One of the mantras that we hear a lot in the world of personal finances is “budget, budget, budget.” But is this type of mentality really the best way to build wealth? More and more, some in the personal finance realm are starting to switch to a net worth mentality in order to better define progress on the road to financial independence.
I see a budget as more of a management resource. When you focus on a monthly — or even a yearly — budget, you simply managing your resources. You keep track of your income, and you make adjustments in order to keep your expenses from over-running your income. In this scheme, small amounts — like $10 or $20 — don’t really make that big of a difference. After all, if there is room for it in the budget, spending it on a lunch out or a couple of lattes doesn’t really matter. It isn’t going to mess things up for your budget.
However, I do see value in the budget mentality as a valuable tool to help you learn financial self-discipline. It is also great for getting started in managing your own personal finances. You get used to understanding how cash flow works, and you learn how to prioritize. But I think that once you have the budget down, and you have established a solid foundation, it is time to expand your horizons to a net worth mentality.
Net Worth Mentality
The net worth mentality, on the other hand, forces you to consider things from a long-term standpoint. The net worth mentality goes beyond simply managing your resources month in and month out. Instead, you focus on a plan for building long-term wealth. Sure, with a budget you can set aside money for savings. But with a net worth mentality, you look at ways to grow small amounts of money into larger contributions to your financial independence. The Simple Dollar offers this illustration:
You might not think a change that saves you $10 a month is a big deal from just the view of a monthly budget, but that $10 saved every month over ten years creates quite a different picture – used properly with an 8% annual return compounded monthly, that $10 a month becomes $1,802.12.
I think that nicely captures the difference between a budget mentality and a net worth mentality. If you have a net worth of $100,000, that’s almost 2 percent of your net worth. Consider what would happen if you could make several $10 changes a month, or if you could make some larger changes.
To sum up: Budget Versus Net Worth Mentality
- More of an income management tool.
- Focuses more on the short-term.
- Doesn’t show you the larger picture.
- Great for getting used to disciplining yourself.
- Excellent learning tool for money management.
Net Worth Mentality
- Builds on basics learned from the budget mentality.
- Takes a long-term view.
- Helps you build wealth, rather than manage income.
- Gives you a larger picture of your wealth.
- Tool for helping you achieve financial independence.
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own blog at Miranda Marquit.
I agree about both being tools that serve different purposes. I didn’t realize it until now that my main focus has not been on controlling day to day expenses, but on growing my net worth. Having this long range view is a huge help when it comes to making choices. I personaly like to view a budget from a different perspective. I like to call it a spending plan. Same action and tools, just a different view. It is like dieting. People hate being on a diet and rarely stick to it. When they do, it is for a short… Read more »
“I think that once you have the budget down, and you have established a solid foundation, it is time to expand your horizons to a net worth mentality.”
It can be very difficult to adjust to looking at the very long-term picture (as in, 10 years, or retirement goals), but I agree – that should be the goal.
Sure, but most people don’t even want to think about retirement until they are in their 40’s or 50’s. But, their are advantages to thinking about it in your 20’s and 30’s, but it’s much harder to look at all those negative numbers. Most people don’t have a positive net worth until their later 30’s or early 40’s. Even the financial bloggers that post their net worth don’t publish until they are positive.
Here is an article that I wrote about it
My Next Financial Goal is Getting to Zero
It’s reassuring that I have some net worth due to real estate which I inherited.
Having made so little $ over the years, it was almost impossible to save, except in terms of collecting items that were under-priced, but gained value. A few years ago I did sell an etching once that I had bought for $40 for $1500. So I had a certain degree of “net worth” sitting around. Unfortunately, that contributes to my hoarding tendencies!
I like the net worth mentality and profit mentality. I spend money to make profit and increase my net worth.
I sometimes take exception to people who penny pinch and spend all their time thinking of ways to save money on different things. They talk about how they saved $1 on this item. Meanwhile they spent a few hours doing it.
I like to think of how my time and my money will be leveraged.
My personal view on this is that you need a twin track approach which is flexible enough to cope with the demands of sudden market and economic changes. It’s not always about budgeting but it’s not always about a long term view, more often that not it’s a mixture of the two. Really good summary Pinyo.
My plan is to define my family’s monthly budget and then look for areas to try and cut on expenses. Any cuts in expenses will be used to buy assets to increase my monthly positive cash flow.