Growing Your Net Worth

Growing Your Net Worth

Recently, I read an article about a couple living in New York who has a combined annual income of $500,000, which is way above the median income level there. You would assume that the couple’s net worth is quite substantial, but you would be wrong. The reason is because they hardly have any savings. We sometimes judge wealth by somebody’s monthly income; but in actuality, your wealth is tied to your net worth.

Your net worth is the most important number to focus on if you ever want to reach financial independence. There are so many stories of high-income families that end up saving very little every month, so that’s why it’s important to focus on net worth and not how much you make. Don’t make the mistake of equating high income to being wealthy.

As you make more money over the years, be sure to keep a tight lid on spending. Living below your means is the best way to increase your net worth. You want all that extra income to fall straight to the bottom line; you can then save and invest that money and watch it grow! Often times, our spending increases alongside our income, which is called lifestyle inflation. How successful you are in resisting lifestyle inflation can make a huge impact on your ability to retire early.


The Difference Between Assets and Liabilities

Many years ago, I went to a financial planning conference to hear Robert Kiyosaki talk about his book Rich Dad Poor Dad. He stressed the difference between an asset and a liability. One notable thing I agreed with was his emphasis on the importance of generating passive income.

I believe that most people is savvy enough to know that if your house is worth $400,000 and your loan is $250,000, the part that you own — or the equity you have — is $150,000. The equity value of your house is what you own, after deducting the mortgage from the value of the asset.

Home ownership can be a significant contributor to the growth of your family wealth over time. Of course, you should be aware of the costs of home ownership and not stretch yourself just to buy a home. You should strive to accumulate more assets over time, but also recognize that any loans or debt against those assets need to be deducted before you calculate how much equity you have. History has proven that real estate is an appreciating asset over long cycles, and I believe it is definitely something worth investing in.


Run Your Household Like A Business

I’ve previously discussed the importance of having a financial budget, and the significance of running your family finances like a company. Every company needs to have a balance sheet. List out all of the assets that you own; including money in bank accounts, brokerage accounts, home, car, etc. Then list out all your liabilities; including mortgage, auto loans, student loans, etc. By subtracting your liabilities from your assets, you will derive your equity — or net worth.

The reason why your net worth is so important is because it represents the total assets you own after paying off your debt. I don’t believe all debt is evil. If utilized responsibly, debt can be a beneficial and significant tool to enhance investment returns. Most successful real estate investors take advantage of debt financing to buy properties when prices are attractive. But similar to a company, too much debt can create a stressful financial situation for the owners.

In general, only use debt to supplement a worthy investment. Do not use debt to upgrade your lifestyle. For example, I wouldn’t recommend taking out an auto loan. If you don’t have the cash to buy the car you want, then don’t buy it. The car you can afford may not be your dream car, but at least you’re living within your means. Similarly, don’t use your home equity line of credit to pay for a vacation. Debt has a way of making you feel like you are wealthier than you really are — so be wary and use it wisely!


Improve the Performance of Your Assets

As you go through the process of building a balance sheet, take this opportunity to evaluate how each asset is performing. As obvious as this may sound, cash sitting at the bank does not give you a great return. In fact, if inflation is increasing at 2% a year and the annual interest rate you are getting is only 1%, you are actually losing real purchasing power. Essentially, things that you can afford today may be out of reach in the future as prices go up faster than the interest you’re getting from the bank.

Always analyze how you can improve the performance of your assets. In other words, don’t keep too much cash in the bank unless you have an immediate need for it. I recommend keeping in your bank’s checking account an amount that equates to around six months of your household expenses. That should be enough for an emergency fund in case something unexpected happens.

It’s important to make short-term and long-term forecasts of your net worth. Accurate tracking of changes in your financial well-being and goal setting is vital for anyone trying to reach financial independence. At the end of every year, compare the value of your net worth to your forecast. Did your net worth increase as much as you had anticipated? Closely monitor how your assets are performing and decide if you can improve the return. If you’re not satisfied with what you’re seeing, then it’s time to implement some changes. Having defined goals will make your financial dreams seem more real and obtainable.