If you’ve ever read one of Warren Buffet’s famous letters to Berkshire’s shareholders, you know that he starts each letter the same way. Each letter begins with how the company’s book value changed from the prior year. Here’s how he opened his must recent letter:
In 2012, Berkshire achieved a total gain for its shareholders of $24.1 billion. We used $1.3 billion of that to repurchase our stock, which left us with an increase in net worth of $22.8 billion for the year. The per-share book value of both our Class A and Class B stock increased by 14.4%. Over the last 48 years (that is, since present management took over), book value has grown from $19 to $114,214, a rate of 19.7% compounded annually.*
By book value he means the net worth of the company. He doesn’t point to how much money Berkshire Hathaway made last year (although that’s important, too). Why? Because net worth is the clearest picture of the financial value of an entity.
If you think about it, net worth is a result of how much we spend in relation to how much we make. Spend more than you make, and your net worth goes down (often in the form of credit card debt or reduced savings). Spend less than you make and it goes up. Pretty simple. And that’s why it’s important to track your net worth–it’s the best indicator of your financial progress.
If you are not keeping a balance sheet (sometimes referred to as a personal financial statement), I highly recommend that you start now. Your net worth is very easy to calculate and track. Below I walk through what I think is the best way to prepare your balance sheet, and then I’ll discuss a free online tool that automates the whole process.
How to Track Your Net Worth
Tracking net worth is easy, but there are a few questions you need to answer. For example, do you include in the calculation absolutely everything you own down to the last piece of flatware? Do you include your house, and if so, at the purchase price or current value? Do you include only your investments? Do you include the value of a business, and if so, how do you value the business?
The answers to these questions depend in part on what purpose the net worth calculation serves. For example, if you are applying for a loan, you’ll want to include all of your assets, including personal property. In contrast, for tracking what I consider to be our true progress toward financial independence, we use a modified version of net worth.
We include all investments, cash deposits, rental properties and our home, along with all debt. We exclude, however, our cars (even though they are paid for), furniture, and other personal property that goes down in value over time. Why do we do this? There are two reasons:
- Depreciation: Assets like cars, boats, and personal property generally lose value over time. Eventually, these items must be replaced. As a result, while they are technically assets, the day will come when they have no value. As a result, listing them in our net worth inflates our real financial position.
- Gut Check: We pay cash for our cars. We pay cash for everything. When we buy a car, our net worth as we calculate it goes down. Why? Because cash comes off of our balance sheet and we don’t add the value of the car back in. This forces us to reflect on our financial decisions and the impact they have on our future.
In terms of our home, we include it at current value in our net worth calculation for several reasons:
- The value of our home is a significant asset for us, representing about 50 percent of the total assets in our Net Worth calculation. The equity in our home represents about 40% of our Net Worth. To exclude our home value (and related mortgage), would omit a substantial part of our financial picture. True, we don’t intend to sell our home in the foreseeable future (which is why some exclude it from the net worth calculation), but we don’t intend to sell our mutual fund investments, either.
- Although we don’t have plans to move any time soon, we do expect eventually to down-size and move to a less expensive area. And we intend to use the equity in our home to pay cash for our retirement home. Including our home in the Net Worth calculation helps us keep track of the equity in our home for this purpose.
- It helps us look at our home as an investment. While our home is much more than an investment, including it in our Net Worth calculation helps to remind us that it is a valuable asset in our overall financial picture.
Finally, we keep track of each individual investment we have. Our balance sheet lists each mutual fund, ETF, and individual stock that we own. While you don’t have to go into this much detail, we do it so we can see the performance of these investments on a month-by-month basis.
Net Worth Tracking Tools
All of this may seem like more work than it really is. It’s really not. While I do keep a spreadsheet to track our net worth, we also track it in a free online tool called Personal Capital, which updates automatically. We’ve even included our home using the value provided by Zillow. (Incidentally, there are a number of great home value tools worth checking out.) Personal Capital can then produce graphs of your net worth, like this one:
Read More: Personal Capital Review
Regardless of whether you use Personal Capital, a spreadsheet (here’s a free personal financial statement Excel template), or just a piece of paper, keeping track of your net worth is the best way to measure your financial progress.