On our path to retirement, there are 2 things to keep track of: passive income and net worth.
We track these by examining our financial statement: income, expenses, assets and liabilities.
So what is meant by Passive Income and Net Worth, and why is it important we track these?
Passive Income refers to the portion of your total income that is generated by your assets.
To be free from working, you need your passive income to be greater than your expenses.
Net Worth is a way to calculate your wealth, by subtracting your liabilities from your assets.
Your assets may be stocks, property, etc. Your liabilities are debts you have like loans, etc.
In this article I discuss passive income: what it means and how it’s used for early retirement.
I also talk about net worth: what it means and why it’s important that you keep track of it.
Finally, I explain how you can use my new passive income and net worth tracker for yourself.
So what is Passive Income?
Simply put, passive income refers to income that’s created passively i.e. without you working.
In other words, it is income that is generated from your assets, not from your employment.
Let’s say that you are invested in stocks and have a stock portfolio that generates dividends.
The dividends that you collect is regarded as passive income i.e. income without you working.
Let’s say that you own a property that you rent out that gives you income in the form of rent.
This rental income is also regarded as passive income because you didn’t have to work for it.
Your employment salary is not passive income but active income i.e. you have to work for it.
It is called active income because if you do not go to work for example, you will not get paid.
The goal is to increase your passive income, but not necessarily more than your active income.
So how much passive income do you need to escape from (at least) full time employment?
How much Passive Income do you Need?
There are different levels with regards to how much passive income you would actually need.
The first level of passive income is to increase your income to be greater than your expenses.
Let’s say that your monthly expenses (fixed and variable) amount to a total of around £2,000.
Fixed expenses is the mortgage, bills, etc. and variable expenses are the food, transport, etc.
By having your passive income to be £2000, this means you would no longer need to work.
The next level of passive income is not just covering your basic needs, but all your wants also.
£2000 may be sufficient to cover your needs, but maybe you want an extra £1000-£2000 also.
This would give you enough room to allow you to eat out, go on holidays, buy things, etc.
The more passive income you require, the more assets you would need to create this income.
This is where your Net Worth is: it helps you to monitor all your assets, as well as your liabilities.
What is Net Worth all about?
Net Worth is a phrase you often hear when you’re comparing the richest people in the world.
E.g. Elon Musk has a net worth of $175.5 billion, but Jeff Bezos has a net worth of $114 billion.
From the figures, I can see that Musk is richer than Bezos, but what does this actually mean?
It means that Musk’s assets minus his liabilities, is great than that of Bezos’ (or so we believe).
How does this apply to us: are we supposed to compare our net worth with Musk and Bezos?
Heck no, or else we would be vastly disappointed: my net worth is probably 0.001% of Musk’s.
Instead, you want to calculate your net worth and then compare it to each month, year, etc.
The idea is that you want to grow your net worth each and every month (as best as you can).
To calculate your net worth: subtract the sum of your liabilities from the sum of your assets.
However, that leaves us with one question: what are my assets and what are my liabilities?
What are your Assets and Liabilities?
The first question on everyone’s mind: is your home (that you own) considered an asset?
Some people say yes, some say no. Me personally, I do consider my home to be an asset.
Why? Although it does not provide me with passive income, its value increases every year.
They say that on average, UK house prices double in value every 7-10 years (more or less).
That means that if you bought a home today for £400k, it would be £800k in roughly 10 years.
I don’t know about you, but that sounds like an asset to me, based on its capital appreciation.
However, it is also a liability if you have a mortgage on it, which would need to be paid back.
Other assets you have may be your pensions, stock funds, business, as well as your savings.
Liabilities on the other hand may be your mortgage, student loan, car loan, credit cards, etc.
As your assets go up in value and your liabilities go down, you want to track these regularly.
Track your Passive Income and Net Worth every Month
Once you have an income in mind for retirement, you can track your progress every month.
Without tracking your progress, you won’t know how long you have until you reach your goal.
This is why I’ve created the Passive Income and Net Worth tracker tool for you to use.
By using this tool, it automatically calculates your passive income and your net worth.
Simply input your income and expenses to see your passive income and monthly cashflow.
It tells you the percentage of expenses your passive income can cover and how long to go.
You can also use the tool to calculate your net worth by entering all your assets and liabilities.
Use this resource to track your net worth each month and see if it increases, decreases, etc.
Use this tool each month as part of your monthly finance meeting to quantify your progress.
By tracking your progress on a regular basis, you may be closer to retirement than you think!
If you’re interested to find out more about early retirement, check out: Quit Like a Millionaire.
In the book, the authors talk about how they were able to retire early in their thirties!
To find out more on investing and retirement, check out my investing and retirement articles.
I talk about early retirement strategies, which funds to invest in, and which accounts to have.
Are you on your way to early retirement? Are you investing? Let me know in the comments!
