As we established last time when we talked about wealth vs. income, net worth (how much you keep) is more important than income (how much you earn).
Net worth doesn’t give us the full picture though. For that we need to understand how our net worth is made up of assets vs. liabilities.
“Assets put money in your pocket … liabilities take money from your pocket.”
Robert Kiyosaki – Rich Dad Poor Dad
This simple definition of assets and liabilities is so powerful it can change your life forever.
A lack of this knowledge is the reason why some Lottery winners end up broke.
The more money you keep and invest into true assets the faster you will become rich enough.
Likewise the fewer liabilities you buy the faster you will become rich enough.
I followed the usual path for the first ten years of my career:
Chasing increases in income, letting my lifestyle inflate to match, and taking on increasing amounts of debt to buy the usual liabilities: a nice house and brand new cars.
Luckily I also spent that time reading some truly life changing books.
These lead me onto the path towards financial independence.
What makes up your wealth?
I recently stumbled across the awesome infographic above (from this page) showing the breakdown of net worth at different levels.
The red and orange in the graphic show the liabilities (primary residence and vehicles).
Both of these categories continue to take your money from you in the form of running costs, maintenance, insurance, bills, and additional purchases. The more expensive the house or the car the higher the ongoing costs.
It is no coincidence that those with high net worths have a high proportion of true assets and relatively few liabilities.
It is tempting these days, with low interest rates and easy access to finance, to load up on liabilities and take on the appearance of wealth.
But it is so much more strengthening to build true wealth by investing in assets.
Down the line some assets can also provide a lot of pleasure. For example, an apartment in the mountains or by the ocean can provide both income and free vacations.
Take on the habits of the rich
It is also obvious from the infographic that you’re only going to become a billionaire by creating and owning businesses.
Don’t worry though, you don’t need to be a billionaire to be rich enough. It is possible to reach financial independence as an employee by taking on the habits of the rich:
- Keep as much as you can of what you earn
- Invest in assets
- Don’t take on debt to buy liabilities that are only going to make you poorer
Same Net Worth – Different Outcomes
Imagine the high income high spender we met when we discussed wealth vs. income starts with the same net worth as the Rich Enough saver heading for financial independence (FI).
The spender’s net worth is likely to be dominated by liabilities. An expensive house and a fleet of brand new cars (that are regularly replaced) along with all the associated extra purchases and costs that these things bring.
They have to keep going back to a job to earn more money that is then given straight back to others.
The Rich Enough saver’s net worth has a far smaller proportion of liabilities, including enough house, a pre-loved car (bought for a fraction of the original price), and bikes used for local journeys.
Everything in their life is there because it brings joy and fulfilment. Their things are fully appreciated and fully enjoyed. Any other liabilities have been removed.
The saver’s net worth is made up primarily of assets which will generate a snowball of wealth. The passive income they produce is invested into yet more assets. Eventually the income generated is enough to fund their lifestyle forever.
The saver’s wealth will grow quicker than the spender’s and they will reach financial freedom far faster because they need less.
How much do you need?
It is massively freeing when you realise you can live a lifestyle that is full of all the things you love doing, while spending a fraction of what you used to.
A lifestyle that immediately gives you the space and time to truly live. A life that is actually better now you’re spending less.
As a measure, net worth becomes less important because it doesn’t take into account how much you need to fund your dream lifestyle.
“I have what other wealthy people will never have. Enough.”
John C. Bogle – Founder of Vanguard
So while net worth is a useful measure it doesn’t matter as much as your wealth number (the number of days, months, or years that you could go without earning any more money from a job). The aim being that your passive income can fund your lifestyle forever.
Your Asset Percentage
The percentage of your net worth invested in true assets is another useful measure. The higher the percentage the faster you’ll reach financial independence.
I hadn’t calculated this percentage for our net worth before. Our number has increased massively over the last five years since stepping onto the path towards financial independence:
As of today our asset percentage is 62%.
This increases with every passing day as investments grow and additional savings are made.
Aiming for an asset percentage of over 70% is a good target.
A simple step to take today …
Calculate your net worth and your asset percentage.