When it comes to money, people in our society typically ask, “How much do you make?” Seldom do you hear the question “What is your net worth?” Recently I tried to ask few people about their net worth. They were not clear on their net worth as the majority of the people only understand the working income.
The true measure of wealth is net worth, not working income. Always has been, always will be. Net worth is the financial value of everything you own. To determine your net worth, add up the value of everything you own, including your cash and investments such as stocks, bonds, real estate, the current value of your business if you own one, the value of your residence if you own it, and then subtract everything you owe. Net worth is the ultimate measure of wealth because, if necessary, what you own can eventually be liquidated into cash.
Component of Net Worth
Rich people understand the huge distinction between working income and net worth. Working income is important, but it is only one of the four factors that determine your net worth. The four net worth factors are:
Rich people understand that building high net worth is an equation that contains all four elements. Because all of these factors are essential, let’s examine each one.
Income comes in two forms: working income and passive income. Working income is the money earned from active work. This includes an income from a day-to-day job, or for an entrepreneur, the profits or income taken from a business. Working income requires that you are investing your own time and labor to earn money. Working income is important because, without it, it is almost impossible to address the other three net worth factors.
The more working income you earn, the more you can save and invest. Although working income is critical, again it is only valuable as a part of the entire net worth equation. Unfortunately, poor and many middle-class people focus exclusively on working income, out of the four factors. Consequently, they end up with a low or no net worth.
Passive income is money earned without you actively working. This is another stream of income, which can be used for spending, saving, and investing.
Savings is also imperative. You can earn wads of money. But if you don’t keep any of it, you will never create wealth. Many people have a financial setting in their mind for spending. Whatever money they have, they spend. They choose immediate gratification over long-term balance. Spenders have three mottoes. Their first motto is “It’s only money.” Therefore, money is something they don’t have much of. Their second motto is “What goes around, comes around.” At least they hope so because their third motto is “Sorry, I can’t right now. I’m broke.”
Once you’ve begun saving a decent portion of your income, then you can move to the next stage and make your money grow through investing. Generally, the better you are at investing, the faster your money will grow and generate a greater net worth. Rich people take the time and energy to learn about investing and investments. They pride themselves on being excellent investors or at least hiring excellent investors to invest for them. Poor people think investing is only for rich people, so they never learn about it and stay broke.
Our fourth net worth factor may well be the “dark horse” of the bunch because few people recognize its importance in creating wealth. This is the factor of “simplification.” It goes hand in hand with saving money, whereby you consciously create a lifestyle in which you need less money to live on. By decreasing your cost of living, you increase your savings and the amount of funds available for investing.
To illustrate the power of simplification, here’s the story of one of Millionaire Mind participants. When Sue was only twenty-three, she made a wise choice: she purchased a home. She paid just under $300,000 at the time. Seven years later, in a sizzling hot market, Sue sold her home for over $600,000, meaning she profited over $300,000. She considered buying a new home, but after attending the Seminar, she recognized that if she invested her money in a secure second mortgage at 10 percent interest and simplified her lifestyle, she could actually be quite comfortable living on the earnings from her investments and not have to work ever again.
Instead of purchasing a new home, she moved in with her sister. Now, at thirty years of age, Sue is financially free. She won her independence not through earning a ton of money, but by consciously scaling back her personal overhead. Yes, she still works—because she enjoys it—but she doesn’t have to. In fact, she only works six months of the year. The rest of the time she spends in Fiji, first because she loves it, and second, she says, her money goes even further there. Because she lives with the locals rather than the tourists, she doesn’t spend a lot. It’s all because Sue created a simple lifestyle and, consequently, doesn’t need the fortune to live on.
Power of Four
Again, building your net worth is a four-part equation. As an analogy, imagine driving a bus with four wheels. What would the ride be like if you were driving on one wheel only? Probably slow, bumpy, full of struggle, sparks, and going in circles. Does that sound familiar? Rich people play the money game on all four wheels. That’s why their ride is fast, smooth, direct, and relatively easy.
Poor and most middle-class people play the money game on one wheel only. They believe that the only way to get rich is to earn a lot of money. They believe that only because they’ve never been there. They don’t understand Parkinson’s Law, which states, “Expenses will always rise in direct proportion to income.”
Here’s what’s normal in our society. You have a car, you make more money, and you get a better car. You have a house, you make more money, and you get a bigger house. You have clothes, you make more money, and you get nicer clothes. You have holidays, you make more money, and you spend more on holidays. Of course, there are a few exceptions to this rule…very few! In general, as income goes up, expenses almost invariably go up too. That’s why income alone will never create wealth.
Track Your Net Worth
Make it a policy to know your net worth to the penny. Here’s an exercise that can change your financial life forever.
Take a blank sheet of paper and title it “Net Worth.” Then create a simple chart that begins with zero and ends with whatever your net worth objective is. Note your current worth as it is today. Then every ninety days, enter your new net worth. That’s it. If you do this, you will find yourself getting richer and richer. Why? Because you will be “tracking” your net worth.
(I am doing this exercise periodically for the last several years. It’s helping me to move in the right direction to grow my net worth.)
Remember: what you focus on expands. By tracking your worth, you are focusing on it, and because what you focus on expands, your net worth will expand. Anyway, this law goes for every other part of your life: what you track increases. (Excerpt from book ‘Secrets of the Millionaire Mind’ by Harv Eker)
“Your mind, more than your actions, determine your net worth.”- Robert Kiyosaki