I didn’t get into studying finance until I was in my 30s, but when I did I studied hard and tried to make myself an expert in it. I had to, because I had to teach it. One of the things I latched onto early was the balance sheet. It fascinated me and continues to command my attention. Predictably, when I learned to look at my own personal balance sheet, my personal financial life literally started to come into balance.
Balance Sheets on the Brain
If you watch financial news on TV or read financial headlines, it seems like it’s all about earnings. The income statement is the focus, and this generates all sorts of volatility. If the company’s earnings per share for the quarter exceed expectations by $0.03, the market goes crazy and the stock is up 6% after hours. If revenues dropped by $5 million amid a production back-up, the stock is down 4% and the shorts are tweeting, “I told you so!”
I worry very little about earnings reports and the income statement. When I am interested in learning about a stock, I go to the company’s balance sheet. How much cash do they have on hand? What are their current assets vs. current liabilities (current ratio)? What are their total assets minus total liabilities (book value or equity)? What is their book value minus goodwill and intangibles (tangible book value)? How much debt do they have? How much of it is long term debt? What is the debt-to-equity ratio? After answering these questions, I already have a pretty good idea of what the company is like and how well it is being managed. Then I look at the cash flow statement. Follow the cash. Earnings don’t tell the whole story.
Judging a company based on its quarterly EPS is like judging someone’s health based on what they tell me they ate today. There is not enough information there, and they are probably lying to me about how healthy it was anyway. I could make a much better assessment by checking things like their weight, blood pressure, and cholesterol content. Those things tell me what’s happening inside the body.
I think most people look at their own household finances through the same flawed filter. It’s all about earnings. How much money do I make? What are my expenses? How much fun money do I get after I pay those off? What’s the most expensive house/car/TV/vacation I can afford? Let’s be honest, the most expensive one you think you can afford is one that you can’t afford, and it will catch up to you later. If we only look at ourselves that way, our lives are bound to have as much volatility as the stock market:
- bullish mania–accompanied by excessive spending–when things look good, and
- bearish depression–having to borrow money to keep the lights on and gas in the tank–when things don’t look good.
How many families bounce between these? I know that mine did for quite awhile before I started looking at our balance sheet instead of our earnings.
Net Worth: Your Personal Balance Sheet
Net worth is the total equity in your life, your personal book value. It’s your total assets minus your total liabilities. It’s easy to calculate. All you need is addition and subtraction. The trick is finding all the numbers. Don’t forget about that 401(k) from your former employer (you probably lost the login and have to call them to get it). Also, don’t forget about all the stuff you own. If it can be sold for money, it’s an asset. And don’t forget about depreciation. I calculate my net worth every quarter, and every quarter the Kelley Blue Book value of my car drops about $100.
Once you have tracked all this stuff down and put it in a spreadsheet, it becomes easy to keep up with it. It makes it easy to see exactly where you stand financially, like how well you are saving for retirement and how close you are to being able to afford your next big financial goal. My net worth spreadsheet actually helps keep me sane. When I check in on it and update the numbers, I see the thousands of dollars worth of progress I am making in short periods of time. It reminds me that my plan is actually working and that I am well on my way to financial freedom.
I cannot wait for the day that the bottom line of that spreadsheet says $1,000,000. My wife and I almost never drink, but I feel like we are going to open an expensive bottle of something that day to celebrate. I suppose we’ll have plenty of time to decide how to celebrate though. We have a long way to go to get to $1,000,000.
My Net Worth Journey
The first time my wife and I calculated our household net worth was at the end of 2016. We had a $1,600 emergency fund and over $30,000 in retirement savings. Not bad, right? Well, we had almost $60,000 worth of student loan debt. The bottom line: -$22,080
It’s not as scary as it looks. A net worth that low is common for someone just getting out of college. The problem is that we were 8-10 years out of college. We spent a decade not doing enough to pay down our debts.
-$22,080 is not the net worth of someone ready to buy a house, go to graduate school, or to be on track in preparing for retirement. Those are all long-term goals of mine, so I did what any person determined to achieve their long-term goals does, I set S.M.A.R.T. goals (specific, measurable, achievable, realistic, timely) for the long-term, mid-term, and short-term.
My long-term goal was to be ready to buy a house in 5 years, including having all student loans paid off and a 10% downpayment saved. My mid-term goal was to get my net worth back above $0 within 3 years. My short term goal was to invest an additional $200/month.
I did great at this until Navient raised the interest rates on a bunch of my student loans to above 10% (Navient has to be one of the top 5 most evil companies in the world, by the way). At that point, I had to change strategies. Any debt with an APR that high needs to be priority number one. I stopped putting money in my investment accounts and started paying extra on student loans. While this wasn’t my original plan, it was still focused on improving net worth.
To make matters worse, I received a huge dental bill in early 2017, which was a major setback. It took most of the year to pay it off. However, I didn’t sweat it. I kept my spending low and focused on net worth, checking in on it every quarter throughout the year. My wife and I started a system for reducing our food spending that was a huge help.
My wife and I reduced our debt from $64,813 to $51,134 in 2017. It wasn’t easy to make extra student loan payments while also paying off that dental bill, so I am proud of our progress, but we still have a long way to go. Dave Ramsey has shared enough stories of people who paid off more than that in less time with less income, so we know it can be done.
We also grew our assets from $42,733 to $51,674 in 2017, thanks to 403(b) contributions with employee matching, our other investment contributions, and the gains earned by our stocks and mutual funds. This bull market has been helpful, but so has smart planning and paying attention!
The new bottom line: $540
Net Worth Goals
We improved our net worth by $22,620 this year, and it is now a positive number. We achieved our 3-year goal in 1 year, in 1/3rd of the time we had planned.
Now it’s time to raise the bar and change our mid-term goals. The new mid-term goal is to be debt free by January 1, 2021, one year sooner than the original goal. To make that happen, the short-term goal is to pay off $20,000 worth of debt in 2018, including paying an extra $400 above the minimum payment on our highest interest loan every month. That will bring the most disgusting loan we have down to a zero balance.
It is going to take a lot of sacrifices to pay that extra $400 per month. However, it is going to feel amazing to close another student loan account and to reduce our debt by another 40%. When we are debt free in a few years, and later when we retire as millionaires, it will all be worth it. As Dave Ramsey says, “If you will live like no one else, later you can live like no one else.”
Net Worth Resolution
We are coming up on a new year, and everyone will be talking about resolutions. I have always thought that resolutions are stupid. People say them to themselves, then buy a gym membership, use it 2 or 3 times in January, and then go back to being a slug again.
However, if one is going to indulge in the tradition and does so in a way that actually sets them up for success, I am all for it. If you want to set a new year’s resolution, write it down as a S.M.A.R.T. goal. Make sure it meets all 5 criteria. Don’t share it with anyone until you have completed it.
I set a couple very specific S.M.A.R.T. goals for myself at the start of 2017. One was to read and review 52 books in 1 year (average 1 book per week). I finished book #51 yesterday, and with 2 in progress I and might actually finish 53 by the the end of the year. The other was the 3-year net worth goal that I finished 2 years early. If you want to make a new year’s resolution, consider making a net worth-based S.M.A.R.T. goal.* It is a very effective and rewarding way to understand and improve your financial situation.
*One point of caution about net worth goals: Part of your net worth is based on market returns. If you have $50,000 in retirement savings and the market drops 20% this year, your net worth might take a temporary $10,000 hit that is not your fault. However, if your focus is on how much debt you pay off and how much you contribute to your investment accounts, you can’t lose.