Prescription for Wealth Starts With a Financial Check-Up

Quick … what’s your favorite food? When is your birthday? Who won the World Series?

What’s your personal net worth?

Okay, so the first three were gimmes. But that last question wasn’t. And not knowing the answer to it can spell the difference between success and failure in the personal financial planning game.

Yet, as a financial journalist who interviews scores of financial experts and average investors on a regular basis, rarely do I bump into anyone who actually sat down and calculated his net worth. Worse, rarely do I see many financial advisors recommending that their clients do so.

And that’s a crying shame. After all, how can you complete your journey to true financial independence if you don’t know where you are right now?

Truth is, you can’t. But the good news is sizing up your financial health is a slam-dunk, if you know what you’re doing. That’s where a personal balance sheet comes in handy. Establishing Your Fiscal Fitness

Call it your personal “fiscal fitness” form.

Like a regular check-up from your doctor, a personal balance sheet gives you a blueprint for your financial life, one that you can work from again and again as you make important financial decisions.

It’s a fluid document that you’ll need to revisit every six months or (at the outer limits) every year. And you’ll be glad you have it. It will be the yardstick by which you can measure the success of your financial plan. Plus, being constantly aware of your net worth can serve as a financial planning wake-up call – alerting you to problems on the horizon before the number dips dangerously low.

Simply stated, your net worth is the difference between your assets and liabilities.

Typically, assets include bank accounts, stocks, mutual funds, Individual Retirement Accounts or 401(k) plans, a vacation home, and any other property that could be sold. You could also include money owed to you by others (that you know you will receive) and the value of your life insurance.

Liabilities are your debts. They should be divided into short-term debt (current bills, personal loans, credit card balances, etc.), and long-term debts (mortgages, other installment loans, etc.). You should also include any income taxes that would be owed, as well as any other obligations.

When you take a crack at your balance sheet, remember to include only what you have now. Don’t fudge the numbers because you expect a pay raise or bonus. In technology terms, those are “vaporware” items – revenues that may or may not appear. Those as-yet-unrealized dollars don’t factor into your net worth until you turn that money into an asset.

And be careful about factoring in big-ticket items like your home and car. As Michael Masterson explains in Automatic Wealth…

“I’m going to give you an instruction that will contradict what you’ll hear from just about every financial planner: In tallying your assets, do not include the value of your home, your car, or any possessions you know you’ll never part with. Although these are, indeed, valuable assets, they are assets you will almost certainly want to keep during your retirement years. This is especially true if you are able to achieve financial independence while you still have children at home. If you will be retiring after your children are grown and out on their own, you might very well choose to sell your house and get a less expensive one – but maybe you won’t want to. And I believe in keeping what you have for as long as you wish. (If you follow my six steps to Automatic Wealth, you’ll be able to do that.)”

That’s a point worth remembering. Because if you can’t (or won’t) sell your home or your car and you include those assets in your net worth tally (as most experts advise you to do), the figure you come up with won’t be accurate.

When you total up your debts, include the outstanding amount you owe on your mortgage, student loans, car loans, credit cards, money borrowed from relatives. Exclude monthly bills for things such as the telephone, grocer, rent, and the like. Those things factor into your cash-flow and could be slowing down how much money you pump into increasing your net worth, but they are not a part of your personal balance sheet.

Once you subtract your debt from your assets, you’ll have your net worth. If the number is positive, this is the amount of money you would be worth if you paid off your debts today. If your net worth statement churns out a negative number, it tells you how big a hole you would be in if you were forced to liquidate everything to pay off your debts.

What makes net worth most useful is looking at it on a regular basis – seeing how much it grows or shrinks from year to year. Charting your progress on a year-to-year basis is important, because many people increase both their assets and liabilities at the same time – without realizing it. For example, they put money away into their company’s retirement plan … and, at the same time, finance a new car or increase credit card debt. They may feel “better off,” but they’re not.

What’s a good barometer for solid financial health? In Automatic Wealth, Michael Masterson pegs the net worth that you’ll need in order to enjoy a comfortable retirement at a million – at least. Basically, you take the dollar amount that you will need to live on (the way you want to live) and multiply it by either 8 or 10 or 12, depending on the yield you expect to get from your investments

Here’s a simple 5-step formula to figure out your net worth right now. If your pencil’s broken, keep in mind that some websites, like BYG Publishing’s andThe Washington Post’s provide good online forms that you can use. 5 Easy Steps to Your Net Worth

1. List all of your liquid assets: cash, certificates of deposit, stocks, bonds, and bank accounts.

2. List all jewelry, furniture, and household items at their current value – but only those things that you don’t intend to keep for the rest of your life.

3. Add together all of the above. These are your total assets.

4. Now, subtract all of your debts from your total assets. The result is your net worth.

5. Re-evaluate and update your net worth calculations on an annual or (better yet) semi-annual basis.

Hey, it’s not rocket science. But a personal financial check-up every once in a while can help you hit the ground running when you’re following Michael Masterson’s six-step plan for Automatic Wealth.

[Ed. Note: Brian O’Connell has authored 10 books, including The 401 (k) Millionaire and CNBC’s Creating Wealth. With his background on the Philadelphia Stock Exchange and at the fixed-income trading desk of Delaware Funds as a bond trader, he’s appeared as an expert commentator on business issues for CNN, Fox News, CNBC, C-Span, Bloomberg, The LA Times, and other media outlets. Currently, he operates a freelance writing business, working on books, corporate copywriting projects, and magazine articles for a variety of clients.]