How to calculate your net worth and savings rate

Today’s post will teach you how to calculate your net worth and savings rate. This is an essential step in creating your own financial plan.

When I started putting together a roadmap to financial freedom and moFIRE, the first step was a budget. This was essential, and showed me (in shocking manner) how much money we spent on a monthly basis. It also gave me a clearer picture of how much money we had coming in.

The next part of my plan was figuring out our net worth, and this was tougher. I realized that I didn’t actually know how to do this. Do I count our house as an asset or liability?  How about 529 accounts? Also, how will I know when I have enough money to be financially free?

It was clear that I needed a basic understanding of finances before I’d be able to figure out a plan of how to get to my goal. Luckily, there’s a highly populated ecosystem of bloggers who could help me.

One of the earliest and most respected FIRE bloggers is Mr. Money Moustache, and I found his posts incredibly helpful in getting the basics all set.  There is some difference of opinion with many of these definitions, but if it’s good enough for MMM, it’s good enough for me.

So read below for the basic definitions necessary to generate your own plan for financial independence.

How to calculate your net worth

  • Assets = equity on your house + cash worth of all investments
  • Debts = mortgage + car loans + personal loans (like student loans)
  • Net worth = assets – debts
  • Not included:  cash worth of personal property (like cars or clothing)

How to calculate your savings rate

  • Savings rate = ((take home pay – spending) / take home pay) * 100
  • Why do we use take home pay and not pre-tax income?  Because it’s too hard to figure out how much taxes will be taken out.  It’s simpler and more useful to just use the actual amount of cash in your paycheck as your baseline income.

How to calculate your take home pay

  • Gross pay + Employer 401(k) match – taxes
  • Unless your tax exemptions are significantly off, this should be basically what shows up in your paycheck every couple of weeks.  

The definition of financial freedom

  • AKA, when have I achieved FIRE (financial independence, retire early)?
  • The most common definition of when you have achieved FIRE is when 4% of your investments equals your annual expenditures.  This calculation generates your “FIRE number”.
  • This is based off of the assumption that if you have investments that generate a return of > 4%, you can safely spend 4% of your investments and never run out of money.  
  • The shortcut? Annual spending * 25.
  • Do I count my house as an “investment”?
    • This is controversial, but most people chasing FIRE agree that since home equity doesn’t generate any cashflow and is very illiquid, it may count towards net worth, but not towards their FIRE number.

Each of these topics has subtleties and controversies, and I expect we will come back to address these at some point in the future.

Now with these basics out of the way, we should be able to move on together to mapping out a plan to financial independence!

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