One of the most important metrics for tracking financial progress is net worth. I write about my net worth, or a modified form of it, every month when I report my balances. By watching my net worth change over time—usually increasing from month to month but occasionally decreasing—I can get a fairly decent picture of my financial health.

What is net worth?

Net worth is the financial value of all your assets, everything you own, subtracted by the financial value of all your liabilities, everything you owe. Finance gurus are familiar with this formula:

Net Worth = Assets – Liabilities

The equation works as well for individuals as it does for businesses. There should be no question of what is included in the net worth calculation. It starts out simple. Your bank accounts are assets and your credit card accounts are liabilities. These are easy to include in your net worth calculation because the values of these accounts are expressed in dollars and cents at any moment. You could at any point check your accounts online to get an up-to-the-minute balance.

Investments are assets as well. Generally, investments are held in shares, so a calculation may be necessary to convert your shares to a dollar amount that you can include in your net worth calculation, based on the value of those shares. If your investment is a stock traded frequently, you can generally place a value easily. If your investment is something more complicated like a business partnership, then there might be some wiggle room when coming up with a value for your net worth calculation.

Your house is an asset. Its anticipated sale value, even if you don’t plan on selling, should be included as an asset, while the value of your mortgage if you have one should be included as a liability. Your net worth includes all assets and all liabilities, so if you own a home, you must include your house and its mortgage.

Here’s more discussion about how to calculate your net worth.

How is net worth useful?

You might find that a true net worth calculation doesn’t provide you with useful information all of the time. For example, a true net worth calculation includes the value of everything you own. That includes your television, furniture, car, coin collection, and light bulbs. Since I use my net worth to track my financial progress over time, I’m not concerned about the value of most of the things I own. Including the liquidation value of my electronic equipment would skew my net worth slightly and in such a way that it would reduce the usefulness of my net worth.

I include the value of my car in my net worth, not because I plan on selling it but because it was once associated with a loan. The value of the loan is considered a liability, and it was important to me to reduce that liability as quickly as possible. By including the loan in my net worth, I could track my progress as I eliminated that debt and the effect of the remaining balance on my total financial picture. To include the automobile loan, it made sense for me to include the value of the car (which I check once in a while using the private sale price listed on edmunds.com). After paying off the loan, I left the car in my net worth calculation for the sake of continuity.

It’s this personal continuity that is important. As long as you maintain the same formula from month to month and year to year, it doesn’t matter what you include in your net worth calculation as long as it makes sense to you.

Net worth is an internal metric

Net worth is best used as a tool to compare your progress over time, particularly if you insure it is calculated the same way every month. While some aspects of your net worth you may view as beyond your control, like the performance of the stock market, there is enough information in the numbers to give you a good picture of the results of your everyday financial decisions. There is something interesting about the idea of being able to compare your net worth with those of other people, but there are a few reasons why it’s best to keep your net worth an internal metric.

A quick online search can provide broader statistics so you can compare your net worth with a large population of people in your income range or age range. These comparisons are meaningless, however. Age groups can include a variety of education levels, particularly at the lower end of the spectrum. At the other end, you may be grouping retirees in with CEOs. If you’re comparing your net worth with people with similar incomes, you don’t know whether this income is a full year’s salary, pension, or dividends from investments.

Different people are faced with different situations. If you’re 22, making $40,000 in your first year as a teacher, dealing with student loans, single, and living at home with your parents, what benefit is there in comparing your net worth with another 22-year-old, making $40,000 in his fourth year in a factory, married with one child, owning a home and dealing with a mortgage?

That’s why technologies like NetworthIQ are popular. You can compare yourself with people like yourself to get an idea of where you stand among your peers. NetworthIQ does a good job of encouraging people to calculate net worth in a similar manner and groups members among different dimensions to ensure meaningful comparisons. This gets you closer to being able to compare your net worth with others, but there is still no guarantee that people are providing true information.

As I was one of the first people to blog about my personal net worth and track my finances online in blog form, I think it’s great that tools like NetworthIQ exist now. I’m also slightly interested in blogger comparisons like this one from last year, but they have very little real value beyond voyeurism.

I prefer not to worry myself about other people and focus on my own progress. My goal is to keep my finances moving forward, which usually means showing an increase in net worth each month, and other people’s finances have absolutely no bearing on my progress. By publishing my financial reports each month, I keep myself accountable to the public, and this inspires me to make decent financial decisions. Depending on your psychological tendencies, comparing yourself with others could provide you with motivation to improve your financial condition or it could leave you frustrated with your own situation.

This motivation can be helpful, but don’t look for too much meaning in person-to-person or person-to-average comparisons.

When first attempting to gain some control over your finances, it’s particularly helpful to micromanage. If your money is in a state of disarray due to spending more than you’re earning, then it’s helpful to look at every little expense, at least for a time. This will help give you a more accurate picture of your overall “outgo.” You may decide that those expensive coffee-related drinks you buy every day add up over time, and you can use that money for more important things, like investing for the future. (This idea is known popularly as the “Latte Factor®.”)

Paying close attention to the minutiae of spending is certainly helpful to many people as they learn to gain control of their financial lives and maintain that control. It’s easy, however, to get into the habit of looking through a microscope so often that you fail to see the bigger picture. This is a classic case of being penny wise, pound foolish.

Put another way, buying the wrong car can in an instant undo years of your hard work and financial gains sustained by eliminating your daily latte or replacing it with a $0.99 coffee. Following a tip on a hot stock has the possibility of decimating your investment in a short period of time. In fact, although I wouldn’t consider Vanguard’s Total Stock Market Index (VTSMX) a “hot stock tip,” I invested $5,000 in this fund for charitable causes at the end of of 2008, and the value has already dropped by 10%.

An article at the Motley Fool presents an interesting idea to illustrate just how much one big mistake, though seemingly innocuous, can undo years of scrimping and saving pennies here and there. The article presents a better example for housing than they do for stocks:

Conventional wisdom says that buying a house beats renting because you build equity and get tax benefits on your mortgage interest. But as with any investment, price matters.

And prices got detached from underlying value in a major way during the run-up. Those who took on conventional mortgages with monthly payments they could afford can wait out the storm. Unfortunately, those faced with refinancing teaser rates they could barely afford don’t have that luxury.

To calculate the cost of a housing mistake, let’s assume someone bought a $400,000 house and the house’s value dropped 10% (the latest numbers show average housing prices have fallen 14.4% year over year). That’s negative equity of $40,000, or 10,000 days of lattes. You’d have to skip that pick-me-up for 27 years to make up for this one. Yikes!

While most people decide when to buy a house out of necessity, perceived or actual, many people try to time the housing market, no matter how intelligent they may seem otherwise and how well they’ve convinced themselves of their infallibility. You can pinch all the pennies you want, but if you still make poor choices when faced with major purchasing decisions, you’re no better off.

The best solution is to find a balance between micromanagement and focusing on the entire financial picture.

Don’t Blow Your Retirement With One Mistake, Anand Chokkavelu, Motley Fool, June 19, 2008.

When it comes to tracking my daily spending, I’m not as diligent as I used to be. That’s due in part to laziness and part to the lack of necessity. Let me explain.

First, this topic was inspired by a recent email I received from a Consumerism Commentary reader. Nat asked: How do you keep track of all minutiae of sending? Do you charge everything on your credit card? All the little daily things. And then review your bill periodically? Or do you keep receipts? Jot it down?

Flashback to the 20th century. I had played with programs like the Microsoft Money free trials before so I was familiar with the notion of tracking spending with the intention of finding opportunities for improving my financial management. I was also familiar with my personal need to do something; I had a job but nothing in the way of savings to show for it. I did, however, have increasing debt.

It wasn’t until 2002 when I was out of work for a short time did I finally knock some sense into myself. Without spare funds to buy Money or Quicken, I downloaded the free (at the time) Moneydance and began tracking my expenses. I didn’t get very far right away, however.

When my monthly reports showed “Cash Withdrawal” as one of my largest expenses, I knew I wasn’t getting the information from the software necessary to make decisions about my finances. I knew what I had to do—I had to track every expenditure, even if I used cash.

I changed my methodology moving forward. I created a tracking account in Moneydance called “Cash.” When I withdrew money at the ATM from my checking account, I recorded it in the software as a transfer rather than an expense. Then when I spent that cash, say at the cafeteria at my new job or at the movies, I could list the transactions as outflows of cash, categorized as “food:convenience” or “entertainment:movies.”

For this to be successful, I had to be very diligent, almost (but not quite) obsessive. It was actually a very simple process. I would ask for receipts for everything and save the receipts in my wallet. At night I would dump my wallet onto the table and enter the day’s expenses, whether paid by cash or credit card, one by one into the software.

I’m saying that this is “not quite” obsessive. If I had been obsessive, I would have written down every purchase for which I could not be provided a receipt. I relied on my memory for many expenses, and I was usually able to do so because I opened Moneydance every evening.

I used the knowledge gained from tracking the minutiae, as well as from discussion boards like The Motley Fool where I learned about cash-back credit cards among other financial tidbits, to make better-informed decisions about spending and saving.

This continued for a while. As the availability of cash back credit cards increase, more and more of my spending was electronic. Eventually, I switched from Moneydance to Microsoft Money and finally Quicken to take advantage of more features, such as the automatic reconciliation of credit card transactions with the bank’s information, but the process remained fairly the same.

As the next few years progressed, I was managing to net anywhere from one thousand to several thousand dollars each month. That’s mainly due to increased income from a variety of sources, but also due to smart spending. I went without anything but the basic cable television for a while, I kept my rent expense low even when I was living alone, and I made sure I had a reliable car that did not guzzle gas and required little maintenance. For much of that time, I had no car and made use of public transportation almost exclusively, and even in New Jersey, that wasn’t easy.

In a few short years, I went from spending more than I was earning to just the opposite. And for the most part, the difference between my income and expense was large enough I wasn’t in any immediate danger of increasing my debt to pay for necessities. At this point, tracking every single cash expense is not worth the effort. I still collect my receipts, particularly for anything that may be a business-related expense, purchases with the possibility of being returned if defective, or large expenses in general. The receipts generally get filed away.

Every few days, I open Quicken to enter transactions. Now I rely on my memory for a large portion of my cash expenditures. I don’t fret over whether I get something exactly correct or if I miss something. I generally round up when figuring my cash expenses, so that pay make up for forgotten transactions.

This does affect the accuracy of my monthly financial reports, but the purpose of these reports has changed over the past few years. At first, I needed to know with good accuracy where my money was going in order to find ways to chip away at it from different angles. Now, I look at the big picture: how are my investments performing, am I seeing a decline in business income, how big of a vacation will I be able to afford, etc. This information and the decisions based thereon are not affected by the $7.00 I spend at the office cafeteria. I still try to account for everything, but I’m past the point of pseudo-obsession.

Photo credit: PPDIGITAL

Ethanol: a study of unintended consequences

As recently as two years ago, ethanol was considered by many to be the solution for this country’s reliance on imported oil. Ethanol can be produced domestically, and it costs no more to make a car that runs on ethanol than it does to make a car that runs on gasoline. Following Brazil’s example with sugar cane, farmers began converting their corn crops into ethanol for use in automobiles.

Like this 2006 story from 60 Minutes, not many people were considering some of the downstream effects of using food crops for other purposes. The Earth Policy Institute provides a good example how ethanol has been a victim of the “law of unintended consequences” through two of its articles, separated only by time and events. In 2005, the institute praised efforts to promote ethanol.

Agricultural residues, such as corn stalks, wheat straw, and rice stalks, are normally left on the field, plowed under, or burned. Collecting just a third of these for biofuel production would allow farmers to reap a sort of second harvest, increasing farm income while leaving enough organic matter to maintain soil health and prevent erosion. The agricultural residues that could be harvested sustainably in the United States today, for example, could yield 14.5 billion gallons of ethanol—four times the current output—with no additional land demands.

The organization does not hold this opinion today. Earlier this year, the Earth Policy Institute called ethanol production “the beginning of one of the great tragedies of history.” This opinion is fostered by the unintended consequence of the popularity of and demand for ethanol. The prices of food worldwide are sharply increasing.

From 1990 to 2005, world grain consumption, driven largely by population growth and rising consumption of grain-based animal products, climbed by an average of 21 million tons per year. Then came the explosion in demand for grain used in U.S. ethanol distilleries, which jumped from 54 million tons in 2006 to 81 million tons in 2007. This 27 million ton jump more than doubled the annual growth in world demand for grain. If 80 percent of the 62 distilleries now under construction are completed by late 2008, grain used to produce fuel for cars will climb to 114 million tons, or 28 percent of the projected 2008 U.S. grain harvest.

Moving father down the chain of cause and effect, rising prices of food staples are “translating into social unrest.” Across the world, protests and demonstrations are increasing. While originally studying Brazil’s success with ethanol, these consequences were not anticipated.

Unintended consequences in your life

On a more personal level, the law of unintended consequences is present. Often, unintended consequences arise as a result of ignorance, error, or immediate gratification. Using credit to fund purchases beyond the level of affordability can have unintended consequences, fueled by ignorance. In this case, the consequence can be a lifetime of debt. Certainly this was not the predicted outcome when signing up for the first credit card offer. Immediate gratification can result in unintended consequences when dealing with credit as well.

The decision not to fund an emergency plan can have unintended consequences. Without the obligation to create an emergency fund, you have more cash available for spending—even if all you spend money on are necessities. But all other things being equal, it’s easier to divert $10 a week to a high-yield savings account now than it will be do scrounge several thousand dollars for vehicle repair, a hospital bill, or emergency house maintenance later, if you don’t have a buffer.

Here’s another example. Let’s say you have two job offers. One offer includes a $100,000 annual salary, long hours, responsibility, and growth prospects. The other offer is a $60,000 annual salary and a more manageable work-load, and a more enjoyable and emotionally fulfilling career. Many people will take the $100,000 salary, no questions asked, and “learn to deal” with the feeling.

There could be unintended consequences to this decision. Yes, you may move up the corporate ladder faster, but perhaps the stress will take a toll on your health. The high-powered career and resulting stress may knock a decade off your life span, providing you with ten years less to enjoy with your family. The desire for more money, more recognition, even more freedom, satisfies immediate gratification, one of the causes of unintended consequences.

What can you do to prevent unintended consequences?

Not all unintended consequences can be avoided. Many smart economists never expected the increased demand of ethanol to cause a deathly stampede in Chongqing, China.

No matter how much you go over a decision, considering its effects, it’s unlikely you’ll think of everything. It might help to staying away from instant gratification and short-term satisfaction that conflicts with long-term growth. Educate yourself about your situation so you can make your decisions as complete as possible.

Taking the example of the first credit card with the consequences of years of debt, when signing up for the card. you might have known you’d be in debt. The knowledge may have only been on a superficial level. The number of years it may take to pay back your debt at a particular interest rate and a particular monthly payment is a piece of information that will help you understand your decision on a deeper level. It may be this deeper knowledge that prevents unintended consequences.

Image credits: r-z, @aius

Almost 3 million children in the United States have learning disability (LDs). Different types of LDs have different effects on a child’s ability to perceive, comprehend, and interpret information, and these effects can last into adulthood. For example, dyslexia and dysnumeria can make financial calculations difficult, and temporal problems can lead to a tendency to pay bills late.

Arlyn Roffman, Ph.D. is an active psychologist who specializes in young adults with LDs. She presents a number of suggestions for parents interacting with middle and high school-aged children to help overcome financial and consumer struggles due to learning disabilities.

1. Orient your child to a variety of types of stores. As you visit grocery stores, department stores, pharmacies, etc., discuss the layout of the stores with the child. Allow them to help find the products you intend to buy by looking for the posted signs and similar items.

2. Help your child learn the sizes of the shoes and clothing she wears. Dr. Roffman indicates that many parents continue choosing clothing for children with LDs beyond the point the parents would stop and allow the children to choose otherwise. As children grow up, they should be allowed to express their personalities and start defining their own “image” through clothing like their peers.

3. Discuss tipping with your teen. Charts and calculators are available to help determine the percentage of a bill for tipping. If a child is involved in the tipping process when dining out with his family, he will likely be more comfortable when placed in these situations without parents as he becomes more independent. Also discuss the “going rates” for other service providers, like bellhops.

4. Counsel her about credit cards. Some aspects of credit cards are difficult to understand even without a learning disability. Dr. Roffman suggests discussing credit cards with a child once they start receiving credit offers in the mail, but I would suggest starting sooner. Middle school or early high school is probably a more appropriate age. They will have already noticed their parents’ spending habits at this point or have friends who use their parents’ credit cards.

5. Teach your teen about basic contracts. Warn teens against high-pressure sales tactics. Explain how contracts work (cell phone contracts, for example) and pay attention to the details, like termination fees and other traps.

6. Establish a basic budget early in the teen years. If you provide an allowance to your child or if he earns money from working, help him create a spending and saving plan.

7. Encourage her to use a “budget envelopes” book. The “envelope” system of budgeting is a simple method to maintaining a budget. If taken literally by using real envelopes and real cash, the concrete and tactile nature of the activity can be beneficial for a child with LD.

8. Toward the end of high school, teens need to learn how to manage a checkbook and pay bills. Dr. Roffman offers a great suggestion. Children with LDs may find the choice of carbon copy (duplicate) checks more beneficial. Dysgraphia can be a strong obstacle in writing checks, so you can slip in a “cheat sheet” into the checkbook if necessary, including proper spellings of numbers.

9. Help your teen set up a home office at a desk table. This suggestion seems to acclimate children towards working at a desk job, like many people in the United States. It also provides a central location for all the tools of money management, including the checkbook, the computer with Quicken for tracking financial accounts, and a paper file for maintaining records and bills.

Most of the suggestions above work well for children without learning disabilities as well, but children with LDs will face some extra challenges as they grow into adult consumers.

National Dissemination Center for Children with Disabilities
Dollars and Sense: Teaching Teens with LD Consumer Skills and Money Management [GreatSchools]

How are you feeling today? According to a psychologist from the U.K., January 24 is the most depressing day of the year. There’s an actual scientific formula that has been used to determined this fact. Some of the conditions that have led to this conclusion are specific to Britain, but there are seasonal cycles that contribute to this feeling anywhere throughout the winter, which is now, at least in the northern hemisphere.

This inspired me to think about my finances. Does my spending go through seasonal cycles? Checking Quicken, I see that my discretionary expenses do jump a bit from December through March compared to other times of the year. I don’t believe this has to do much with the weather or with therapeutic spending—shopping to make one happy when sad or depressed.

Obviously, Christmas and Hanukkah start the winter and Valentine’s Day occurs in the middle of the season. These holidays lead to more spending, at least for me. Additionally, I take a week-long vacation in February to coincide with my girlfriend’s winter break. (She is a teacher.) So for me, the winter is one of the most expensive seasons.

Perhaps offsetting this spending, I am more inclined to stay inside during the cold winter rather than go out and spend money on outside events like concerts and days spent in New York City.

What about other financial cycles? I wonder if people make worse investing decisions in the winter thanks to turbulent emotions, unpleasant weather, or both.

Image credit: scottfeldstein
Jan. 24 called worst day of the year [MSNBC]

In the next few days, I plan on reviewing my 2007 progress against my goals. However, I need to start thinking about 2008 before I have a chance to compile all the data. One of my biggest plans is to save a higher portion of my income. 2007 was a spend-heavy year for me, and it’s time to return to more basic levels of expense in most categories.

When I lay out my goals for 2008, that will be a primary focus.

Helpful for next year’s planning, Kiplinger has six suggestions for a prosperous 2008.

• Take advantage of higher IRA limits. The maximum contribution to all IRAs combined (in the role of an employee) is $5,000 (or $6,000 if you are over 50 years old). I say, “in the role of an employee” because self-employed people, as an employer, can contribute more to the SEP IRA. I may find that I no longer qualify for a Roth IRA, so while I’m considering a lump sum investment, I may wait before pulling the trigger.
• Stretch your raise even further. Use some of your raise to boost your 401(k) contribution. Now that the Roth 401(k) is available to me, I am splitting my contribution between the new account and the typical pre-tax account. Depending on other income sources, I may try to maximize my 401(k) contribution to the full $15,500.
• Focus on high-interest debt. Interest expense on debt is an unhealthy and in many times unnecessary payment. The only debt I have right now is a student loan. With savings account interest rates shrinking, it would be more beneficial for me to pay off the remainder of my student loan in 2008.
• Start gathering your tax records now. Ever year, my tax calculation increases in complexity. I think it’s time to hire a professional to make sure I’m finding every deduction and not making any mistakes. Many banks provide tax records electronically now, but it’s still important to develop a filing system to ensure everything is readily available.
• Put your bills and savings on autopilot. My telephone bill and cable bill are deducted automatically from a rewards credit card account. I am required to pay my rent by check, so that cannot be automated. My credit card payments change each month, and I cannot schedule in advance without knowing the exact amount. Savings, on the other hand, are easier.
• Protect your assets. I have not been a good protector. I’ve accumulated a fair amount of non-financial assets in the last few years, and particularly in 2007. I do not have a strong renter’s insurance policy to cover everything. This will be one goal of highest importance for the new year.

  6 Moves for a Prosperous New Year [Kiplinger]

I just ran across a cute article by TODAY Financial Editor Jean Chatzky which really spoke to me as a hater of all things mathematical.

According to Chatzky, math anxiety, one of the biggest roadblocks to getting one’s finances together, affects half of all Americans at some level. It can result from any early numerical trauma, from a bad experience in school to overdoing things on your first college credit card. And it’s a recognized condition:

The phobia is so real, it has its own diagnosis code from the American Psychological Association: 315.1.

It’s a serious affliction, Chatzky says, because to do money, you need to do math. To get beyond the fear and into your finances, she offers some useful suggestions:

1. Take a refresher course - Noncredit courses at a local community college are a great way to dive back in. Not only will it improve your skills, but can help you develop positive associations with math.

2. Start a money group – Clubs can help you to overcome a math phobia and increase your learning in a fun, social way. I think investing clubs sound like an interesting way to get information and experience on a topic that might otherwise bore me to tears. Even Finance 101-type topics would be very valuable to me, so I think I need to follow Chatzky’s advice on starting a “money group” among your friends:

At one meeting you might cover the basics of investing, at another you’ll talk about sending your kids to college. This support system can be a huge confidence booster, but more than that, you’ll be able to feed off of each other’s strengths. If your friends don’t go for the idea, you can link up with an existing group in your area by visiting Oprah.com/jean and clicking on “money groups.â€?

I bet that Meetup.com has some groups in my area as well. Just as long as I can make sure I’m not lured in by an advisor with a personal agenda, I think this can be really helpful and enjoyable.

3. Use shortcuts – Calculators and estimating, especially when rounding up, can make things simpler since you’re not manually crunching every digit.

4. Learn by osmosis – Even if you don’t have time to focus on financial topics, listening to a radio show or perhaps some Jim Cramer or Suze Orman in the background might help you start to absorb more information. Personally, I’ve found I burn more calories on the elliptical trainer when Mad Money is on at the gym. If you find you’re more open to reading about finance, the local paper or personal finance magazines at the library are great places to start expanding your knowledge.

5. Set your kids on the right track – Discuss math at home so that you help future generations of your family to be more financially confident. Real-life examples help you monitor your progress towards financial goals as you educate.

Have math anxiety? It might hurt your finances [Today Show at MSNBC.com]

Image Credit: Silence of Night