There are two ways to increase one’s net worth: increase assets or decrease liabilities. That is all there is to it. It really is a simple equation in principle but very difficult in practice. That is because we are conditioned by the media, our friends, and many other external influences to think that we need this or that such that when we spend our hard earned money on these items, we really aren’t doing anything to increase our net worth.
Why Track Net Worth?
Tracking your net worth gives one an idea of financial progress. It is calculated by adding up all of our assets and then subtracting the sum of all of our liabilities. The resulting number is your net worth, which can be positive (meaning you own more than you owe) or negative (which means you owe more than you own.)
One number by itself may not mean much (unless your net worth is several million). But being able to follow the trend can help you determine if you are improving your financial situation or not.
Now I am not one to track my net worth on a monthly basis since I don’t want to get caught up in the noise of fluctuations of asset values or debt totals that can occur in the short term. But I do have times when I am forced to list out all of my assets and their values along with my total liabilities to determine my net worth. Usually this is related to a business loan although in February of this year, it was for a different reason.
With that said, I had to list out the information this past weekend and I am pleased to say that the net worth is up again. I will probably write about it in more detail over at Cash Flow Mantra. However, I did want to make a few comments regarding assets and liabilities.
Understanding Components of Net Worth – Assets And Liabilities
To fully understand the importance of net worth, we have to look at both assets and liabilities and see how they both affect our bottom line.
What Is An Asset?
An asset is anything that you own which has value, although I prefer the interpretation that an asset is something that puts money into your pocket. For now, I will go with the banking definition. For me, my assets did increase mainly because I kept contributing to various savings vehicles such as retirement and college savings accounts. Even though stocks have taken a hit recently, the overall value was up because of the increased contributions. I also count the house, car, and some personal property as assets.
So in summary, your assets include the following:
- Investments (both retirement and non-retirement)
- House (fair market value)
- Car (fair market value)
- Personal belongings – examples include clothing, electronics, furniture, etc. (fair market value)
- Baseball card collections
What Is A Liability?
Typically, banks consider liabilities as debts and other obligations for one’s cash or assets. I like the cash definition that a liability is anything that takes cash from your pocket. So even though the house is an asset in the bank’s view, for me, it still takes a lot of cash out of the budget for such things as the mortgage, taxes, insurance, and maintenance. It is clearly not very liquid and can’t readily be used to fund any sudden expenses.
I have also been trying to not add any debt and make extra payments to start paying off some credit card debt. This is the main reason that I was able to increase my net worth since February. I have been able to decrease my overall indebtedness. Every time I make a payment and don’t use my credit cards, I am able to increase my net worth. I am actually quite surprised by the amount of debt reduction in just these past 3 months.
In summary, your liabilities include the following:
- Credit card debt
- Car loans
- Student loans
- Personal loans
How To Decrease Liabilities (And Increase Net Worth)
Decreasing liabilities can be a great way to increase net worth. The benefits are several:
- A decreased balance to available credit can increase a credit score
- The improved credit score might lead to improved interest rates on future borrowings
- Paying off debt is tax-free
- Return on investment when paying off debt is guaranteed
- Decreased debt service payments can improve monthly cash flow
- Decreased debt leads to less emotional and mental stress which is good for health
- More freedom in life – can afford to take a lower paying job that you love
- Potential for financial independence
Obviously, I am feeling pretty good this morning knowing that I am heading in the right direction. It is encouraging to see the results of the efforts that I have been making.
Action Steps For Increasing Assets And Decreasing Liabilities
What are some steps you can take to improve your net worth? Here are a handful of ideas to get you started:
- Start saving: the more you save, the higher your assets will be. When you add interest into the equation, your assets will grow faster over time. You can do this effortlessly with Digit.
- Start investing: same idea here as saving above. The only difference is the potential for greater growth of your assets. Get started quickly and easily with Betterment.
- Put extra towards debt: the more you can put towards your debt, the more your liabilities will decrease.
- Question spending: before you run out and buy that cool new item, think about it. Do you really need it? Will it really help you succeed long term? The more you question your spending the more money you will keep and can use to save or pay off debt.
- Be patient: your net worth isn’t going to skyrocket overnight. Unless that is if you find some ways to illegally make money. For most of us, it will take time. Be patient and let it grow over time.
Do you track your net worth? If not, I would encourage it. It may be disappointing at first, but seeing where you are can only help you figure out where you need to go and how to get there. I would also track it only every 6 months or so since there will be some good months and bad months. I would hate for you to get bummed out by the bad and stop tracking it.
One final point just to make it clear – don’t focus solely on one side of the equation, but look at both assets and liabilities when trying to increase your net worth. Over the short-term you will have success when focusing on one or the other, but over the long-term, great financial health comes from focusing on both assets and liabilities.
Readers, what are your thoughts on tracking net worth, assets and liabilities?