4 min read
Net worth is the golden barometer of personal finance. In general, the higher your net worth, the better you’re doing financially.
Many of us even use net worth as a number to determine financial independence. It’s widely accepted that once your net worth is equal to 25 times your annual expenses, you’re financially independent.
But net worth doesn’t always tell the whole story. And for some, net worth isn’t the most important financial metric to track.
Sam the Saver
Consider our friend Sam who is 33 and has contributed $18,000 to her 401(k) account for the past ten years. Supposed her contributions have grown at a rate of 7% each year:
This means Sam has $266,000 in her 401(k) account. Let’s pretend Sam has no other savings, except for $2,000 she keeps in a checking account.
Sam’s total net worth is $268,000. Using the net worth comparison calculator, we can see that Sam has a higher net worth than 90% of her peers:
Simply looking at net worth alone indicates that Sam is doing incredibly well for her age. But does this tell the whole story?
The point of saving money and increasing your net worth is to enhance your quality of life. With enough money in the bank, you can craft a life of freedom. You can decide what type of work you want to pursue, where you want to live, and how you want to spend your time.
Does Sam have freedom?
If she wanted to take a gap year from working, try her hand at freelancing, or take an extended vacation, she actually has very little money available to use. If she does withdraw money in her 401(k) account, she’ll pay a 10% penalty and income tax on the amount she withdraws.
She could use that money for spending, but she would forfeit so much of it to penalties and taxes that it would cancel out a huge chunk of her dedicated savings over the years.
Sam has a high net worth, but not necessarily freedom.
Fred the Freelancer
Consider a different scenario. Fred is a 33-year-old freelance writer who loves his job. He earns $4,000 post-tax each month writing articles for various companies, which is enough to support his family.
Over the years, Fred has managed to save $10,000 in a savings account and $6,000 in a Roth IRA.
Fred’s total net worth is $16,000. Using the net worth comparison calculator, we can see that Sam has a below-average net worth for his age:
Simply looking at net worth indicates that Fred isn’t doing so great financially. But does he have freedom?
He does work he enjoys and has the flexibility of being his own boss. He lives life on his terms and has the power to set his own working hours.
Fred has a low net worth, but a significant amount of freedom.
Cash Flow is the End Game
These two examples are made-up, but they illustrate an important concept. It’s possible to have a high net worth with very little financial freedom. Conversely, it’s possible to have a low net worth and still have the ability to live life on your terms.
Ultimately, cash flow is what allows you to live a life of freedom.
If you save up enough to be financially independent, your cash flow simply comes in the form of dividends or selling your assets to pay for expenses. If you save up $1 million and receive $35,000 each year in stock dividends, that cash flow allows you to pay the bills.
For the average person, cash flow comes in the form of a 9-5 job. You work 40+ hours per week, collect a paycheck every two weeks, and use that cash to pay for your living expenses.
For some, cash flow comes from owning rental properties. There are plenty of people who have a fairly low net worth but a high monthly cash flow from the properties they own.
For others, cash flow comes from running their own business or website. They earn money from selling products or services.
The Pros & Cons
If cash flow is the key to a life of freedom, should you be concerned with your net worth?
It’s wonderful to earn cash flow from a job you love, whether that’s a 9-5 or a freelance position, but this source of income isn’t always reliable. In the case of an economic collapse, you might find that the demand for your freelance work quickly disappears. Or the market might change and no longer need your services. Cash flow is never guaranteed.
Having a high net worth and savings in the bank has some serious benefits. In bad times, you have money set aside that you could access if you need to. Dividends from assets like stocks, bonds, and REIT’s are also fairly reliable long-term. If you’re living purely off dividend income, your cash flow is much more consistent and predictable than if you’re living off cash from your freelancing or side-hustles.
Chase a High Monthly Cash Flow and a High Net Worth
If possible, the best financial decision would be to simply chase a high monthly cash flow and a high net worth.
Strive to have money in the bank, but also work to increase your income streams outside of your day job. If you have income from another source (like blogging or tutoring) combined with some dividend income in a brokerage account, you have some financial freedom even if your net worth isn’t as high as you’d like.
Personally I’m chasing a net worth of $100k or higher over the upcoming months while also building up my income streams outside of my day job. I recognize that cash flow outside of a 9-5 job isn’t always guaranteed, so I’m striving to strike a happy balance between saving money in retirement accounts as well as my brokerage account. I’m on a quest to save money for the long-term with my full-time job while also generating cash flow in the short-term through blogging, freelancing, and dividend income.
A high net worth offers stability and reliability that cash flow can’t always offer. At the same time, cash flow offers freedom to live how you want that net worth can’t always offer. It’s best to pursue both a high net worth and high monthly cash flow to maximize your freedom.
Zach is the author behind Four Pillar Freedom, a blog that teaches you how to build wealth and gain freedom in life.
Zach's favorite free financial tool he's been using since 2015 to manage his net worth is Personal Capital. Each month he uses their free Investment Checkup tool and Retirement Planner to track his investments and ensure that he's on the fast track to financial freedom.
His favorite investment platform is M1 Finance, a site that allows him to build a custom portfolio of stocks for free, has no trading or maintenance fees, and even allows him to set up automated target-allocated investments.
His favorite way to save money each month on his recurring bills is by using Trim, a free financial app that negotiates lower cable, internet, and phone bills with any provider on your behalf.
His favorite micro-investing app is Acorns, a free financial app that takes just 5 minutes to set up and allows you to invest your spare change in a diversified portfolio.
His favorite place to find new personal finance articles to read is Collecting Wisdom, a site that collects the best personal finance articles floating around the web on a daily basis.
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