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How to Create a Budget and Calculate your Net Worth

pile of money and coins adding to your net worth

As I mentioned in the About Me section, my wife and I have recently relocated from Minnesota to Montreal, Canada as part of a career change. In order to do so, my wife left her stable and well paid job as a sales and pricing analyst at a Fortune 50 company headquartered in Minnesota. Because she has not yet found a new job in Montreal (most jobs require fluency in both French and English) she has generously volunteered to edit my posts. After reading my last post titled, “There Are Only 3 Ways to Get Rich” she provided some excellent feedback. She said, “you talk about budgeting and net worth, but how do you actually do it? I bet many of your readers would benefit from actual examples.” Great catch.

So, the purpose of this post is to offer some simple guidance on how to set up a budget and track your net worth, with some handy tips sprinkled throughout.

How to create a budget

There is a lot of advice on how to create a budget, as well as a lot of downloadable templates and excellent tools and apps (Mint.com, etc.) to help you along, so you should consider using many of these. However, I think it is still useful to discuss budgeting in detail and how you can simply and easily create a budget you can stick to.

The traditional way of setting a budget is pretty straight forward: Each month, take your net pay (this is your “gross” or total pay with taxes or other withholdings taken out…that is, that amount deposited in your bank account on payday) and subtract out all of your expenses. Expenses are anything that uses money like your mortgage or rent, car payments, debt payments (student loans, credit cards), etc. Once you take your net pay and subtract out ALL of your expenses (it’s critically important to track ALL of your expenses…no point in skipping stuff as you are only cheating yourself…) what is left is excess money that can be spent or saved (preferably saved). I have provided a simple example below:

+ Net Pay (amount of the check) $4,000 This is your starting point
 – EXPENSES Housing $2,000 Housing / Rent
DEBT: Credit Card $500 NOT the minimum… the TOTAL
DEBT: Student Loans $200
Transportation $200 Car payment, gas, insurance
Food/Grocery $200
Cable/Phone/Internet $100
Clothing $50
Entertainment $50
Other All other spending
WHAT IS LEFT $700 Formula: Net Pay – All Expenses

 

In the example above, the hypothetical person with an income of $4,000 per month (after taxes), after paying all of their expenses, will have $700 left over. This is perfectly good template to use, but I would propose some slight modifications:

 

Monthly Budget
Gross Pay $5,000 Before taxes… listed on your paycheck
Taxes and Deductions $1,000 Income tax, State tax, social security tax, Medicare/Medicaid, etc.
 + Net Pay (Amount of the check) $4,000 This is your starting point
 – EXPENSES SAVINGS: $500 PAY YOURSELF FIRST! Make savings a priority!
Housing $2,000 Housing / Rent
DEBT: Credit Card $500 NOT the minimum… the TOTAL
DEBT: Student Loans $200
Transportation $200 Car payment, gas, insurance
Food/Grocery $200
Cable/Phone/Internet $100
Clothing $50
Entertainment $50
Other All other spending
WHAT IS LEFT $200 Formula: Net Pay – All Expenses

 

So, what is different? A couple of things:

  • Track your taxes. Taxes are a REAL expense that the vast majority of people do not pay enough attention to. As you move up the corporate ladder and make more money, learning how to (legally) reduce your tax liability becomes more and more important. Also, knowing what you pay will make you a better citizen as you will be more informed come election time.
  • Put SAVINGS as your first expense. That is, make savings a priority. Treat it as an expense. Set a target and stick to it each month. Why? Because if you don’t, it’s really easy to spend the “what’s left over” money in the first budget example above instead of save it. If your goal is to reach financial independence (which it should be), treating savings as an expense is very important. [Note: There are a (very) few exceptions. If you have a lot of high interest debt, pay it down first. Think of it this way; if you have a lot of credit card debt at 20% interest, its like giving yourself a 20% raise in income by paying off that debt as quickly as possible.]
  • What’s left over. As you know from prior posts, I firmly believe that discipline is the secret to success. If you have money left over after all of your expenses, fight the urge to splurge. Rather, your first two options on what to do with that extra money should be, 1. Create an emergency fund (if you don’t already have one), or 2. Save! Before you spend, ask yourself: “What would make me happier…these socks/dinner at a fancy restaurant/new clothes, or the peace of mind of being out of debt? Or financial independence so I no longer have to work crushing hours? Or an early retirement? Be aware of your spending–a good budget, and the discipline to follow it, can help.


Net Worth Calculator

Now that you have the basics of budgeting down, let’s migrate to the concept of net worth. Net worth is simply how much assets you have (stocks, bonds, savings, etc.) vs. how much debt you have. If you have a negative net worth, you have more debt than assets (sadly, this is surprisingly common). If you have a positive net worth, you have more assets than debt. Any positive net worth you have is WEALTH. Wealthy people have a high net worth.

It’s CRITICALLY important at this point to state something that seems obvious, but given the ridiculous levels of debt carried by people in North America (and globally) apparently it isn’t obvious: WEALTH is how much net worth you have, NOT HOW MUCH MONEY YOU MAKE. Said another way, many people would consider someone with a $1 million per year income as “wealthy.” However, if that person has a mortgage on a $5 million home, drives multiple luxury cars and spends their money indiscriminately, they likely have a negative net worth. In short, they are not wealthy, they are POOR.

Pause for a minute and let that sink in. This is the reason a majority of extremely highly paid sports stars declare bankruptcy within 5 years of retirement. This is also why it is a COMPLETE WASTE OF TIME to try to “keep up with the Joneses” as the Joneses likely have a negative net worth, meaning they are POOR, regardless of the size of their house or what kind of car they drive.

So, how does one figure out their net worth? It’s surprisingly simple.

  1. Make a list of all your assets.
  2. Track their value over time (weekly, monthly, quarterly).
  3. Subtract your debts.
  4. Track the value of your debts over time.
  5. Subtract your debts from your assets. This is your net worth.

Here is a link to Microsoft Excel Online to get started: https://office.live.com/start/Excel.aspx
(You can either create an account or sign in with your Microsoft email — it’s free.)

Some important things to note regarding net worth:

  1. Capture ALL assets you have.
  2. If you have debt, subtract it from your net worth. This helps you realize that debt is a boat anchor on your finances.
  3. Track it monthly. This helps you keep track of where you are succeeding and where you are falling short. It also helps show you are making progress toward a major goal. If you don’t track your progress, saving seems so abstract and far away. If you check your balances monthly, you can see the progress you are making. It also makes it fun!
  4. Share progress. Share your progress with your spouse. It helps align priorities and sets expectations about spending and saving.

Doing only the two things discussed in this post (making and sticking to a budget and tracking your net worth) will start you on the path to financial independence and, ultimately, the freedom from debt and worry that will allow you to pursue a life of fulfillment.

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