The Most Important First Step on Your Money Journey is knowing where you are starting. In terms of money, that means your net worth.
Have you ever been lost at the mall, trying to find a certain store? Where exactly is Hollister? Where is the jewelry repair shop? The map is clearly marked with giant letters and color coded. But even the best map isn’t helpful if you don’t know this one thing: You are Here.
That magical red arrow that determines exactly where you are, where you’re starting from. Because I am severely directionally challenged (if you tell me to head “South,” you might as well have told me to follow the scent of the color green). So I’ve spent a lot of time looking for the magical “You are here” starting point.
That is the key also, to starting a more deliberate financial awareness practice. We do better, whenever we start out on a course of improvement to know (a) where we’re going, and (b) where we’re starting. We do this with our weight—it’s hard to say, “I lost 7 pounds,” if you don’t know what your original weight was.
Balance Sheet
And so it is with our money. The one piece of paper you’ll create is called, “I am here!” And that one piece of paper is called a Balance Sheet. This exercise, outlined below, will be done once a year, ideally the same time each year. The simple idea is you divide the paper lengthwise in half.
Left Side Assets
On the left, list your assets in terms of dollar value: checking, savings account balance, CDs, investments, retirement accounts (Roth, 401K). Then list your “personal use” assets: residence, auto 1, auto 2, collections (the fair market value today, not what you bought them for). Make a grand total.
Right Side Liabilities
On the right side, list your debts (whole debt, not monthly payment): credit card balances, auto 1 loan, auto 2 loan, student loans, family loans, personal bank loans, mortgage pay off amount.
Subtract, Here’s Your Net Worth
Subtract column two from column one. If you have a positive number, then you have more assets than liabilities, a negative number means you have more debts than assets. If your results are a positive net worth, good job and keep moving in that direction! If your results are a negative net worth, congratulations, there’s nowhere to go but up! (This assumes you get aggressive, cut up your credit cards, and stop incurring any new debt.)
In my classes, I usually recommend that participants do this first as a “best guess” game and then go home and really pull out all of their bills and statements for a more accurate tally. Once you’re done, study it for a bit.
Beware “Personal Use” Assets
I don’t put a lot of stock in “personal use” assets, because, other than a home, they usually go down in value. I don’t even add our cars to our balance sheet because, even though they are paid off, they go down in value every year and if we sell one, we’d have to replace it. So in the asset column I focus on savings, retirement accounts, home and real estate values as a true estimation of assets. In the liability column I don’t include credit cards that are $300 and will be paid off in full from checking. Our debt is our current home and rental home (temporary until we move back).
But this is what I want you to evaluate on your balance sheet. Do you have debts that you could easily pay off, without touching any retirement accounts? Do you have a lot of “stuff” that you could potentially sell and move that profit over to clearing up or reducing some liabilities?
What Am I Seeing??
If your Balance Sheet’s “You Are Here” looks a lot like, “Holy S%$#, I’m swimming in debt” (even if your income covers all the payments), then I can’t recommend enough getting full-board on deck with Dave Ramsey’s 7 Baby Steps as part of the Total Money Makeover.
Ramsey is the absolute genius and guru of motivating hundreds of thousands of people out of the chains of debt. He recommends getting “gazelle intense” (inspired by a video he shows with a gazelle out running a cheetah) and taking 12-24 months to get 100% debt, except for house, by taking on additional jobs, living on “rice and beans, beans and rice,” no vacations and no eating out and sticking to a budget. Further, he recommends paying off smallest debt first (rather than % interest rate considerations), because each small win builds hope, optimism and momentum. Money is behavioral, it has very little to do with math.
If You Have A Lot of Debt, Start Here
So if you have debt, this is a legitimate starting point for your money journey. Clean up that balance sheet. Eradicate everything on the right column except for your mortgage. Listen to Dave Ramsey’s podcast. Fridays used to be dedicated to “Debt Free Screams.” You will learn that on any income, people have been able to pay off enormous debt balances in a reasonably short period of time, just by becoming laser focused on that one goal.
Once you do that, you’ll be ready to grow wealth quickly. You won’t be quick to buy a new boat, expensive car, or an obscene amount of louboutins knowing that it will clog up your balance sheet with debt or quickly depreciating assets. Depreciating assets do very little to grow your net worth. (But I still recommend buying a car over leasing a car every day of the week—leasing is a financial nightmare, created to keep you in leasing bondage. The price to buy out of the lease would be in the debt column.)
What does grow your net worth? Avoiding debt and consistently putting cash away into long term, diversified, low cost investments, like index funds. I talk more about index funds here. If you’re out of debt, max out your company’s tax deferred retirement plan. (In 2019, a pre tax 401K max is $18,500; a post tax Roth IRA max is $6,000.) To learn the difference between these two accounts, click here.
Quickie Balance Sheet Today
Do your Balance Sheet, even a quickie one, today. List the value what you own versus what you owe, strictly from your head. Finalize it with documents this weekend. Date it and put it in a folder that you create for your financial planning. Make it pretty and appealing. Planning for a beautiful and healthy financial life is fun and feminine.
If you make huge strides in a short time to “clean up your balance sheet,” then make a new one in a few months and add it to the folder. At minimum, however, we’ll do this activity once per year and you’ll be astounded how much progress you can make. If you regularly invest in index funds (stock picks that mirror the broader market), and you get a stock market return of 10%, your money will double every 7 years. If you only get 7% returns, your money will double every 10 years. (It’s a mathematical principle called the “Rule of 72.”)
Rule of 72, Why Early and Often is Better
The Rule of 72, my friends, is why it’s important to start investing early and regularly. And the worse the market is doing, the more excited you should be to invest, that just means everything is on sale—or some of the overoptimistic pricing has been knocked out of it. And if the market is high, still buy on schedule, the gain won’t be as obvious in the short term, but over the long haul, you’ll be glad you were in the market.
Remember, “being in the market” just means you own a little stock in a bunch of different publicly traded companies, like Apple, Tesla, GE, Disney. They are motivated to make money and be profitable. They want their stock to go up. As they raise prices and make money, the value of your stock goes up too. As they fall short, your stock falls short (as do theirs). But the real key is to hold stock in such a broad array of companies, a hiccup or bankruptcy of one company does not your account break.
Beware of Your Employer Company’s Stock
With that said, if you have lots stock or options with the company you work for, as soon as you are able, diversify and sell those holdings for a more diversified mutual or index funds. As a technology attorney, I’ve been burned more than once by having too many shares held in my companies’ stock (in one I received 8 cents to every $1 invested after the company went into consensual foreclosure). With that same company, however, I had a 401K that suffered in the general market too, but that money—invested in various stock and bond mutual funds—bounced back beautifully because I had the option to leave it alone.
When the stock market recovers from a big hit, it’s not unusual to have 20% gains in one year. So leave your money alone. Let the economy bounce back and your investments will bounce back with it—as long as you are well diversified. Whatever you do, don’t panic and start selling. Then your “losses” become real, and the money really is gone. When you try to jump back into the recovering market, you’ve now sold low and are buying higher. Don’t sell your favorite pumps for $30 and buy them back next year for $40…just leave them in the box and wait.
Should I Sell Stocks to Pay off Debt?
If the stocks are in any of your retirement accounts, then no. Not even if you’re doing a loan and “paying yourself back” I don’t recommend it. Here’s why: first, in the case of a self-loan, debt doesn’t solve debt. Consolidation just makes your debt number, one lump sum and makes it psychologically harder to get little wins by paying of smaller debt. Second, you lose out on growth that your money could have been doing if you left it alone. Third, there may be withdrawal penalties (even if not, see reason #2). Fourth, if you make paying of your debt “painless,” there is a good chance you’ll get into debt again.
Let me tell you a story about my sister. She had over $10,000 of credit card debt and a $401K loan and wanted to know of what I thought of her taking out a slightly higher mortgage on her NYC apartment to pay it off. I said, “Nope, that would be too easy and you’ll just find yourself overspending again. You have to feel the discomfort of paying it off.” So I challenged her to use her tips (she is a concierge at a high end hotel)—the money she treats as “free money” and runs around taking cabs and splurging on expensive restaurants and gifts—and use that money to pay off both the credit cards and the 401K loan. Use her personal paycheck only to pay bills and buy treats. She had both debts paid off within a year and was so happy with herself. She has not gotten into debt since and is now working toward paying off her apartment.
The Exception
The exception to this answer is if the stock is not part of a retirement fund. Maybe you have a general brokerage account or received a gift. In that case, it is a purely personal decision whether you want cash out those stocks to pay down debt. I never want you to substitute anyone’s advice for your own wisdom; study it out in your mind, if it makes sense for you are your family to let go of that investment, then it may help give you a big jump on reducing that debt side of your balance sheet.
Today: Scribble a quick guesstimate of what your own personal balance sheet looks like. For fun, add a red, “You Are Here.” Embrace it as one step in your journey to financial wellness!