Money 101: How to Measure and Track Wealth

This piece is part of a series I'm calling Money 101 and is designed for those who might not be as advanced in their personal finance knowledge and experience.

One key to building wealth is to measure it and track our financial progress. Just like there's no way to tell what's happening in a sporting event without a scoreboard, you can't measure your success in wealth building without some sort of tracking.

Income is Wrong

In almost every article written by the mainstream media, "wealth" is used interchangably with "income." While the amount of money you earn each year (income) does have a major impact on whether or not you have the opportunity to accumulate great wealth (and how quickly/how much), the two are far from the same thing.

I believe this mix up occurs for two reasons. The first is ignorance. Most of the people reporting on personal finances know very little about the subject -- at least managing money on a day-in day-out basis. Sure, they might be educated or have read several books on the subject, but they are (generally) not wealthy and as such don't know the ins and outs of how to grow great wealth and track it.

The American public is no better. Most believe that someone making $100,000 a year in income is "rich" while someone making $30,000 a year is "lower-middle-class." But if they knew that the person making $100k spends $125k a year and the "poorer" person spends $25,000 a year, they might think differently. But Americans rarely consider the expense side of the equation (which accounts for the poor state of finances many have.)

The second reason is data availability. Income data is readily accessible in large amounts and thus easy to use in articles and posts. It doesn't make it right, but it's the truth.

True Measure of Wealth

There is one true measure of wealth -- how much you own. It's called "net worth."
 
Net worth in its simplest form is assets less liabilities. You add up the value of the assets you own: investment accounts, banking accounts, retirement funds, real estate, and the like. Then you subtract every debt you owe: mortgage, car loan, credit card balances, student loans, etc. The difference is called your "net worth". It's the amount you truly own. It tells how "wealthy" you are.

In my opinion, net worth is the single-most important financial measure to track. It not only tells you how much you own, but when looked at over time it lets you know whether your wealth is increasing or decreasing and by how much. It's an accurate and (unfortunately in bad times) ruthless measure of how you're doing in growing your wealth.

As such, it's vital that you measure your net worth on a regular basis.
 
Tracking Your Net Worth

There are different ways to track your net worth. You can use the old-school method of a simple sheet of paper, a more modern option like a spreadsheet, or an automated selection like Quicken. Which option you choose doesn't really matter. As long as you're consistent, you'll be able to determine if your actions are growing your wealth or not.
 
Personally, I track mine monthly. Each month in Quicken I update the performance of my investments, put in my income and spending, and run a net worth report. I then record it in a spreadsheet and compare it to the other months of the year as well as my status for the same month the prior year. (I know, this last part is a bit overkill, but I'm that kind of tracker.) Doing this gives me a quick report card on how I'm doing managing my money and highlights where I might need to make changes. In addition, I record my final net worth at the end of each year (and have done so since the early 90's.) That's how I know that my net worth has grown at a compounded annual rate of roughly 14.5% since then.
 
I used to update my net worth weekly, but that was simply too obsessive -- even for me. In addition, there were too many wild swings (up big one week, down big another) as the market went up and down, big bills were paid, etc. Looking at it only once a month seems to level the swings a bit. As such, this time frame works best for me.

Monthly tracking is probably the most frequent you'd want to monitor your net worth (any more frequently doesn't really give you enough time to see progress.) Others measure their net worth quarterly or twice a year. I recommend that you check it every three months at the very least. Whatever your timeframe, just be sure you review your net worth regularly. 

Bottomline: Tracking your net worth (and then responding based on what you find) on some sort of regular schedule is a must for any serious money manager, and doing so is a vital habit in the quest to become wealthy.

Comments

[Joe]

Once a month is good. Sometime I update it when there is a big movement in the market, but that's a bit obsessive. It's good to see your progress.

[John S @ Frugal Rules]

I think as long as you're doing it once a month or quarter you'll generally be good. You're spot on with how people view income. It just goes to show you that just because you make a lot of money does not guarantee financial literacy.

[Mrs PoP @ Planting Our Pennies]

That's one of the reasons I recommend mint to many people, especially those just starting out. The net worth tracker is built in and gives great insight into your progress over time.

[Old Limey]

I keep track of the value of our investments once/month. Since I'm almost 100% in muni and corporate bonds I use their coupon value and ignore the daily fluctuations in price. It's really just an academic exercise since we live comfortable on our two pensions and our two SS checks. Once/month I reinvest all of the interest that has been deposited by buying more bonds.

At this time in our life (I'm 79, my wife is 80) things couldn't be much simpler. We have no concerns at all about money since we just spend the basics such as food, gas, clothing, utilities, property taxes, insurance, prescriptions etc. and since we gave up taking trips at the end of 2010 the biggest expense we now have is paying the taxes on the minimum required distributions on our IRAs. We also gave up eating out after my wife had to give up her driver's license. I just couldn't take the risk of getting a DUI on the way home from a restaurant after a couple of glasses of wine.

Our $7M portfolio continues to grow by close to $350K each year which just means that our three children will end up with more money one of these days even though two are already multi-millionares. Thus "Money" is no longer an issue. Our issue is "Staying Healthy" and continuing to enjoy life.

[rubin pham]

most american i know can not tell the difference between wealth and income.

[Paul]

Its great to attempt to track wealth, but with respect to many possessions (e.g., homes, cars, art, furniture, etc) you may just be guessing the current value. True value is what you can sell it for, which in my opinion, most people overestimate.

[JNEW]

Good post FMF. All true, especially the wealth and income disparity by the main stream outlets.

Net worth is the only way to get the big picture. In fact the articles on net worth are what attracted me to this blog in the first place

The other chronic problem, IMHO, is looking only at the "asset" side of the balance sheet. It drives me nuts. People assume wealth by the possessions their neighbors have. A vacation home? A sports car? NFL tickets? High lifestyle?

You cannot ignore the liability side of the equation. Or the definition of "asset" for that matter. What percentage of those "assets" are consumable depreciating "stuff" like cars, TV's, gadgets, clothing and household goods? How much of all that stuff was purchased with credit card debt?

I have a friend who crows that he has $1MM in debt. Somehow HE sees that as a gauge of wealth? He says Net Worth is "old school". He is my friend.... but I couldn't disagree more. And I would never want to be on the "treadmill" that he is on.

If its a depreciating asset-- I don't even bother to include it on my net worth statement.

[Old Limey]

JNEW
I couldn't agree more. One of the most important things to strive for as you start to accumulate wealth is "Security". That's why getting out of debt as soon as is feasible is a very good idea. Another aspect of "Security" when you are young and raising a family is to always have a contingency plan just in case you lose your job. In my case I worked for a leading aerospace company and if I had been laid off it would have no doubt required moving my family to another state. This is a particularly worrisome problem if you own a home that was recently purchased which may even force you into selling it at a loss.

Fortuntately my wife and I both came from working class families in England and I was the first in ever in our extended family to obtain a degree. We arrived here at age 22 with a chest full of wedding presents, $400 in cash and no backup security if things went bad for us. With that kind of background you never become a big spender. I am glad I don't know your friend, he isn't the kind of person I would have anything in common with.

[SteveD]

Like Mrs PoP, I highly recommend mint.com for tracking net worth automatically. It can track all of your accounts in one place, and even uses Zillow to estimate your house values (which isn't 100% accurate, but nothing is). It's also good for things like checking for specific transactions (did my tenants deposit their rent yet?), getting account values (preparing paperwork for refinance), and you can set budgets if you want (how much did I spend on restaurants this month?).

Call me crazy, but I check my net worth daily these days. It's helped reinforce good financial decisions (my 2010 real estate investments made several times more than my job this year), and given me the security to take some fantastic opportunities in life (I took a year off at age 31 to travel around the world because I realized that I had enough money to live for 6.5 years -- and at the end of the year, my net worth was up despite not working a single day!). Most importantly, it's a constant reminder of my financial goals, and keeps me on track for a secure and early retirement.

[getrichwithme]

theres plenty of people out there who earn alot of money but are poor, because they either spend it all - or spend more than they earn.
1st rule of being wealthy is spend less than you earn!

[Jon @ MoneySmartGuides]

Great post. I've been tracking my net worth for close to 10 years now. It not only helps me see how I progress, but it also helps me to refrain from spending. When I first started tracking my net worth, I was in the red since I was fresh out of college. Just as I hit positive net worth, I wanted to buy a car for $20,000. Doing so would have put me back in the red. I delayed buying the car simply because I didn't want to have a negative net worth again.

[[email protected]]

I agree that net worth is a true indicator of wealth. Doctors are notorious for being "poor" they make high six figures but spend their youth in school being deprived. Despite hundreds of thousands in loans new doctors buy the fancy house and car and have a negative net worth for years.

[getagrip]

Networth is fine as long as you use it as a tool and don't use it to trick yourself into thinking your better off than you are. For example, you can feel real good about yourself and your lack of annual savings if you've got a million dollar stamp collection you inherited from Grandpa. But unless you plan on selling it off to fund your retirement, it's nothing but little bits of paper. Even if you do plan on selling it off, appraised value or insurance value versus realistic auction value are often different things, usually you get less especially if you are selling because you have to and can't pick the best market to sell in. So you have to be careful about what your networth shows and how you interpret it.

That said, networth can show that you are house poor, or that you've got too much in one investment, or that you have multiples of the same kind of investment, or that you're simply not saving as much as you thought you were. It's just a tool that helps you see where your money is, and based on that you can decide if you want to make changes.