## How much are you worth?

Your Net Assets are the sum of everything you own that has a monetary value . Many of these assets will have an immediate, obvious financial value, like the money in your bank account or the amount you owe on a credit card.

Other assets and liabilities require valuation and may have transaction costs to turn them into money. For example, if you own a car outright, the asset value of the car is the amount you would receive if you sold the car tomorrow. By definition, the value of your car is only an estimate because you don’t know for certain how much somebody would pay for it.

Importantly, assets or liabilities that do not have a certain market price – like a house or a car – should not be valued be valued at the price they could be sold for TODAY. Not, the price you paid for them. So if you bought a car for \$20,000 and it’s market value is \$8,000, then the Net Asset value of the car is \$8,000. And you’ve experienced a \$12,000 decrease in your net asset value.

Net Assets are a snapshot in time. Your assets and liabilities will change and fluctuate on a daily basis. So, net assets are always related to a certain date. On Tuesday, August 2nd, 2020, at 8pm, my Net Assets equalled \$184,200.

Many people focus on their cash in and cash out each month, or their income and salary. But Net Worth can actually be far more revealing of how you’re progressing towards Financial Freedom.

## What is the Net Asset equation?

Net Assets = Assets minus Liabilities

It’s called Net assets because we are netting off (or deducting), your liabilities from your assets.

## An example of calculating Net Assets

Jemima adds up all of her financial assets. She has \$2,000 savings, \$500 in her checking account, and \$20 in a piggy bank.

Her total assets are simply the sum of the value today of all those financial assets. In this case – Jemima’s total assets are – \$2,520.

Next, Jemima adds up all of her liabilities. She owes \$800 on a credit card, and \$200 on an overdraft. Her total liabilities are therefore \$1,000.

Finally, Jemima deducts here liabilities from her assets. \$2,520 minus \$1,000 = \$1,520. Jemima’s net assets are \$1,520.

## Quick way to Calculate your Net Assets

Pull up any bank accounts, savings accounts, loans and credit cards you have. On paper or a simple spreadsheet, note down the number you see. Be sure to mark any negative balances – like overdrafts or credit card bills or mortgages – as negative amounts

Now, if you hold other monetary assets, like shares, stocks, bonds, precious metals, bitcoin, check their value today. Add that to your list.

Last, if you have any big non-financial assets, like a house or a car, scribble down an estimate of how much these would sell for after all costs. Don’t forget to include any loans or mortgages on the properties as negative items in your list.

Add up the quick list of net assets. The total at the bottom of your page or spreadsheet is a great estimate of your personal Net Assets as of today.

And yes, it is possible for the number you’ve reached to be a negative number. That’s if your liabilities are larger than your costs.

There’s also a long way to calculate net assets too. We’ll come on to that later. If you become more sophisticated about you’re finances you might want to get more accurate. But for now, the quick way to calculate your net assets is perfect.

## How do my Net Assets change over time?

Every month, your personal balance sheet (aka your Net Assets or Net Worth) will change. Income and Gains may flow in, Expenses and Losses may flow out.

For example, on the day you are paid a salary, your Net Assets will increase. On the day you make a mortgage payment your net assets will decrease.

When your Net Assets increase or decrease because you have received cash or paid out cash, we call it cash in or cash out.

Your net assets can also change in value because the market value of the asset has changed. For example, if you own a house and it has increased in market value from \$500,000-\$600,000 over the last month, your net assets would increase by \$100,000.

When your net assets increase or decrease because of a change in market value we call this a revaluation.

So, some changes to your net assets are from you actively doing something, like going to work getting paid. Other changes to your net assets are passive – you haven’t had to do anything for the value to change. An increase in the value of the house you own is an example of a passive change to your Net Assets.

## Measure your net asset position on a regular basis

Take a quick method for calculating on the assets and form a habit of re-calculating your net assets on a regular basis. Although your letter says change every day, we will have limited time. I recommend assessing your net asset position once a month.

## Benefits of regularly calculating your Net Asset position

There are several benefits from calculating your net asset position on a monthly basis.

1. Over time, you can understand whether your net asset position is improving, standing still, or going backwards. Your net asset position is a snapshot in time, so only by seeing several snapshots can you understand the dynamics of your personal assets.
2. A regular review of your net assets allows you to check in on the individual performance of each asset. For example, you might notice each month whether your credit card bill is rising over time. Or, you might see that the value of that crypto currency you bought whilst drunk is still falling.
3. Some people just get a kick out of seeing their financial firepower grow.
4. Calculating Net Assets is a much quicker method of knowing your financial position than methodically counting every penny in and out – the traditional budget. The phrase penny wise, pound foolish sums this up. A traditional income and expense budget has you obsessing over tiny details of your financial position but it does not give you the big picture. In life, start with the big picture.
5. You can use your net asset position, as the basis for understanding how close you are to financial independence. Your net assets are a key indicator of your progress towards financial freedom.

The only real downside to regularly calculating your net asset position is that it takes a little time. There are tools to allow you to automate this process. Some people prefer to perform the task manually.

## Is my net asset position good or bad?

So you get your Net Worth number for the month. Now what? Does looking at it make you feel a little sick? Do you puff your chest out with unmitigated joy? Or possibly, do you blink in vague recognition, unsure whether this number is good or bad news.

Let’s give your Net Worth a quick diagnosis. From Spiralling and Scrabbling, through to being a New Born, an Accumulator, Wobbling, before progressing to Financial Independence.

For this you need to have at least two months of net asset information. Don’t worry if didn’t record your net assets last month. You can simply look at your last months bank and valuation statements. They won’t have changed.

To diagnose your net worth position, you need to know: whether your Net Asset position today is Positive, Zero or Negative (i.e. is starts with a minus sign). And, you need to know how your Net Asset position has changed since the previous month.

These two factors give you a direction of travel.

For example, if Beryls net asset position was minus \$20,000 she has negative net assets. If her net asset position improved from minus \$30,000 last month to minus \$20,000 this month, her net assets improved by \$10,000 so she is improving.

The table below breaks down for each combination of Net Asset Position and how it compared to last month, a diagnosis.

Using Beryl from above, she had negative net assets, and her net assets were improving. So, using the table, Beryl would be classified as Scrabbling.

## What’s your current net asset trajectory?

Once you have identified your net asset trajectory, you can understand what it means and ultimately take action. The descriptions below run through all of the possible net asset trajectory.

## Net Assets: Spiralling

Your Net Assets are negative, and fell compared to last month.

Red Alert. Having a worsening, negative Net Worth is the single most dangerous stage of anyone’s financial journey. Not only are you in debt, the distance to solvency is growing. Your Income and Capital Gains aren’t covering your Expenses and Capital Losses

Should you panic? No.

Should you act? You bet.

You must take immediate action if you don’t want to find yourself in a bankruptcy court anytime soon. What sort of action? You need to reduce costs or increase your income. You need to improve your savings rate.

Take those actions successfully, and you will hit rock bottom.

## Net Assets: Rock Bottom

Your Net Assets are negative but the same as last month.

We all hit it.

Everyone.

The day where your incomings are equal to your outgoing. For most of us, it’s when we are earning a wage and spending just as much.

Okay, you may have a little bank interest or even the odd dividend, but hitting rock bottom is when your after tax salary (also known as disposable income) matched your expenses.

The good news when you hit rock bottom? All you need now is to earn one pound more than you spend and you are heading towards financial independence.

So, it’s time to get scrabbling.

## Net Assets: Scrabbling

Your Net Worth is negative, but grew compared to last month.

Your current situation is bad, but your trajectory is good. You’ve got your hand on the rope and pulling yourself up the mountain. No longer are you at rock bottom, you’re climbing out of the pit.

Your Income and Capital Gains have grown faster than you can spend them this month. I’d also say your Inflows are greater than your Outflows. So crack open the champagne, or maybe just some sparkling water from the SodaStream. Don’t drink too much though, you’ve gotta watch those Outflows.

Once you are scrabbling, keep going. Once you’ve pulled yourself out of a negative net asset position, you can declare yourself New Born.

## Net Assets = Zero: New Born

Congratulations. Halleluia When people are born they may be dependent on others, but most have a zero net worth. No debt built up yet (unless your parents have assigned the mortgage to your name, not unknown in Japan). No assets to speak of (apart from that random Premium bond from Grandma).

And then life, and credit cards, and pay day loans, and mortgages get in the way.

Well congratulations, believe it or not, reaching a zero Net Worth is a major milestone. Give yourself a high-five.

Before you get too excited, no, you aren’t Financially Independent just yet! But as of today, you are officially able to cover all the debts in your life with the assets you own. Maybe not in a Fire-Sale, where you need to access cash immediately. And it would require you to sell all of your assets if you wanted to be truly debt free.

Still, this is a sweet moment.

## Net Assets: Plateauing

Your Net Assets are positive and did not change compared to last month.

You have spent all that you earned this month. In other words, you’ve had one month of financial dependence. That’s not a problem for a month or two, but in the long run you will never reach financial freedom.

With positive net assets, to remain static you must either have all your income AND spent your investment returns. That’s not sustainable. Time to get back on track. You want to be an accumulator.

## Net Assets: Accumulator

Your Net Assets are positive and grew compared to last month.

Forget the Terminator. Any one with financial sense knows they want to be an accumulator.

Good. Your inflows continue to be greater than your outflows. Look for ways to grow the income and capital gains, and shrink the expenses and capital losses.

Keep this going. Look for ways to boost your income, control your costs if you want to accelerate further, make sure you’ve got a sensible, yield-generating asset allocation and so on.

But always be careful. Although you are accumulating nicely and you’re net assets are growing, there is always the risk of a wobble.

## Net Assets: Wobbling

Your Net Assets are positive but reduced compared to last month.

What happened? All that good work so far. You’ve proved you can build your asset base, but you’ve hit a bump in the road. Without care, you could erode all the good progress you’ve made so far. If this continues, you risk eroding everything you’ve built.

If your assets have been growing but have now taken a turn for the worse, you need to calmly consider what might have happened, is it permanent, and what other actions you can take to get back into forward gear.

## Temporary causes of a fall in Net Worth can include:

1. Forgetting to Include one of your assets (seriously, say you’ve opened a new bank account or investment vehicle but not included it on your spreadsheet. With a data point of one I can promise you this is often the cause of my New Worth falling on paper.

2. Unexpected One-off spending. Broken Boiler, Dog Bite,. Anything that sucks out money as a rarest

3. Transaction costs. These are the pesky costs you have to incur to invest your money, that do not immediately increase your income. The classic in the UK is Stamp Duty when you buy a house. It’s a big number, and it adds zero to the value of your house. Confused?  Say you have a net worth of £10,000 and decide to use this as a deposit for a £100,000 house.  Ignoring Stamp Duty and other Transaction Costs, you’re Net Worth would not change. You start with £10,000.  You end with £100,000 of house asset and £90,000 of house liability, leaving a NET £10,000. This is vital to understand when understanding Net Worth. Buying an asset does not change your Net Worth. EXCEPT, when you factor in transaction costs. If  stamp duty was 1% of the sale, you would have to pay £1,000 to the government. This therefore reduces your Net Worth by £1,000, leaving you with £9,000. Almost all asset purchases have transaction costs attached. Provided they are small or rare, there’s not too much bother. But one to watch.

3. Predictable one-offs. Whilst there are some expenditure that’s difficult to plan for, other costs seem to come around every year – Mum’s Birthday, Christmas, Annual Holiday, Friday Drinks. You know the ones. If you can predict them, and you’re still finding they reduce your Net Worth from one month to the next, you are likely spending too much. As a rule of thumb, no predictable spends should reduce your monthly Net Worth. If they have, you’ve spent too much (or earned too little).

4. Market movements. If it’s your investments dropping, this may well be part of the normal cycle of gains and losses. See if you have spare cash, see if you can switch some of it into investment assets – they may be on sale.

5. Income drop. If the drop is caused because of a drop in income, someone in the household losing their job perhaps, you need to pause. This will not be sustainable long-term. A career break may be fine. But if your Net Worth has dropped you aren’t Financially Independent yet, and you’re not yet able to cover your expenses.

6. Divorce. This drop is likely to be permanent…

Once you’ve got back some stability and moved away from the wobble, keep on accumulating. Keep growing your Net Asset base.

If you do everything right, eventually you might even become an FI baby.

## Net Assets: FI newbie

Okay, okay. I said that Net Asset is a more important to measure than a normal Income and Expenses budget. But if you don’t even know what you’re monthly expenses are, how have you got this far in life.

I’m joking of course. If you’ve not yet calculate your monthly expenses, go back to our lesson on life’s two certainties.

But this moment is a jaw dropping moment.

Remember the days when you earned a salary each month, it dropped into your bank account, and somehow, without fail, by the end of the month it had all been spent.

Well those days are LONG GONE.

This month, you literally lived off your capital. Other people did the labouring, whilst you took the risks.

If you took home £2,000 salary last month, and you find one month later that you have increased your Net Worth by £2,000 or more in the following month, then congratulations you have achieved a ONE MONTH PERIOD OF FINANCIAL INDEPENDENCE.

Your non-salary income and capital gains have done the hard work. They have entirely covered your monthly expenses!

There is no way you can declare yourself Financially Independent without climbing through this major hoop. You’ve saved 100% of your post-tax income. AMAZING.

Ok, you’re thinking, if I can do it for one month, I can do it again. Well, now’s your time to prove that. Maybe you had a super low cost month because you’ve taken up fasting. Maybe your Aunt Mildred gave you a surprise birthday postal order. You’re now looking for consistent, material gains to your Net Assets.

## Does achieving financial independence for one month mean you are financially indecent forever?

You’re… probably not Financially Independent yet.

Surely, you’ve made it now. You’ve grabbed a Financial Independence calculator, thumped in the numbers and everything concurs. Assuming a 4% Safe Withdrawal Rate, as the jargon goes, with 25x your monthly expenses, you’re there. Time to send that email to your wart-faced boss and retire?

Well, maybe.

I don’t want to be a party pooper. But remember upfront I said that Net Worth is NOT the same as your Finance Independence number.

Why not?

A few examples leap to mind…

1. Your Own Home. You know the line on your spreadsheet – quite possibly the one with the biggest value attached to it – with House written next to it.If that’s included in the Net Worth number, it’s not generating you any Inflows. (Unless you’re planning to sell it, downsize, live in a box, rent a room or two…) To correctly calculate your FI number, you’re going to need to remove your house value, the associated mortgage, but adjust your monthly expenses to cover the interest costs. This gets a little complicated, so for now, just take it from me that you have to skip it from your net worth.

2. Badly invested assets. The FI calculation assumes you have a sensible set of investments. Things like globally diversified, low-cost, yielding assets like Index Funds of Share Indices and Bonds. If you’re net worth is tied up in BitCoin and 18th Century Art, the calculation may well not work.

3. Monthly expenses need to be “Post-Retirement” in nature. Hopefully, if you choose to stop ordinary work after reaching Financial Independence, some of your expenses may rise. If you’re planning to buy a boat, a second home in the country, a golf membership and up your international travel to 52 weeks a year, you may find there’s less money in the coffers. It will help if you do a bit of a calculation now into what your Post-FI Expenses will be. That’s the right number to use.

## Next month… What’s next?

Continue to assess your net asset trajectory every month. Ideally, for the rest of your life. Make it a habit and stick to it.

It may take you months of Scrabbling before you become a New Born again. Once you get there, don’t give up.

Once you are accumulating, you may have the occasional wobble. Don’t give up.

Continue to focus on improving your net asset position to drive up your Net Asset trajectory.

## Are net assets the same as net worth?

Yes. I prefer the term net assets because your worth is more than just your finances. You can be a good person and not have any “net worth”.

## I’ve hit rock bottom. Should I give up?

No. Of course not. Never give up.

At rock bottom, the only way is up. Key pushing, keep striving. Read about how to reduce your expenses, increase your income and improve your investment returns. Then take action, and improve!

## Key takeaways

• Net assets are financial assets minus financial liabilities.
• Knowing you net assets is key information for financial freedom.
• Everybody has a different net asset position.
• Know your Net Asset trajectory

## Key actions

• Calculate your personal net assets
• Diagnose your net asset trajectory – is it positive or negative – is it increasing, decreasing or staying still?

This is not the first attempt to describe the phases of financial freedom. Here are other excellent resources gathered from around the web:

The seven stages of financial independence

The stages of financial freedom

The 11 Stages of Wealth

The 7 stages of financial independence

## What’s next?

Now you are ready to understand the Financial Independence equation.