Wednesday, April 28, 2010

My Maths Equation to Increasing Networth!

To me, at my late twenties age, I find that to massively increase our networth, three factors are extremely crucial. They are:
(i) Income
(ii) Savings
(iii) Investments

The three factors above are all equally important. My mathematical formula for gaining networth is:

Gross Gain in networth = Income * Percentage Savings Invested * (1 + Returns on Investments) + Current Networth * Returns on Investments

*Edit: Percentage savings invested as suggested by LP.
In layman terms, it means that the gain in networth is dependent on the percentage of savings from our income, and how we grow this savings and our current networth exponentially via prudent investments.

Let's say, we have the following:
Monthly Income: $4500
Percentage savings: 60%
Returns on Investments: 10% p.a.
Current Networth: $50000
Gross Gain in networth per year = $4500 * 0.6 * (1 + 0.1) * 12 + $50000 * 0.1 / 12 =$40640

* Edit: Why gross gain? Inflation is not taken into account here.

As we can see, tweaking any of the factors above serves to help increase our gain in networth. A high current networth would already give us an advantage of a high networth gain rate. A gain in income will naturally bring about a faster gain. A higher percentage of savings would also gives us a higher gain. Finally, a higher return on investments will grow our nest egg faster!

My comments for each of the factors, other than current networth:

(i) Income
Income here refers to active income. It refers to the income received from our day job, sidelines, blogs (it's active to me), or trading. Income here does not refer to any form of passive income or dividends.

Many times, people put great focus on savings and investments, but neglect the powerful multiplying effect of  income to gaining networth. Percentage savings and investment returns are also multiplier terms... such that an increase in income will result in an equal proportion of networth gain, assuming that the percentage savings and investment returns remain a constant.

For me, I have my main job, I have my tuition sideline, and I earn a little coffee money as well from the advertisements placed on this blog. In addition, I'm starting to write my notes, which I will eventually publish. The target for completion will be by end of next year. These... are my plans to increase my active income for my equation.

(ii) Savings
The percentage of savings invested* is another factor we have to take note of when we want to increase our networth. The higher your percentage of savings, the higher the gain (like duh....).

This is related to (i) in the sense that if our expenses remain constant even when we increase our active income, then the percentage savings will automatically increase! The problem here is that there are some who do not plan and track their expenses. Their expenditure automatically grow to accommodate the increase in active income until it "disappeared" into thin air.

In our quest towards our destination of financial freedom, we have to make compromises to maintain a moderately high percentage of savings. Before an expenditure, determine if it is necessary, or if it is within your budget. The key word here is budget... work within a budget...

For example, my budget for my personal expenditure on food, transport and misc stuffs is $900 a month. I track my daily expenses, and make sure I do not exceed this budget every month. So far, I have been very successful, because this amount still allows me to bring my girlfriend for an occasional "big" meal in restaurants.

*Edit: Percentage savings invested as suggested by LP.

(iii) Investments
This is the final factor of my equation. On top of increasing active income and saving a respectable percentage of total income, investments hold the key to further grow our savings to make sure they are not only not eroded by inflation, but grow further.

The return on investments is a key to how fast we can grow our nest egg. Some believe fervently in capital gains from value investing in undervalued equities. As for me, I believe in investing for dividends, which is an additional source of passive income for me. However, one really needs to be patient as massive returns usually take some time for the compounding to work its magic.

Investments is an extremely big chapter. Equities are only a small portion of it. We have corporate bonds, government bonds, properties, private businesses, as well as personal development, to invest in as well. The whole topic is too big to talk about in a short blog post like this, but the summary is that critical and prudent investing will help catapult us to a higher networth.

In conclusion, we cannot neglect any of the factors. Master each factor well, and make them as high as we possibly can... and we will see our networth gain in an exponential manner.

Of course, if our current networth is already extremely high, active income can be zero, but current networth * return of investments would be more than sufficient to feed us and take care of our basic needs!


  1. For investment part, if get it seriously wrong will destory wealth

  2. Hey mo²,

    Just some thoughts on the robustness of your equation:

    1. What if the savings you did is not all put into investments? Unless you define your % savings as the amt saved purely for investment.

    2. Same thing for current networth - not all the networth that you had can be invested. Some cash cannot be touched, some are not even cash.

    3. Returns on investment for current networth and new portion of savings might not be the same too. Can be higher or lower.

    4. Lastly, I feel something is missing out - the effects of inflation. I tested the eq by assuming that we had zero returns on investment. It's zero, but inflation will erode that amt too. In other words, I mean if the ROI is less than inflation rate, the net gain is actually negative. Unless you define your gain in networth without regarding inflation i.e. gross gain.

  3. Hi CW8888,

    that's true as well. Thanks for your feedback.

  4. Hi LP,

    you are right that it is not very robust. It was a very simplified equation. Perhaps I should have mentioned that on hindsight.

    1) This is very right. My bad. Perhaps I should have used total returns, since banks give interests as well, no matter how small it is.

    2) Extremely true again. Thanks.

    3) I didn't make this clear in my post :(
    I want to mean nett return on investments.

    4) You are very right about the gross gain part. Inflation wasn't on my mind in this equation.

    I shall edit the equation a bit. Thanks!

  5. Hi mo²,

    Well, based on this new version of the equation, there are some new factors to talk about:

    1. How the % of savings invested matters

    2. How earning a ROI of less than inflation rate is not gd enough for your networth

    3. How lowering your debts and not spending so much on depreciative assets can free up your networth that is available for investing. Lighten your balance sheet, so to speak.

    You're quite prompt - just commented and you came up with new version already :)

  6. Hi LP,

    thanks for the idea of a follow up post! :)


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