True wealth comes down to net worth, a measure of not only what you truly own (your assets) but also of your debt (your liabilities). Once you determine your net worth, you can make the reimbursement of your loans and unpaid bills a priority, after which you can get started on the path to saving.
Three steps for measuring your net worth
First, calculate your total liabilities by adding up all your current debt amounts: outstanding credit card balances, mortgage loan, car loan, student loan, line of credit, personal loans, and so on.
Next, add up your assets: bank accounts, savings (RRSP, TFSA, RESP, stocks, bonds), potential pension funds, shares of a company, the value of a parcel of land, the cash surrender value of an insurance policy, etc.
Finally, subtract your total liabilities from your total assets. The result is your net worth.
For example, if you own a house with a market value of $200,000, a $20,000 vehicle, and $5,000 in bank savings, your total assets amount to $225,000. If you owe $215,000 on your mortgage, $15,000 on your car loan, and have unpaid student loans and credit card balances of $20,000, your liabilities add up to $250,000. Your net worth is therefore negative: -$25,000.
Something to keep in mind when you calculate your total assets: do not be fooled by certain numbers that give the illusion of having more than you actually do. For instance, when it comes time to wind down your RRSPs, funds that had accumulated tax free will now be subject to tax. Therefore, each $100 withdrawn will be worth only $70, perhaps even as little as $50. Gains from shares held outside a TFSA are also taxable.
The impact your lifestyle has on your personal finances
Since net worth is not a measure of what you possess, but of what you truly own, it is worth taking the time to reflect on another important factor: your lifestyle. Reviewing some of your living habits could be a very profitable thing to do, especially when your income is increasing. You could see the sums you set aside as savings grow more rapidly if you opt, for a while at least, to maintain your existing lifestyle rather than expanding it.
Naturally, the choice is yours entirely: you can buy the car of your dreams for $100,000 and after a few years be the owner of a vehicle—the same one—worth $20,000. You will have an $80,000 write-off, or almost $160,000 in pre-tax terms. Or you could wisely invest the same $100,000 and, just 10 years later, find yourself with an extra $50,000 in funds.
Taking advantage of compound interest
Boosting your net worth is simple: if you spend less than what you take in, you can save the difference. Then, by investing those savings wisely, you can make your money grow, notably by taking advantage of compound interest.
Thanks to compound interest, the amounts earned as annual returns on investment (sums of interest, share appreciation) themselves grow each year. Over the long term, this additional growth adds up to a considerable sum. What might your return on investment look like in 10 years if you decide to start saving and investing today?
How can you reach your financial goals?
Saving and investing remain the keys to achieving financial independence. And aiming for financial independence clearly involves making the best possible investment choices for tomorrow. If this is a goal you wish to pursue while still enjoying a comfortable lifestyle within limits, the first step is therefore to calculate your net worth.
By then by being more of your spending and applying sound financial
discipline, you will be able to reap the benefits of the most
profitable investment of your life: you.