How does one measure personal financial success?
Some think it is to do with the balance in your bank account, while others use their salary as a guideline.
If you’re one to keep up with the Forbes list of top wealthiest, however, you’ll see that the measure of financial success is neither of these two values.
For example, topping the list is none other than Bill Gates with his net worth valued at a whopping $79.2 billion. Locally, sugar, palm oil, and real estate tycoon Robert Kuok takes the spot with his net worth commendably valued at $9.1 Billion.
In my previous article, I have outlined how investing with net worth in mind is far more efficient as compared to only managing your investments with Return On Investment (ROI) in mind. ROI is in fact merely a single factor of several which affects the end result – your net worth.
What is net worth and why is it important?
Net worth is essentially a monetary value from which is derived after totalling up your total assets – such as the value in all your bank accounts, shares investments, unit trust investment, the current value of your property(s), EPF and so on – and then subtracting the total value of all your outstanding debts such bank loans, taxes, etc.
While net worth is used to gauge your current financial standing, it also serves as an excellent KPI for investing. It quantifies each good and bad financial decision you make thus rendering it one of the best measure of one’s personal wealth. How does this work?
Let’s say you decide to pay more than your monthly mortgage repayment to settle your loan sooner. While you think your wealth has shrunk due to the fact you have less cash to your name, in the long run you benefit from lower interest charges, therefore increasing your net worth.
For medium to long term investments, it makes better sense to take a little risk and invest in a few blue chip stocks than to take the risk adverse path by keeping any surplus cash in a bank account. The quality and payoff of the decision to invest in blue chip stocks would be reflected in the growth of your net worth some 5 to 8 years from now.
Having a positive net worth also provides you with financial security.
Let’s say, for some reason tomorrow you lose your job. A person with large savings and zero debt (high net worth) would have a more worry-free time in between jobs, as compared to the next person who had a high paying salary but zero in savings and a large amount of debt (negative net worth).
Similarly, a person with a high net worth has the freedom to pursue his or her life’s dreams and ambition even at the expense of drawing a low starting salary. On reflection, a person with negative net worth will not have the luxury and freedom to do as such.
From this scenario, you can already see the different dynamics net worth provides as compared to the mere value of your take home pay or the amount in your bank account.
How does one increases net worth?
The four drivers of net worth growth are Savings, ROI, Risks and Costs. All these factors work in tandem to influence your net worth as a whole.
To increase your net worth, you’ll need to:
Savings is the raw material needed for your net worth growth.
To increase your net worth exponentially, you need to invest. And to invest, you’ll need to have capital. Thus the more you save, the more investment capital you have at your disposal.
The good news is that, among all the drivers for net worth, savings is within your control. The amount you end up saving annually is entirely dependent on your discipline and saving habits.
For example, you would have accumulated RM 549,143.57 at the end of 20 years if you have saved RM12,000 annually with a 8% return. For an additional RM48,000 savings per year, i.e. RM 60,000, you would have accumulated RM 2,745,717.86 instead. The difference that you have accumulated in your savings could go a long way.
In fact the more you save, the better it is because it makes you less dependent on the other 3 factors.
2. Increase your ROI
The higher the ROI the faster your net worth will grow.
Naturally, a unit trust giving you a return of 8% annually is preferred over Fixed Deposits with 4% return. The investment vehicle with the higher return would grow your net worth faster.
Beware of the risk-return tradeoff. It is generally understood that the higher the ROI (more than 12%), the higher the risk. You could lose part if not all of your investment capital, an outcome which could be a terrible set back to your net worth.
Contrary to what some people might choose to think, ROI is a driver that is not within anyone’s control.
3. Decrease your exposure to risk
Risks, is also beyond anyone’s control.
While you’re taking active steps to grow your net worth, you’ll need to also take measures to protect yourself against any risks of losing your net worth.
The higher the risks, the higher the potential of your net worth being depleted.
Health related risks for example, could deplete the net worth you have spent years to achieve. Without medical insurance, you may have to fork out a lump sum of RM30,000 during a medical emergency. However, for a small monthly fee, you can transfer this risk to an insurance company, thus preserving your net worth value.
Investment risks should be taken into account as well. The Geneva gold scam and the infamous Madoff investment scandal are two perfect examples of investment fraud. Investors had lost millions, many losing 100% of their money because they were blindsided by the upside and failed to consider the risk of.capital lost Those who suffered the loss of their entire life savings, also irrecoverably have their net worth affected.
Therefore, always take the time to do your research and due diligence and study your options before you part with your hard earned money.
4. Decrease your costs
Most people may not realise this, but cost can be a factor which will deplete your net worth. Therefore one should strive to decrease all unnecessary costs that limits net worth growth.
For example, those who have purchased properties at a higher interest rate should strongly consider revising their interest rate now that the rates have dropped.
A difference between a 20-year housing loan for RM500,000 at an interest rate of 8.6% versus 4.6% is phenomenal – with the former, you’d end up paying RM548,995 in interest, where else with the latter, you’d only fork out RM265,672 in interest payment. A quick revision here could save you money otherwise spent unnecessarily.
Another cost to look out for is the cost of estate administration upon death.
Ironically, many of us spend the majority of our energy and waking hours working in one way or another to grow wealth, but fail to realise the one major cost that could cripple all that we have strived for when we pass on.
Estate administration cost can often reach the leagues of hundreds of thousands of ringgit. Drawing up a comprehensive estate plan for your net worth or inheritance could save you and your loved ones from unnecessary costs incurred (e.g. legal fees, administration fees, fees for court proceedings, etc.).
Getting a snapshot of your overall financial health regularly will give you a measurement of progress over time, motivating you to reach your financial goals. As such, Net worth should be meassured on a regular basis- at the very minimum once a year.
Growing one’s net worth also involves a multi-dimensional approach.
ROI may play an important role in one’s pursuit of wealth, but it is a means to an end, not end in itself. To assume such, would be just like placing all bets on a singular number in a game of roulette.
Most investors make the rookie mistake of focussing solely on ROI as a means to grow wealth without realising that they are other elements at play.
To increase your overall wealth, it all boils down to the 4 drivers of net worth growth – Savings, ROI, Risks and Cost, and how effectively you manage them.
Now that you know the four cornerstones of growing net worth, it’s time to put it into practice and steer your way to a financially promising future.
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