Category: Videos

What is Net Worth?

The formal definition of net worth is the combined value of everythingn you own (Assets) minus the value of everything you owe (Liabilities).  In other words, if you total up your financial life: sell everything that you own and pay off all of your debts, what do you have left over?  

Net Worth = Assets – Liabilities

What I love about net worth is how easy it is to understand and how easy it is to calculate.

Assets are things that you own that have monetary value such as: cash, checking/savings accounts, retirement accounts, houses, cars, personal property, etc.

Liabilities are cash (or value) that you owe to other people or institutions such as: mortgage balance, student loans, car loans, credit card loans or personal loans.

What does Net Worth really tell you?

If you have a positive net worth, that means that you own more stuff than you owe and that’s great!  A negative net worth on the other hands means that you owe more than you have. This is typical when you are young and starting out: you might borrow aggressively in order to fund your future growth. Things like an education (student loans) and a mortgage (to buy a home) might lead to larger debt than you have assets.

When calculating Net Worth periodically (quarterly or yearly), it can be viewed as a financial report card that allows you to easily evaluate your financial health at a glance.  Is it moving in the correct direction (more positively)? And if not, what are the causes?

Like the stock market, your net worth will fluctuate. However, also like the stock market, it is the overall trend that is important. Ideally, your net worth continues to grow as you age: as you pay down debt, build equity in your home, acquire more assets, and so forth. At some point, it is normal for your net worth to fall, as you begin to tap into your savings and investments for retirement income.

Why is Net Worth Important?

A few reasons that I like tracking Net Worth include:

• Track your financial progress. It’s quick and easy to calculate your Net Worth each quarter or year. This allows you to measure your progress over time and compare it to previous time periods. You want to see a growing net worth; a decline in net worth means you have more work to do.
• Look beyond Income. How to grow your income is often a financial focus. But honestly that’s really less than half the equation. The important parts are: how much are you saving (adding to net worth), how much are you investing responsibly (growing net worth) and how much are paying off debt (reducing liabilites = adding to net worth). Even if your income is growing, if your net worth is flat or declining, your financial situation may not be improving at all.
• Avoid focus on Asset Value. Many people focus on the value of their assets as a measure of their personal financial health. But if you take on a lot of debt to fund many purchases, you’re no better off. Look beyond the positives of assets (the fun stuff!) and make sure to include all of your debts. The good news is that for many debts, the balances are shrinking with those monthly payments and therefore you get positivie reinforcement when including debts along with assets (valuing both equally).
• Keeps debt level in perspective. It’s natural to get overwhelmed with large debt obligations like a mortgage. But knowing that you have an evern larger asset offsetting that debt can help keep things in perspective.

When you see financial trends in black and white on your net worth statements, you are forced to confront the realities of where you stand financially. Reviewing your net worth statements over time can help you determine where you are, and how to get where you want to be. This can give you encouragement when you are heading in the right direction (i.e. reducing debt while increasing assets) and provide a wake-up call if you are not on track.

Ways to Grow your Net Worth.

So how do you effect your Net Worth in a positive direction over time? Recall the equation:

Net Worth = Assets – Liabilities

There are two parts that both effect your net worth in a positive direction:

1. Increasing asset values
2. Decreasing liabilities

Take advantage of both of those in order to grow your Net Worth.  Here are some examples

• Pay down debt. The great news is that those monthly payments are adding to your net worth by paying down the principal balance. Some of the payment is going towards interest (not helping!) but with low-interest loans, much of each payment is going towards the principal. Using your cash flow to pay down debt is one of the best ways to increase your net worth because it focuses you from spending that income on fleeting items that don’t add to your financial life.
• Be Responsible with Purchases. When you are considering things to buy, are they adding tremedous value to your life? Focus on the items and experiences that add significant value or even add to your net worth (using income to add assets!)
• Pay Attention to Assets and Liabilities. Make sure to understand both parts of the equation. By watching out for the opposite of net worth (decreasing assets and increasing debt!) – you’ll become more financially aware of your actions.
• Make a Habit of Tracking. Check your net worth every so often (month, quarter or year). When you pay attention to a number, and the component parts, you will automatically make smarter choices. You are a product of your environment: use it to your advantage! Remind your conscious brain of what’s important and the subconscious will play along.

Photo by Juliane Liebermann on Unsplash

In this video and article I explain how I personally use a backdoor Roth option to save significant money each and every year. 

The quick nuts and bolts

Let’s get to the point and I’ll explain what I do each year:

• My wife and I each have both a traditional IRA and a Roth IRA at our brokerage.
• Each year we each contribute the maximum amount to our traditional IRA accounts (currently $6,000)
  • We cannot deduct this contribution on next year tax returns. It’s after-tax money.
• A few days later once the transfer is complete, I transfer 100% of the money from our traditional IRA to our Roth IRA.
• I then invest that money per our investment policy (into stocks, bonds, etc)

That’s it. It now grows tax free over the coming years (hopefully!) and it’s 100% all our money (no taxes owed).

It can’t be that easy?

It’s true, I’ve skipped a lot of details in the setup of the above. However, yes it’s that easy each year now. The big caveat and what you’ll find with some online research, is that doing a backdoor Roth requires to take into account all your existing traditional IRA, SEP IRA and Simple IRA accounts. Any money that is in those accounts tax-deferred (you took a tax deduction or it’s had growth) is taken into account during the backdoor conversion to see if you owe current taxes. So, you have to do a big conversion first, partial conversions or some other transfer – and that’s definitely got a lot more tax implications.

If you have no money in a traditional IRA, SEP IRA or Simple IRA – then it’s super easy: you can perform the steps I mention at the outset.

How much is it worth?

Here’s the fun part: you can save a lot of money over the years because a Roth account is 100% your money, you don’t owe any taxes. Let’s make some basic assumptions: 7% growth rate and 24% tax bracket in retirement. By the end of 20 years that $6k has grown to just over $23k. In a traditional IRA, you owe taxes of over $4k, but owe none if that’s in a Roth IRA. That’s the power of doing the backdoor conversion and getting that investment into a Roth IRA. And, if you and your spouse both contribute, that’s double savings!

Have you ever wanted simple, actionable financial advice that will make a difference in your life? This page contains such advice from a variety of financial advisers. Each adviser provides something unique that you can build from to create a successful financial future.

“Just Get Started”

Justin Green – Four Ponds Financial Planning

How often do you feel not ready yet, that you don’t have time or necessary knowledge? Maye you’ll get to it next week. And time goes by, and then another year goes by. The power of time is extremely important in investing and financial planning: the more you have, the greater position you are in. So, just get going! Start today with some education, some planning, some savings, some investing. Take tiny steps forward and soon you’ll find the momentum to succeed.

“Understand Your Investments”

Tom Fisher – Fisher Financial Strategies

However you decide to invest your money and what investment products and vehicles make sense for you and your family: make sure that you understand them! There are some many nuanced products out there and each one has a variety of details, fees, and disclaimers. Make sure you do some research and understand what you are getting involved in, what the expectations are and why it makes sense for you.

“Take Prudent Risks”

David McPherson – Four Ponds Financial Planning

We all need to take some risks in life, not just in our financial lives. When you embark on an adventure, whether out on the trails or buying an investment product, make sure that you understand the risks involved. Are you willing to lose some money? How much money? What are the potential downsides and expected upsides to your strategy and individual investments? To get where we want to go, we need to take risks: just make sure they are prudent for you.

“Spend less than you make”

Chuck Levin – Levin Financial Planning

You won’t get far in your financial life if you can’t manage to spend less money than you bring home. If you run a deficit at home, you can’t just issue more money like the government! In order to get anywhere, you have to first save some money. Only then can you enter the wonderful world of investments, strategies and building a financial future.

http://www.youtube.com/embed/Kl9uT_n9-wE?wmode=opaque

“It’s all in the Doing.”

Mike Morton – Morton Financial Advice

Having a financial plan is all well and good, but it doesn’t get you anywhere if you don’t actually do something! You have to put the knowledge into motion to create power. Take your plan, and start putting it into action.

If you have already maxed out your retirement accounts for 2018, congratulations! Give yourself a pat on the back. If you haven’t yet, watch the video or read on to see how much you can save. 

I’m not suggesting that you try to pinch pennies, save more or don’t buy those holiday gifts. If you have money in taxable accounts or maybe an extra balance in your checking/savings account that you’ve carried all year – you can spend $1,000 from that account and put a corresponding $1,000 into your retirement account [employer 401(k) or personal IRA]. It makes a big difference over time.

What’s the big deal?

It’s just a little tax, right? Remember, it’s not what you have (or earn), it’s what you get to keep. Let’s crunch the numbers. Scale the following up (or down) based on your situation, but here’s a very simple example. Let’s start with the assumptions: 5% return / year (3% growth and 2% dividend), $1,000 initial investment, 24% marginal tax bracket, 20 year time-frame, re-investing the qualified-dividends (taxed at 15%) each year. Your experience may vary (significantly) from this simple example, so scale up or down.

$1,000 grows to almost $2,800 by the end of 20 years (start of the 21st year). That’s awesome. But wait, depending on how it grows, you might owe the government some of that money – remember they want their cut too!

So, let’s assume we have this growing in a taxable account, as an investment in a mutual fund, or ETF. During those 20 years, you have both growth (3%) and dividends (2%). The qualified-dividends are taxed at capital gains rate (15%) each year and the growth is also taxed at 15% when you sell. 

From the example, instead of the $2,800 that we enjoyed, we only get to keep $2,468 when this money grows in taxable account. That’s too bad. Is there a way we can keep the whole thing? Enter: Roth. Both Roth 401(k) accounts and Roth IRA accounts allow you to put in after-tax dollars (the same as those in your taxable brokerage account), grow it tax-free and take it out tax-free at the end! How cool is that? So in a Roth account that same $1,000 grows to the $2,800 and when we spend it 20 years later, we get the whole $2,800. 

What this means?

If you have yet to max out your retirement accounts for 2018, and you have a brokerage account, or some “extra” balance in a checking/savings account that you’ve had all year, you can do the following:

1. Spend $1,000 from your brokerage / checking / savings account
2. Put a corresponding $1,000 from your paycheck into your retirement account by
   1. Calling up your benefits department and having them take it from your paycheck
   2. Logging into your personal IRA and adding it to your account (in this case, don’t actually spend it in step 1 above!)

For the 15 minutes of work this month, you’ll gain over $300 in the future. Not bad.

How about a Traditional 401(k) or Traditional IRA?

The same math (essentially) works in a traditional 401(k) or IRA. The difference is:

1. You call your employer (or click in your IRA) and put in $1,300 instead of the $1,000.
   1. You get to deduct this on your taxes and so save $300 in taxes (24% marginal rate) making it equivalent to spending that $1,000 from your brokerage account
2. The $1,300 grows tax-free over 20 years, leading over $3,600 in funds! But wait, you owe taxes now.
3. When you take it out, it’s taxed at your current rate. Let’s assume 24% marginal, but it might well be less in retirement.
4. You get the same amount: $2,800. See table below.

Get it Done

So go ahead and call your benefit department or do those few clicks online to maximize your retirement accounts. Your future self will thank you (big time!)

Notes on the Assumptions

• 5% return may be high or low, I have no idea. History says stocks grow at more like 10% / year, but we may be in an environment where the future looks more bleak than that.
• 2% dividend is about where the S&P 500 is right now.
• I used 20 years. Longer time and/or higher returns add up to even more savings!

I’m saving over $1,500 by utilizing this tax strategy for 2018. Find out more in the video below, or read on!

The new tax laws for 2018 make itemizing tax deductions less likely to be effective. The new standard deductions has doubled (to $24,000 for married couples) and we lost some of the highest deductions possible (SALT). However, I still find myself right on the border of itemizing versus not, and there is a simple strategy that can save a few thousand dollars: bunching charitable giving.

I’m going to keep this article short and sweet with just the bullet points. If you’re interested, research mode details via Google. The bottom line is that if:

1. You give to charities each year and 
2. You are close but not over the $24,000 that make itemizing deductions worthwhile then

You can “bunch” a few years worth of charitable giving (via a donor advised fund) this year (and itemize deductions) and then take the standard deductions over the next couple of years.

Are you over $24,000?

In brief form, count up your deductions from the following that are (the biggest items) available to itemize:

1. Medical Expenses (in excess of 7.5% AGI or 10% AGI). This is a tough one because of the AGI limit, but if you have a lot of medical expenses, they can be deductible.
2. State and Local Taxes (SALT). This is now limited to $10,000.
3. Mortgage Interest. This is also somewhat limited, but only for mortgages over $750,000.
4. Charitable Giving.

Let’s add up an example (mine!) and see how it works for real.

1. Medical Expenses: $0. I don’t have nearly enough to surpass the AGI limits.  
2. SALT: $10,000. I live in Taxachussets, so I hit the maximum in property taxes here.
3. Mortgage Interest: $8,500. I still have a pretty large mortgage, so I get quite a bit here.
4. Charitable Giving: $3,000. My wife and I give to our alma maters each year and then quite a few smaller donations throughout the year.

Total for 2018: $21,500. Oh so close, but the standard deduction is higher.

However, if I pre-give 3 years worth of alma mater donations to my donor-advised fund (and then actually give them out each year), I get to take another $9,000 in deductions this year, which brings me to $30,500. In this case, I’ll get to itemize those deductions this year and then the next few years, will take the standard deduction of $24,000 each year.

Let’s keep it simple and assume I’m in the 24% tax bracket, this calculator shows that I’d have a tax savings of $1,560. It’s not going to change the world, but it’s real money.

Here at the end of the year, this is a good strategy to double check for yourself. Me? I’m going to do it and save some $$. (Better yet, I’ll donate appreciated stock to get yet another tax-savings for my charitable giving!)

“What’s the best piece of financial advice you can give in under 2 minutes?“

I was recently asked that question by my good friend Christina Empedocles for a project that she’s working on.  I had to give it some thought, but came up with something I believe is highly relevant for all of life.  Check out my response in this video.