and our county assessor. But net worth and annual spending are two metrics that don’t come as easily. I’d encourage you to make an annual habit of computing them and tracking your progress. While using software such as Quicken or apps like Mint or YNAB can make the process easier, you only need a calculator or spreadsheet to do the job.
The net worth statement simply adds up the value of your assets and then subtracts your total debt. Often when valuing assets, we tend to put down how much we paid for household items, cars, and other similar assets. Instead you should use how much your assets would fetch if they were sold to another party. So you get full credit for your checking account balance and investments. Vehicles should be valued according to Edmunds.com or a similar resource for their private party sale value. Furniture and most household goods are best kept at zero, as anyone who has frequented estate sales can tell you.
Let’s run through the finances of the mythical Cruz family. They have a single-family home with a Zillow estimate of $550,000 with a mortgage of $325,000. Jasmine Cruz has a 401(k) plan through work of $180,000 and a Roth IRA of $25,000. Brian Cruz works for a nonprofit and has a 403(b) retirement savings plan of $140,000 and a Roth IRA worth $28,000. The Cruzes have a joint checking account with $13,000 and total credit card balances of $7,000, although they pay them off every month. Finally, they have a total of $36,000 in Colorado 529 plans for higher education for their children. Jasmine drives a 2015 Toyota 4Runner worth $26,000 with a $23,000 car loan. Brian leases a 2018 Subaru Outback for $399 a month.
Adding up the value of their assets, we include the value of the Cruz home, retirement plans, Roth IRAs, checking account, owned car, and the 529 balances for a total of $998,000. Almost millionaires you might say, but alas they have debts of $355,000. This gives them a net worth of $643,000, far above the average household in this country. Note that the leased car gets no value as they are merely paying for depreciation and borrowing cost over the life of the lease.
While computing net worth may present little challenge, annual spending can be a little tougher to unlock. You may think that you need to tabulate every single spending category to understand your annual spending. But you can use the “top-down” approach to quickly come to an answer. Look at your checking account balance at the beginning and end of the year. Then look up your year-to-date paystubs to see how much has been deposited into your checking account for the year.
Imagine the Cruz family earns a gross income of $160,000 a year but after income and payroll tax withholdings, retirement plan contributions, and employee health insurance premiums they deposited $4,300 biweekly into their checking account. That totals up to $111,800 in deposits for the year. Let’s add $10,000 for the checking account balance at the beginning of the year and subtract $13,000 for the ending balance, you end up with annual spending of $108,800. If the Cruzes had made any transfers to investment accounts or prepaid any mortgage principal, we would subtract that from their spending estimate.
Now that you have your net worth and annual spending figures, what should you do with them? I’ve found that tracking them every year can give tremendous insight into your financial health. If you truly want to measure your financial power, you can divide your net worth by your annual spending. If you find your financial power increasing every year, this means you’re on the road to financial independence.
David Gardner is a certified financial planner practicing in Boulder County. The opinions expressed by the author are his own and are not intended to serve as specific financial, accounting, or tax advice.