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Financial Friday 171: How do you Measure Financial Growth?
If you are reading this you probably have a keen interest in improving your financial situation — but how are you going to measure your progress?
The easiest way is by setting and achieving a goal. This could be short-term and focused, like wiping out a credit card debt. On the other hand, it could be a long-term endeavor like burning the mortgage five years ahead of time after twenty years of scrimping and saving.
Achieving either of these goals is a great accomplishment, but they may not tell the whole story. The problem with both of them is they are independent from all of the other factors that affect your financial standing. What if the value of the house you now own has dropped 20% over the last year, or you paid off one credit card only to see another card or line of credit head in the opposite direction?
No single metric tells the whole story of your financial progress. Paying yourself first and putting $250 from every paycheque into your RRSP and investing that money is a great way to build wealth and prepare for retirement. However, you also need to monitor the growth in value of your RRSP as well as any other assets that are contributing to your retirement fund. The ultimate measure is that the value is steadily tracking in the right direction and you are making progress towards your overall goal.
Cash flow is another common measure of financial progress. Tracking your income and expenses helps you understand how much money you have available after covering your costs. Positive cash flow is a surplus that can be used for saving, investing, or paying down debt — but it doesn’t measure how effective you were at putting that cash surplus to work. You may think you are making progress, but if you let the cash sit in a bank savings account instead of a GIC in your TFSA, then you actually made comparatively poor progress.
If you want to keep it simple and look at only one metric to get a holistic view of your financial health, measuring your net worth can provide you with valuable insights. It's an easy-to-understand concept that will help you analyze your financial health and overall progress towards your financial goals.
Calculating your net worth isn’t all that difficult and although it represents only a snapshot in time, the main advantage is that it provides a comprehensive snapshot. It takes into account all of your assets (such as cash, investments, real estate, and valuable possessions) and subtracts your liabilities (such as debts and loans).
Calculating your net worth forces you to be aware of all your financial accounts. This awareness can help you make more informed decisions about your spending, saving, and investing habits. For example, if liabilities form a significant portion of your net worth equation, it indicates that you need to focus on debt reduction strategies to improve your financial health.
As you work to increase your assets and reduce your liabilities, your net worth should ideally show positive growth. This growth signifies that you're making smart financial decisions and accumulating wealth over time. Seeing your net worth increase over time can be motivating and reinforce positive financial behaviors. On the flip side, if you notice a decline, it can signal that you need to reevaluate your financial decisions and make necessary adjustments.
Monitoring your net worth helps you understand how effectively you're building wealth. Although the market value of assets such as stocks or real estate fluctuate, comparing your net worth to previous periods can still help you evaluate the effectiveness of different financial strategies you've implemented. This allows you to refine your approach and make changes as needed.
Your net worth is an essential factor in assessing your retirement readiness. It helps you determine if you're on track to maintain your desired lifestyle during retirement and whether you need to adjust your savings and investment strategies. It can also influence your estate planning decisions. It's important for determining how you want your assets distributed after your passing and for considering strategies to minimize potential estate taxes.
Old budgeting trick given a new twist, and a new life No success with budgeting spreadsheets or apps? Putting physical cash in envelopes for designated purposes is a budgeting technique that works for a lot of people, but what about the risk of having cash-stuffed envelopes all over the house?