Building your net worth has a lot of moving parts. Savings, earning, investing, taxes. Sometimes it’s hard to know where to start and how all the pieces work together. To help, I developed a simplified equation to provide a framework for thinking about your personal finances. Thinking about your finances in this way can provide a powerful starting point for jumpstarting your journey to financial independence and early retirement.
Net Worth Equation:
Net Worth = (Earnings – Income Taxes – Spending + Last Year’s Net Worth) * Investment Returns – Dividend & Capital Gains Taxes
Why is this equation helpful?
The reason this equation is so powerful is because it draws a clear relationship between growing your net worth and changing all the variables within the equation. Increase your earnings, and your net worth will increase. However, if you increase your earnings and your spending, they cancel out and you won’t see the jump in net worth you may have been expecting. You can even take it one step further and get a bit more technical. If you reduce your spending by $1, your NW goes up by $1 TIMES whatever money you made by investing that $1.
The other reason the equations is important is that it can put into context nearly every personal finance post out there. It doesn’t take long to associate an article with at least one of the variables in this equation. “Diversifying your income” articles target increasing your Earnings. Budgeting articles aim at reducing Spending. IRA versus taxable investing help to reduce both Income Taxes and Dividend & Capital Gains Taxes.
Throughout my journey towards financial, my goal is to always be working to improve at least one variable in the Net Worth equation. There are always improvements that can be made, and some are going to be easier than others. However, by making incremental changes, I will supercharge the growth in my net worth to help me achieve my financial independence goal.