Today we will look at Part 1 of this two part article. Be sure and come back on Wednesday for Part 2.
There is one measure of your financial health that is the most important and the most indicative of where you really are: your net worth. You should check your net worth at least quarterly to measure your financial progress. It is like checking your pulse to determine your current state of health.
How to Determine Net Worth
Net worth is simply the difference between all your financial obligations (debts) and all your assets. You determine it by making a list of all your debts and a list of all your assets and then subtracting to find the difference. The ideal situation is to always have a positive net worth and a growing net worth. A negative net worth or a shrinking net worth are not good signs. The most notable exception to this is when you are elderly. As you draw down on your retirement investments your net worth will come down, but it should remain positive.
A positive net worth simply means that your total assets are worth more than your total debts. It means that if you had to liquidate all your assets (sell them) and pay off all your debts you would have money left over.
Net worth is the valid measure of your wealth. If your net worth is negative you have no wealth. It does not matter how many “things” you own or how nice they are, if the net worth is negative your wealth is a fantasy because if financial disaster strikes you can lose it all and have nothing but residual debt left over. We call that bankruptcy.
An accurate measure of your true wealth
is your net worth.
Let’s say you have $1,562,000 in the bank and $1,500,000 worth of real estate and personal assets. Let us say that your mortgages and other debts are $3,956,000. Here is your net worth:
$1,562,000 – bank accounts
$1,500,000 – real estate and personal property
$3,062,000 – total assets
$0,894,000 – net worth (negative)
You may look very well to do with a very high end home and a million and a half dollars in the bank, but when you deduct the debt you are worth, in financial terms, nothing, in fact you are $894,000 in the hole.
Now for most readers discussing million dollar values may be meaningless. Just remove the last two zeros and you may be more in your own range. A negative net worth of $8940 is not at all unusual today and a negative net worth of much more than that is not unusual either.
There are four simple rules to build net worth:
1. Always spend less than you earn, thereby netting some gain each month.
2. Use this net gain each month to pay down all debt and to save for investments and emergency funds as we discuss in this book.
3. When your cash reserves are large enough consider investing in something that will pay you passive income, such as a sound real estate investment or wisely invested equities.
Avoid incurring future debt by paying as you go. If you do not have cash to buy it, you cannot afford it.
If you follow this four point formula throughout your life you will always maintain a growing positive net worth and you will build true wealth.
On Wednesday we will look at Part 2 of this article.
Wishing you success and prosperity,
Daniel R. Murphy
Helping People Learn to Build Wealth
Wishing you Success and Prosperity,
Daniel R. Murphy
Wishing you well,
Daniel R. Murphy
Educating people for building wealth, adapting to a changing future and personal development.