Updating your net worth spreadsheet can be an exciting affair.
Nothing quite like getting a dopamine rush as you watch the numbers tick up, bringing financial independence firmly into focus.
Another dollar, another step closer to leaving the cubicle behind.
There is no doubt the absolute number is an important starting point. So is analyzing the way it has changed compared to the last time you ran the numbers.
Is it up? (yay! )
How much? (who-hoo!)
However, if you want to get the most out of your next net worth update, focusing on the bottom line is just one part of the exercise.
There are other, equally important observations you should be making that can help you optimize your investing journey.
To that end, here are five questions I ask myself every time I calculate our family’s net worth.
Question 1: How Much Money Have I Contributed To My Portfolio?
Imagine you have a $100k equity portfolio and are contributing an additional $10k/year.
In a year when the stock market is up 30%, you’ll end up with $140k ($100k + $30k investment gain + $10k contribution).
Alternatively, if the stock market is down 30%, your net worth will land at $80k ($100k – $30k investment loss + $10k contribution).
The point here is that once your portfolio reaches a certain size, the way your investments perform will have a much bigger bearing on your net worth than your contributions.
And yet, it is your contributions that ultimately determine how much money you will end up with at the end of your investment journey.
In a perverse way, the change in your net worth number becomes a less relevant benchmark the further you are on the journey.
It’s easy to get complacent in the first scenario above. When asset prices are going up, people feel wealthier and inevitably end up spending more, with less money directed towards their nest egg.
And it’s equally easy to get frustrated when the stock market is going down and you are watching your “stash” decline despite all your hard work and dedication. What’s the point of saving all that money?
The bottom line is that once you’ve decided on your asset allocation, you have zero control over the performance of your investments. It’s highly unpredictable in the short term – and the market will do the heavy lifting for you in the long term.
However, the one thing you can control is maintaining (or ideally, growing) the contributions you make each year. Make this your focus area instead.
Question 2: Do I Have Enough Cash?
In his recently published (and excellent) book, The Psychology of Money, Morgan Housel writes:
“Say cash earns 1% and stocks earn 10% a year. That 9% gap will gnaw at you every day.”
“But if that cash prevents you from having to sell your stocks during a bear market, the actual return you earned on that cash is not 1% a year – it could be many multiples of that, because preventing one desperate, ill-timed stock sale can do more for your lifetime returns than picking dozens of big-time winners.”
This is probably the most eloquent articulation of why you need to have a sufficient cash balance on hand.
It may feel like you are leaving money on the table, but the last thing you want is to be forced into a fire sale.
The amount of cash you need primarily depends on two factors:
- Your monthly expenses – and the ability to reduce them in an emergency, and
- Your job security.
Those who own investment properties have a third factor to contend with – being able to sustain a period of non-payment by tenants.
Personally, I keep a cash buffer equal to 12 months of expenses and 6 months of rental income. It may well be a bit too much. I sure hope I never get to use it.
But with two young children and an unpredictable job, I’m happy to forgo some investment gains in return for peace of mind – and the ability to avoid large losses in a downturn.
Question 3: What Is My Debt To Equity Ratio?
Getting rid of debt is the core tenet of the FIRE philosophy. It makes a lot of sense – when it comes to high-interest, consumer debt.
For a variety of reasons, borrowing on the margin to invest in the stock market is also not a great idea.
Mortgage debt, however, is a different beast entirely. In today’s low-interest-rate environment and subject to a reasonable LTV ratio, it can be a fantastic wealth-building ally.
Below is an example of how much of a difference remaining a “mortgage slave” can make to your finances:
At present, our household debt-to-equity ratio (i.e. our total debt divided by our net worth) stands at about 40%.
The more mortgage-financed properties you own, the higher this number is likely to be. I certainly expect ours to go up if my plans to acquire more real estate work out.
There’s a fine line here. After all, one can make the argument that slowing down mortgage repayments in favour of stock market investing is the same as borrowing to invest.
To me, that’s semantics. Unlike margin loans, mortgage debt isn’t callable. And no one forces you to put money in the stock market. Many people choose to buy additional properties instead.
The key is to find a level that’s comfortable for you – and make sure you’ve got enough cash on hand to fund any emergencies.
Question 4: What Is My Allocation Between Equities and Real Estate?
I happen to like both. That being said, I certainly wouldn’t want to be too heavily skewed towards one asset class over another.
At present, our property investments (net of mortgages) represent only 25% of our net worth, significantly below stocks. Therefore, I am focused on adding at least one (and ideally two) more investment properties over the next 12-18 months.
Despite what many people would like you to believe, real estate investing isn’t as easy as it seems. But, provided you acknowledge the challenges, it can also make you rich.
If you happen to like real estate as an asset class, you’d be well advised to come up with an allocation that works for you – and make sure the pendulum doesn’t swing too far in either direction.
Question 5: Are My Investments Properly Allocated Between Deferred and Accessible Investment Vehicles?
Allocating your investments to these two buckets can give your net worth a very nice boost in the form of government tax breaks and employer matches.
The catch, however, is that you cannot access any of the money until you are well into your late 50s – and that goalpost may well be moving further away.
It makes perfect sense to think of your golden years first. That was certainly our logic when my wife and I started maxing out our workplace pensions in our early 30s.
However, once you’ve built up a certain balance in your pension and LISA accounts, you may want to let time and compounding do the rest of the work – while you refocus on your ISAs.
Overshooting the target in your pension pot is a high-quality problem (as long as you don’t exceed the LTA). There are many ways to “bridge the gap” of a couple of years.
That being said, you don’t want to be in a situation where you are ready to pull the plug at 45 – but cannot afford to do so because all of your money is tied up in deferred investment vehicles.
Next time you run the spreadsheet, take all the time in the world to pat yourself on the back for the progress you’ve made.
Then, take the time to ponder the questions above. Thinking through them may well make your journey shorter – and more enjoyable.
About Banker On Fire
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Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.
Find out more about me and this blog here.
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