The equity curve is the single most important financial metric to track in order to achieve financial success. It’s more important than your budget. Yes, even The Budget Boy openly admits there is something more important in personal finance than keeping a budget. Of course you should always be keeping a budget, but that alone will not ensure your success. Armed with only a budget by itself, you don’t know whether you are truly making progress or not.
Tracking your equity curve trumps all other financial tools and metrics because it is the final result of all financial decisions. If the Finance & Accounting department in the Business of You wanted to know their most important function, tracking your equity curve is the answer.
What is the Equity Curve
Equity curve is a term more typically used in trading. In personal finance, it is more commonly described as a net worth tracker. I find equity curve to be much more succinct. Regardless of the moniker used, its purpose is exactly the same — to provide a graphical representation of a person’s net worth, or equity.
Net Worth = Equity
A stock trader must measure the performance of his portfolio. By plotting the total portfolio value over time, one can very clearly see where upswings and drawdowns occurred. Most importantly, it shows which way the portfolio is trending.
While the stocks you bought can “only” go to zero, your net worth isn’t given the same luxury. A report by Credit Suisse estimates that 25% of Americans have a negative net worth. That’s terrifying, yet at the same time completely unsurprising as 68% of college grads enter the workforce with student loan debt at an average amount over $30,000.
No matter whether your net worth is positive or negative the focus should be on the direction it’s moving, which means that your net worth at a single point in time is much less useful than knowing it over time. If Jenn calculates her net worth today to be $40,000, is that good or bad? If her net worth was negative two years ago, then that’s fantastic! But if her net worth was $150,000 two years ago, her current trajectory is heading towards financial ruin.
Do you know if your net worth is in an uptrend, downtrend, or trading sideways?
Why Track Your Net Worth
Just as it is imperative for the stock trader to measure his portfolio’s performance, it is absolutely vital for us to measure our net worth. It is the accumulation of all the little financial decisions that are made on a daily basis. Are you staying on budget? Growing your assets? Paying down debt?
The equity curve reflects the net sum of all those actions in one place. It is your financial scoreboard. Keeping score is essential for measuring progress. If you play golf and never keep score, how would you know how well you played? You would be relying on intuition, which is often deceiving because it’s based on emotion. We remember one really good drive and one really bad approach we chunked into the water. If we’re not keeping score, it’s easy to forget that the bad shot actually costs us two strokes and we still have to hit the same shot again.
Our feelings register the quantity of positive and negative emotions but struggle to register their weight. This month you may have won a $50 gift card card at work but also needed a car repair that cost $400. One gain, one loss. Feels even on an emotional level but obviously a net loss. The equity curve forces you to come face-to-face with your financial decisions, which may be pretty scary for some. But the devil you know is better than the devil you don’t know.
How to Calculate Net Worth
The equation for net worth can very easily be derived from the accounting equation:
Assets = Liabilities + Equity
Equity = Assets – Liabilities
As stated above, net worth is equal to equity:
Net Worth = Assets – Liabilities
Assets are things of value that you possess, such as cash, checking/savings accounts, property, investment accounts, retirement accounts, etc.
Liabilities are things that you are responsible for paying, such as mortgages, car loans, credit card balances, student loans, taxes that are due, etc.
By simply adding up all your assets and subtracting all your liabilities, you get your net worth at a single point in time.
How to Track Net Worth
There are apps for everything these days, but I am a spreadsheet advocate. The goal is to take control over our personal finances and a spreadsheet gives us total control over our method.
Using either Excel or Google Sheets, create a spreadsheet where you:
- List every asset and liability account
- Input the balance of each account
- Update at pre-determined intervals
- Plot the equity amounts on a chart
This simplified balance sheet lists the most typical asset and liability accounts. You may or may not have certain accounts and there are many potential accounts not listed here. But this gives a visual idea of how to easily track your net worth over time, which can then be made into an equity curve chart. As you accumulate more and more data, the chart tells a better and better story.
Manually updating the balance of each account on the balance sheet helps us understand the nitty gritty of net worth changes. In the sample, we can see that debt is being paid down while savings is also decreasing (likely to pay the debt!), but overall equity is increasing. By “touching” each account, we absorb the information better and build discipline. Discipline is a skill necessary for proper financial management. Lack of discipline is the main reason people struggle financially.
How Often to Track Net Worth
I recommend updating your equity curve once a month. Once a month is ideal because it aligns perfectly with a monthly budget, which itself is ideal because payments for mortgages, car loans, student loans, credit cards, cable, phone, etc. are all monthly bills. At month end, you review your monthly budget to see where you stayed on track, where you didn’t stay on track, and get the immediate feedback of seeing its impact on your net worth. This allows you to instantly apply the information by tweaking the next month’s budget as needed.
Companies do quarterly reporting but that is way too much time to get feedback in personal finance. If you prefer a different updating interval, I would suggest twice a month as the second best option. The problem with updating multiple times a month is that the information becomes less valuable due to timing. Many people are paid biweekly, so the dates constantly change from month to month.
The significance comes from looking at the month-over-month performance. Bimonthly updates with specific dates such as the 1st and 15th of the month allows for more frequent feedback while still being able to see the monthly impact.
The equity curve forces you to manage your assets and liabilities rather than just your income and expenses. It is your financial scoreboard, the accumulation of all financial decisions you make (and the fluctuations of market investments). By tracking net worth in this way, the impact of your transactions truly sinks in. For instance, you may be paying student loans every month but do you know how much you are actually paying down the principal?
It’s as if your goal were to lose weight and the only habit you created was stepping on a scale every morning and night. By simply taking that action, you become much more aware of all the decisions that you make throughout the day.
Shifting your thinking from a budget mindset to a net worth mindset will get you trending the right direction (hint: up and to the right). To ensure you are in fact trending upward, you need to track your equity curve!