Perhaps, if you are reading this, you might be in the midst of making some financial decisions. They could be:
- Should I use EPF Account 2 to settle my mortgage?
- Should I invest my bonus first or settle my liabilities?
- Should I invest in unit trust, stocks, or properties?
- Should I buy a new fancier car or a bigger house?
And, the list goes on. You get the idea.
Most people may be overwhelmed by them as a decision either way will move you forward or backward financially. Understandably, many will choose to procrastinate because it will seem to be the “safer” option since many financial decisions can be irreversible.
However, here’s the real problem: How do you make smarter financial decisions if you are not equipped with the right tools to make them?”
Here is a straightforward technique that we believe will be helpful for you to make sound personal finance decisions. The tool is known as the “Return on Net Worth Analysis” or RONW.
What is RONW?
RONW tells you how efficient you are in using capital. It is quite similar to the ROE (Return on Equity) ratio we often look at when analysing corporate financial statements.
Calculating Your RONW
Here is how to calculate it:
Step 1: List down all your assets and its value, including the projected return rate of each asset, such as “REITs − RM10k − 6%”, “Cash − RM20k − 3%”, “Rental Property − RM300k − 8%”, etc.
Step 2: List down all your liabilities, including the effective interest costs, such as “Credit Card − RM5k − 18%”, “Mortgage − 200k − 4.5%”, etc.
Step 3: Calculate the RONW
RONW = (Total return – total interest) / Net Worth
What does RONW Tell You?
If you have calculated your RONW and discovered:
Your RONW is Negative:
It means your net worth will shrink every year. You may start by clearing out debts with high interest rates such as personal loans and credit card debts to ease your financial burden. Then, you may follow up by adding productive assets to further improve your RONW figures from negative to positive.
Your RONW in Positive:
Congratulations! You have more productive assets than liabilities. If your net worth is still small, then, you may continue to grow both your net worth and your RONW. If both your net worth and RONW is significant, most likely, you are wealthy and are enjoying financial freedom.
To Answer Above Questions Using RONW
1: Should I use my EPF to settle my Mortgage?
Let’s say you have RM30,000 in your EPF account 2 and you are considering withdrawing it to clear RM30,000 off your mortgage. Is this a smart financial move? Let’s see. Based on the RONW, we would consider:
Returns from EPF:
RM30,000 x 6.9% = RM 2,070.
Interest Payable from Mortgage:
RM30,000 x 4.5% = RM 1,350
If you withdraw EPF to clear mortgage, we would save RM1,350 in interest payment but will forgo RM2,070 in EPF dividends. Thus, you would net out RM720 per annum if you go for it. Hence, the answer is a straight “No” based on the RONW formula.
2: Should I Invest or Settle my Liabilities?
First, it depends on how good you are as an investor and what liabilities you owe currently.
For instance, let’s say, you are a good stock investor who knows how to make 6% dividend yields from your stock investments. You have the following debt such as credit card debt of RM10,000 where the interest rate is 18% and PTPTN loan of RM10,000 where the interest rate is 1%. Today, you are given RM10,000 to either invest in stocks or pay off any of the two debts mentioned. What should you do?
The answer is obvious. You pay off the RM10,000 in credit card debt because its interest rate is higher than the 6% dividend yield from investing in stocks.
But, if there’s no outstanding credit card debt, then, you may invest in stocks that pay 6% in dividend yields as it is higher than the 1% interest charged by your PTPTN loan.
3: Should I invest in Unit Trust, Stocks or Properties?
Your investment objective is to maximise your RONW safely without taking unnecessary risks. So again, it depends how good you are in investing in unit trusts, stocks and properties. Some seasoned investors go all out to invest in stocks and properties.
4: Should I Buy a Fancier Car or a Fancier House?
Let’s start with a fancier car. Apparently, a car depreciates over time. But, the amount of your car loan and interest payment will increase after you’ve purchased or upgraded to a new fancier car. So, should you refrain from getting a brand new car? If you are now into improving your RONW, then, don’t do it. But, if you are not, then, you may go for it if it makes you happier.
Meanwhile, a fancier house might not affect your RONW as severely as having a more elegant car as properties appreciate over time. Nevertheless, you will still end up with lower RONW after upgrading to a bigger house.
Again, there is nothing wrong with upgrading your home as it does bring more joy to your family. RONW is a measurement of the efficiency of your capital and not the level of your happiness.
In conclusion, RONW is very similar to the way we look at the ROE of a company. Value investors love to hold shares of stocks with high ROE because that shows the efficient use of shareholder’s fund. On the personal level, if you know how to maximise your RONW, you will be doing way better than 95% of the population.
About the author
This article is co-written by KC Lau and Ian Tai.
Ian Tai is a Dividend Investor. Financial Content Machine. Producer of 200+ Articles, Weekly Host and Presenter at KCLau.com. Co-Founded DividendVault.com, an online educational membership site that empowers retail investors to build a stock portfolio that pays rising dividends in Malaysia and Singapore.
KCLau is a financial educator, having published seven books including the current bestseller Money Smart, and co-created a dozen online financial courses. He gives away his popular Money Tips e-book volumes free at his website: https://KCLau.com
