Let’s face it: we have become obsessed with tracking people’s net worth. Whether it be protests on inequality or the Forbes Billionaire List, we spend a lot of time examining the richest people in the world and their net worth at any given time.
This perhaps has an unhealthy side effect. When we look at these billionaires and read about the fluctuations of their net-worth, it can seem completely out of reach to us. But it’s not. Each and every one of us can gain from tracking our net worth, be it once a year or once a quarter.
What Is Net Worth?
While the 24 hours news cycle may fool us into believing that calculating net worth requires a team of forensic accountants, in reality it is a very simple equation:
Assets – Liabilities.
That’s it! No more and no less, and as we will see – everyone holds both, not just high net worth individuals.
What Are Assets?
There are many types of assets. A simple way to think of an asset is anything under your name that has value and that can be sold for cash. The most common asset to us all is the cash we have lying around as well as the value of our checking and savings accounts. If you hold an investment portfolio, the market value of your portfolio is also considered assets. Be it stocks, bonds, or ETFs –these all fall under assets classification. These are financial assets.
Another category would be real assets. When we think of real assets, the most common examples are cars and real estate. Your home, even with a mortgage still has value and is an asset (we will get to the mortgage in a second). Your car is also an asset with value.
Finally, we get into more miscellaneous items that hold value. This can be jewelry, silver, gold, collectibles such as stamps, and items such as top tier watches.
What Are Liabilities?
Liabilities are our obligations to pay someone else. While it is fun listing assets, its less fun is listing all of our debts or liabilities.
A common example of a liability is the aforementioned home mortgage. It is important to bring up this example to show that not all liabilities are created equal, and while there are bad liabilities that should be avoided, there are liabilities that allow us to get ahead in life.
Most people realistically do not have hundreds of thousands of dollars laying around to purchase a home. A mortgage allows us to buy that home despite not having the cash outright. There is a similar argument for student loans – in many cases the long-term benefit of an education outweighs the cost of that debt.
Other examples of debt are auto loans and credit card debt. It is important to note that all of these loans carry very different interest rates for varying lengths of time. However, when considering your liabilities, all of these should be included in calculations.
Best Way to Increase Net Worth
If you looked at the formula above, it’s not rocket science. You have two options: Increase your assets and/or decrease your liabilities.
Generally, more cash is required in order to acquire more assets. To do that most will have to work or earn more – which is not always an option for those with high liabilities. For many, the easiest first step is to focus on the liabilities section.
Here you must consider your essential debt and non-essential debt. Avoid a high credit card balances, or a balance at all. Along with high interest rates, credit card debt can quickly balloon in cost. Repaying these high interest debts early essentially gives the future-you more liquidity, as that money would have gone to paying interest.
After paying off debt and creating a savings, you can divert cash into investments. Investments will grow your assets over time and at the same time reduce your liabilities. This is the path to grow your net worth.
The act of tracking your net worth puts you a step ahead of others. Like budgeting, it bluntly shows you where the issues are and what needs to be done. It also gives you a sense of accomplishment when you see that net worth number growing.
While once you would have had to do this all manually, today there are apps and fiduciary investment services that plug directly into your bank and investment accounts. Services like Betterment and Wealthfront generate net worth reports along with interactive graphs and other features. Click here to read a comparison between the two services by InvestorJunkie.
The second part of the mindset shift is to start asking yourself before every large purchase: is this object going to help grow my assets or my liabilities?
For example: buying your first car in an area that has no public transport could allow you a greater variety of job opportunities, which could lead to better wages. If you need to take out a loan for this car, the ends might justify the means. On the other hand, if there are plenty of public transport alternatives around, the money saved on a car and expenses could be used to pay off debt or invest.
Putting It All Together
Everyone can increase their net worth. The most important thing is to be conscious and small goals to start. Net worth doesn’t swing wildly month to month, it’s a long-term process.
Instead of obsessing over a celebrity’s or billionaire’s net worth, take inspiration from them. To put it in perspective, most high net worth individuals have multiple streams of income. Remember, even just slowly creating two streams of income will be significantly beneficial to one’s net worth.