Your current assets (minus your debts) make up your Net Worth.
We’re trying to grow your Net Worth and there are two ways to do this. 1) Feed it from your Earnings. 2) Make it grow itself.
Your earnings could be thought of as a stream of money, and normally almost all of the stream would be used up on the general business of living, with very little of it surviving to become long-term wealth. We’re going to try to divert some of that flow of cash into a fund which can grow.
Then we’ll try to cause the fund to grow by itself too. This means putting as much of it as possible into something which is productive.
If you have a gold ring, it’s a way of storing your wealth, and it may go up a bit in value over time, but it’s not doing much. If, on the other hand, you own a bit of a company, your wealth is invested in a way that produces a regular profit. Then the profit can either be used to grow your net worth some more, or you can eventually decide to take it out to be used to cover your living expenses.
Let’s do some measuring.
Count up the value of all your assets. This can include the money in your bank accounts, your work pension, and the value of your car and your house, if you own it, and anything else that you own - jewellery, artworks, a plot of land, premium bonds, your collection of Star Wars figures, etc. Try to put a value on everything and come up with a total figure.
Then you need to subtract all of your debts. That includes your overdraft and credit card balances, any debt on your car, and the outstanding value of your mortgage.
What’s left over is your net worth.
Next carry out the same process on your ongoing earnings and spending to see what changes happen to your net worth on a monthly basis.
Count up your monthly earnings, and then subtract all of your monthly spending to see how much money you have left at the end of the month. That remainder tells you how much you’ll grow your net worth by each month, as things currently stand.
Most of us experience “lifestyle creep” and our spending grows to keep pace with our earnings. This may mean that you don’t have much gap between your earning and spending, and aren’t really growing your net worth.
Sweat your assets
The basic building block that we’ll use is to get both your Assets and your Earnings to contribute more to your future.
Have another look at your list of assets and figure out what percentage of them is currently Productive.
Your unproductive assets are not going to help grow your net worth. Worse, some of them are not just assets, they are also liabilities. Your car may have a value and so be considered an asset, but it doesn’t earn you any money, and worse still, it comes with overheads. You have to insure and tax it, put fuel in, maintain it and pay for any repairs. Then its value as an asset goes down over time. It had better be important to your lifestyle because it’s a massive drain on your pocket!
Another example of an unproductive asset is jewellery. Some of your jewellery may have sentimental value, which is fine, but others may simply be shiny and get worn occasionally, but otherwise sit in their box doing nothing for much of the time. Could you put this capital to work instead? There may be some things that you are willing to sell, letting you invest the money instead. Then this capital would be producing a cashflow and adding regularly to your net worth.
We call this passive income because the earnings come from your capital doing the work, without you getting out of bed. The beauty of using this is that over time it compounds - the profit goes to work and begins to make additional profit of its own.
The impact of putting the value of any one item to work will be small, but our plan involves doing this lots of times, with both your existing assets and your earned income.
Your spending
It’s easy to do a little investing. Most of us can, in a fit of enthusiasm, set up a direct debit for £100 a month without too much trouble. We can also look at optimising our work pension by switching funds or possibly providers. Then we hit a wall - we’ve made a start but it’s going to be tough to scale things up to a decent speed.
The problem is that most of us quite simply live to our means. We enjoy a lifestyle to match our income, and habits like that are hard to break. We reach this point by sleepwalking from a frugal kid who is used to having little money, up the career ladder with increasing earning power, and never really stop to think about spending priorities. Life gets in the way, with expensive things like cars and houses to pay for, and we’re often pushing ourselves so hard that we spend the remaining money on treats and conveniences. Spending habits develop.
There are two ways to look at cutting your spending. You can be unhappy and look upon it as giving stuff up. Or you can adopt the Mr Money Mustache viewpoint and embrace the frugality, find the positive in a simpler life where you don’t derive your pleasure from spending money.
There is in fact a sound basis for this viewpoint. Research shows that each additional pound you spend on those treats and conveniences tends to bring you less happiness than the pound before. So this may not be so bad after all - we’re only going to be cutting the last spending, the bit which adds the least happiness!
Conduct a little audit of your spending, to see where your money actually goes. I’ve tried to brainstorm a list of possible spends and put them into categories, but I’ve undoubtedly missed some. Fill in values next to all of these which apply to you.
Home
· Mortgage or rent
· Utilities
· Insurances
· Cleaners / Gardeners / Window cleaners / Services
· Repairs / Redecoration
· Furnishings / Carpets / Beds
Transport
· Bus / train fares
· Car loan
· Car insurance, MOT, servicing, repairs, fuel
· Parking fees
· Car washes
Family
· Childcare
· Gifts
· Pocket money
· Schools fees
· After school clubs
· School trips
Food & Drink
· Groceries
· Eating out
· Takeaway food
· Drinks out
· Subscriptions
Other Shopping
· Clothes / Footwear
· Glasses / Contact lenses /
· Makeup / jewellery
Entertainment
· TV Licence
· Streaming subscriptions
· Gaming subscriptions
· Magazines & newspapers
· Mobile phone / other gadgets
· Computer / laptop
· Cinema
· Days out
Holidays
· Weekends away / short breaks
· UK holidays
· Foreign holidays
Hobbies
· Gambling
Medical
· Dentist
· Optician
· Private healthcare
· Osteopath / Chiropractor / Therapies
Debt repayments and interest
Other
Try to list all your spending and put each item under the nearest suitable heading. Use this to get a sense of where your money is going, which categories take up the most money. If it helps, get into your banking app and look through the various payments that go out. Then think about which of the items on the list that you could cut without too much pain. If you’re considering making more severe cuts, try to balance this is looking at the payoff - you could read my article on the 10 year return of a bacon butty for this. Instead of getting a buzz from spending, try to condition yourself to get your buzz from investing and watching your wealth grow.
Obviously the aim of the exercise is to see what money you could free up for your investing goal. You’re trying to grow the gap between your earning and your spending. It’s all about the gap.
If the resulting sum is low, don’t be disheartened. Not all spending commitments last forever. The pain of your mortgage payment will reduce over the years as inflation has an impact, your wages should go up with inflation, while the amount of your outstanding loan diminishes in real terms. Kids leave home and eventually start paying their own way. These changes will leave you with more money to invest later on. You just don’t have much spare money - yet.
Identifying savings in each category can be hard. Reducing the fuel cost of your commute is definitely a longer term goal; most of us would find it hard to relocate to a job closer to home instantly. The only thing you can really do to slash this is to switch to an EV.
The great news is that by making this effort, you get rewarded twice! As well as investing more, your new frugal ways have reduced your spending. This means that your target spending figure has been reduced by 25 times the savings. Your smaller goal will be a lot quicker to reach.
Measure your Savings Rate before and after this process, to impress yourself with the impact you’ve made. Your Savings Rate is just the percentage of your take home pay that you are saving. If you were at 10%, aim for 20%. If you were at 40%, aim for 50%. Any improvement is useful.
Deploy your resources
Once you’ve got spare money to deploy, where should it go first?
If you’re starting out with very little wealth, first you need some stability. Use your first savings to build yourself an Emergency Fund. This could be £1000 that you keep in a high interest account, or in premium bonds, just somewhere that you can pretty quickly get at it to deal with the problems that life throws up. If your central heating boiler blows up or your car breaks down, you have the money to deal with these problems and it doesn’t derail your finances.
Next I’d set about clearing any debt, starting with the most expensive - the ones with the highest interest rates. The reason for clearing debt before investing is that debt also compounds, in a bad way. If unpaid, the interest on your debt would add to the amount owed, and in turn attract more interest. It’s a downward spiral that we want to halt.
This applies to consumer debt, basically everything except a mortgage. Mortgages are secured against your house and that means they tend to have very low interest rates. You can expect to earn more from investing some money than you would save by using that money to pay off some of your mortgage.
After building an emergency fund and clearing your debt, after celebrating you can finally turn your thoughts to investing.
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