How To Measure Growth
What rate of return did your portfolio generate in 2011? As an advisor, I often get asked the question about investment returns. But, as a fee-only advisor, I feel this question is misguided. While investment returns are an important aspect of our overall financial health, they are simply a piece of the puzzle. As a matter of fact, I don’t even know what rate my personal portfolio returned in 2011.
It probably seems a bit odd to have a financial advisor make this statement. Sound like a plumber with a leaky sink? Actually, it couldn’t be farther from the truth. Ask me how much my net worth grew, and that’s a number I know well.
Why is understanding net worth growth important?
Net worth growth is the best measuring stick we have to judge our overall financial health. It encompasses the pieces of our financial world which we can control, as well as our investment growth (or loss). The following areas lead us to financial success (or financial failure): How much we spend, save, and pay in taxes are the pieces we can control and should be viewed, along with investments, when evaluating financial health.
I have seen people with wonderful investment returns who over spend and don’t save. This poor financial behavior is reflected on the net worth statement. If the market is positive but net worth has declined, then I know something is askew. Negative net worth growth usually is the result of one of two scenarios: the market is having a really bad year, or poor financial behavior is evident. To read more about my thoughts on Behavior Finance click here.
Money contributed into retirement plans positively impact your NWS(net worth statement). Reducing your tax liability by becoming more tax efficient should improve your financial situation and is often reflected on a NWS. The ability to spend within reason is always a positive step and will trickle down to the NWS. In contrast, poorly managing the above three items will be caught by the well trained eye of a holistic advisor. That’s right, you can’t sneak anything by me.
This doesn’t mean I am apathetic towards investing, it simply means I am focused on the sum of the parts. Knowing your net worth and understanding your net worth statement is a valuable tool to make sure you are on the right track to financial freedom.