You may have noticed that in addition to terms such as Financial Independence and Financial Freedom, something I refer to a lot is Net Wealth.
In this article, I’ll give you the run-down on what Net Wealth is and why it is the only type of financial wealth that matters.
What is Net Wealth?
Net Wealth is a similar concept to net income. With income, you have your gross income, or salary, which is say $65,000 a year. However, out of that, you have a tax obligation, including things such as HECs, of say $25,000. Consequently, your net income – which is what goes into your pocket – is $40,000.
Net Wealth works on the same premise. However, it relates to your assets and liabilities, rather than your gross salary and taxes.
In order to calculate your Net Wealth, the first step is to add up the current value of all of your assets (for tangible assets, their value is what you could sell them for today). Your assets include all of your possessions and cash reserves, such as your house, car, home contents and savings/investments.
Once you have your total assets figure worked out, you then need to figure out all of your liabilities. This includes any money that you owe, such as your mortgage, car loan, HECs debt, credit card, money you borrowed from Bob-the-barman for beer the other day, etc.
Once you have both figures, you simply subtract your total liabilities figure from your total assets figure… And, boom, that’s your current net wealth.
Here’s an example:
What’s the significance of your Net Wealth?
Net Wealth might not seem like such a big deal, but it is the best way to figure out your financial health.
A lot of people automatically assume that someone who appears, from outward expression, to be rich, is. However, this is quite often not true at all.
For example, let’s say you think your next door neighbour Joe is rich. You assume this because you know Joe earns $200,000 a year, has about $100,000 of home contents, drives a 2 year old BMW X3 worth $80,000 and has just spent $300,000 remodelling his house that he had already paid $700,000 for.
However, what you didn’t know about Joe is that he recently borrowed another $300,000 to pay for his renovations and therefore still owes $890,000 on his mortgage. Additionally, Joe owes $12,000 in HECs, $72,000 on his car and $13,000 on his credit card. He does have $275,000 in superannuation, but no savings, and no income protection insurance.
Joe’s Net Wealth:
Alternatively, you’ve always assumed that your other neighbour Vanessa, is not doing so well. Vanessa drives a 25 year old Nissan Pulsar worth about $1000 and has the smallest house on your street that you know is worth about $500,000. Additionally, you think she has about $40,000 in home contents.
However, what you didn’t know about Vanessa is that she has a job that pays $100,000 a year. Additionally, she only has $70,000 left on her mortgage and $8,000 left on her HECs debt. Furthermore, she owns her car outright, has $80,000 in savings and $250,000 in superannuation; and she doesn’t own a credit card or have income protection insurance.
Vanessa’s Net Wealth:
… So, which one of them is richer? Vanessa of course! If Vanessa lost her job tomorrow, she has an $80,000 savings buffer to keep her head above water until she finds another job.
As a result, Vanessa would be able to survive without a job for over 2.5 years – if she needed to – before she would fall behind in her mortgage payments.
Alternatively, if Joe lost his job tomorrow… He’d be up shit creek without a paddle! This is because Joe’s weekly obligations are $1700 and he has no savings. Consequently, Joe would fall behind in his mortgage and car loan payments almost immediately. If he couldn’t find another job within a month or so, he would be at risk of losing both his house and his car… Which make up 74% of his assets.
This is why your net wealth is so important, because it defines what you actually own. Whereas assets that aren’t owned outright are always at risk of being taken away.
Perceptions of wealth
One of the most frustrating aspects of Joe and Vanessa’s situations above, is how we perceive wealth. There is an ingrained concept within society that if you have fancy, expensive things then you must be wealthy. And, if you’re wealthy, then you must be successful. And, if you’re successful… You’re pretty much equivalent to whoever the modern day Fabio is.
However, this simply isn’t true. Banks often lend way more than people can afford. And, we Australians, are in debt up to our eye balls…
Between 1995 and 2015, average household debt in Australia rose from 104% to 212% according to the Organisation for Economic Co-operation and Development (OECD). This means that if your household is bringing in $100,000, it’s spending $212,000.
There are many reasons for this, including the fact that pay rises just aren’t keeping up with inflation in Australia anymore. However, the crux of it is that we are living well beyond our means; often in attempt to Keep Up With The Jones’.
This premise is based on the perception that fancy stuff equals wealth… But, as demonstrated through the comparison of Joe and Vanessa above, this is not necessarily true.
If you’ve ever looked at someone with fancy stuff and found yourself feeling jealous or inadequate, then it’s time to take a deep breath and relax.
In our consumer-debt driven society, fancy stuff isn’t just for the wealthy. Credit is available to almost anyone, and usually in higher amounts than can be afforded. This means that a lot of people who outwardly express wealth through fancy stuff, are in huge amounts of debt and always at risk of losing the roof over their head.
Alternatively, being net wealthy and debt poor offers freedom, security and a sense of peace. This is because having high Net Wealth will help you to sail through the seas to the other side of life’s financial storms… With yourself and your boat soundly intact.
And, that’s why Net Wealth is the only kind of financial wealth that matters…
P.s. if you’re after a quick and easy way to calculate and track your net wealth, I have just the thing for you! Sign up to our newsletter and you’ll receive a Budgeting and Savings calculator, plus a monthly Net Wealth tracker for free!