Two Tools You Need to Use to Improve Your Net Worth!

The biggest financial issues most people have these days are debt and overspending. Owing money on high-interest loans or spending more than you can afford really drags down your net worth. So when the team at Nelson Financial Planning works with people who are just starting out investing, approaching retirement, or even in retirement, we like to use two primary tools to help people understand their net worth—balance sheets and income statements.

People and their finances are very similar to a business. That’s why it’s useful to refer to these two age-old financial documents when considering your personal income and expenses. And the beauty of balance sheets and income statements is that they can usually be consolidated down to a couple of pages.

Using Concrete Numbers to Produce Balance Sheets and Income Statements

Nelson Financial Planning generates concise documents to help you understand your personal finances, not 70-page reports that cost thousands of dollars to extrapolate. This makes our balance sheets and income statements digestible, actionable, and an effective means of improving your net worth.

Also, we don’t use the numbers that you think you earn or think you owe when generating our documents. Instead, we use concrete numbers based on your financial statements. This ensures accuracy whether you’re dealing with liabilities or assets.

First, consider student loans. We sometimes have clients come in with $20,000 in student debt and a payment plan of $100 per month, so they think they’re paying down the principal balance. In reality, the interest rate can be so high that they should be paying $300 a month just to keep up. So after four years, they think they’ve worked their debt down to $15,000 when it has actually gone up to $30,000.

Second, consider misunderstood investment accounts. We commonly hear from people who opened accounts 20 years ago and deposited $20,000. They assume the money was invested, so now they think it must be worth $50,000 or $60,000. But then they learn their money has been sitting in cash for two decades and is still only worth $20,000.

This underscores why it’s so important to check your statements and not assume anything about your finances until you see the concrete numbers.

Using Balance Sheets to Improve Your Net Worth

A balance sheet shows your liabilities vs. your assets. When you add up both sides of the equation and subtract your liabilities from your assets, you get your net worth. Writing this out on paper changes your perspective and makes you feel more responsible for your personal finances.

When it comes to decreasing the liability side of the balance sheet equation, it’s important to consider interest rates and the length of the loan. For instance, credit cards are short-term debts that incur interest rates upwards of 20%, so it’s good to pay those off as quickly as you can. On the other hand, mortgage rates are hovering around 3% right now, so long-term home loans don’t necessarily need to be paid down as quickly.

As you consider your assets, think about them in terms of liquidity, or the ease with which you can convert them to cash without losing value. The most liquid assets are cash, money market accounts, common stocks, and US Treasury bonds. The least liquid assets are your car, real estate, and retirement accounts (until you reach retirement age).

Follow these tips to increase the asset side of the balance sheet equation:

• Spend less, save more. This is the easiest way to boost your assets, which builds your net worth.
• Build an emergency savings fund so you have somewhere to turn if your expenses are higher than usual one month.
• Know the asset allocation of your investment accounts. If they’re sitting in cash, they’re not earning any interest.

Using Income Statements to Improve Your Net Worth

An income statement shows the money coming in (income) and the money going out (expenses). The amount you have left at the end of the month should come out positive—if not, you need to make some changes!

Even if you’re in the black, you can increase your net worth by using your income statements to do the following:

• Cut back in little areas like buying coffee every day. $5 each morning may not sound like much, but it adds up to $150 a month, or almost $2,000 a year!
• Pay yourself first. Determine how much you want to save or invest each month, and set that money aside as a line item on your income statement. Don’t approach it as wanting to save, but only if you happen to have anything left at the end of the month.

A Roth IRA With $5 Billion—How Does That Even Happen?

Have you heard this story? A nonprofit newsroom organization, ProPublica, claims that it managed to get a hold of the tax returns of several high net worth Americans. One of them presumably showed a Roth IRA account with a balance of $5 billion. The account is owned by Peter Thiel, the co-founder of PayPal.

When PayPal was new, each company share was worth less than a penny. So Thiel put a bunch of his non-publicly traded shares into his Roth account—which is completely legal, by the way. Even with a $2,000 contribution limit, a Roth account can grow tremendously if the investments within them accrue enough interest. And that’s just what happened.

Now, because Roth accounts are after-tax dollars, you can imagine that this kind of headline attracts the attention of politicians. Some interesting concepts are now floating around because of the one-in-a-million circumstances surrounding Thiel’s retirement account. Here’s what lawmakers are considering that may affect your retirement:

• Account size restrictions
• Roth conversion income limitations
• Restrictions on using alternative assets to fund retirement accounts

Increasing your assets, decreasing your liabilities, tracking your spending, and managing your retirement plan are significant factors in shaping your overall financial picture—and they often require the help of a financial planner. To learn more about growing your net worth, please call Nelson Financial Planning at 407-307-3061. You can also contact us online to schedule a free consultation with a certified financial fiduciary.