Let’s talk about financial goals. Specifically, when we say that we want to achieve financial freedom, what does that mean? Do we know what we’re aiming for financially, or are we just shooting blindly?
Let’s take some time and begin painting the target before we try to shoot at anything.
Let’s ask ourselves a question to start. What’s more important: Income or Net Worth?
Now, income is great. Don’t give me wrong. I do my best every day to make a good income. But ultimately, net worth is more important to our financial freedom.
The problem with solely focusing on income is that it’s only one side of the equation. On the other side are expenses. And if our expenses equal or exceed our income, then we can’t accumulate wealth.
For example, say you know a doctor that makes a high annual income. From the outside looking in it appear that he’s rich. He may have all the outward appearances of wealth: a nice house, a nice car, and all the nice toys. But if he spends everything he makes, then he can’t accumulate wealth or become financially free. If you asked this doctor to leave his practice, he couldn’t do it. That option is not available to him. This is because he has nothing left over with which to support himself and his family. He has no true wealth. He’s going to have to work day after day, year after year to support his lifestyle. He doesn’t have financial freedom.
Now contrast that doctor with someone who makes a lower income but way underspends that lower income. Let’s pretend this frugal individual is the doctor’s administrative assistant. This doctor’s admin would have money left over at the end of every year. This admin would be able to save and invest for the future. And those investments, along with the miracle of compounding, would allow the administrative assistant later on in life to leave his job if he wanted to pursue other endeavors. The doctor, on the other hand, would have to continue punching the clock every day (whether or not he liked it).
So we can see that net worth is really more important than the level of income that we have.
However, let’s make something clear. You can’t have a positive net worth if you haven’t earned something to begin with. So income is crucial – it’s just not the primary target.
The primary target is net worth, which equals assets minus liabilities. However it’s not just any kind of net worth that we want. It’s investment assets.
Let me explain that a little bit. You may have a positive net worth if your assets (what you own plus what you owe) are greater than your liabilities (what you owe). However, if all of your assets are tangible items sitting at your house not earning you money, it will be hard for you to grow your net worth. In fact, if these items lose value, your net worth will actually decrease.
Instead, we should strive to have a large percentage of our net worth be investment assets (for example, income producing real-estate, stocks, bonds or the like). These investment assets work for us. They can grow over time and allow us to leave our profession and the daily grind at some point in the future (if we want to). That is true financial freedom. That’s the target that we need to be painting today.
So, let me summarize:
Good = High Income
Better = High Net Worth
Best = High Net Worth with Large Percentage of Investment Assets
In a future article, we’ll talk about the level of investment funds one needs to achieve financial freedom and to leave that sweat of your brow job. This will help us better define the bullseye of our financial target.
One last parting note…. Even though some tangible assets don’t necessarily work for us, they can be truly important in our day-to-day lives. For example, we may have to have a car to drive ourselves to work, or we may have to have a house or an apartment to house ourselves or our families. And those things are important.
While those assets are not making us money and bringing us financial freedom, they are investments of a different kind. They are investments in our life and in the lives of our loved ones. When viewed from that perspective, those investments are extremely important and cannot be ignored in the pursuit of financial wealth. They have to be attended to with care and diligence.
So, as you can see, it’s a balancing act. And mixed in with all of this, we have to consider what truly makes us happy as well. It’s not a perfect mathematical formula, but that’s what we’re working with.