It took me quite a while to truly understand it, but cash in your bank account and your net worth dollars are two very different things.
What Is Your Net Worth?
So what is a net worth really? I’m sure you already know that wealthy people have a high net worth and poor people have a nearly non-existent net worth, but how is it really calculated? As opposed to many things in life, the net worth calculation is actually very simple.
Net worth = Assets – Liabilities
In other words….
Net Worth = What you own – What you owe
Here’s an example of a typical person’s net worth calculation:
They own a house, a couple of cars, have a meager savings account, a decent start at a retirement fund, and then they have the typical debts: student loans and some credit card debt.
All combined, these people that own a $300,000 and a $40,000 car are really only worth $8,000 all combined?
And the sad thing is, this is the typical story. And it’s because people are much too focused on their income and somehow forget all about their actual worth.
Put simply, they buy too much crap with debt.
Is It Truly Growing?
Is your net worth growing? Do you know? How can you find out?
Let’s take a look at the net worth example table one more time. And let’s add one more column for our estimate of what these items will be worth a year from now, and also what we’ll owe on them a year from now.
As is typical, you can expect the house to grow in value and for your debt balance to go down from year to year, meaning your equity in your home will increase and help grow your overall net worth.
But now let’s look at the other (uglier) side of the net worth equation above. Those stupid cars.
This family decided that they wanted to look uber-wealthy and drive in style with their brand new Chevy Impala with all the bells and whistles. While they might look cool to their neighbors, their buddy “Net Worth” thinks they’re idiots.
They bought the Chevy Impala for $40,000 and took out a $38,000 loan to do it. Before they left the lot, they had equity of $2,000.
One year later, if they tried to sell this very same car (with just a few thousand more miles), they might be able to get $32,000…if they’re lucky. But, they still owe $35,000 on the car note. Their new net worth on this car? Negative $3,000….
After one year of consistent payments, their car actually dragged their net worth down by $5,000.
So did their net worth grow in the above example? Yes. But it was purely because of their house.
What Will Your Net Worth Be in 10 Years?
If you want to be truly wealthy, you’ve got to start thinking about the distant future – at least 10 years in advance.
Will your $40,000 car increase your net worth? Nope – it will almost certainly hold you back.
If you want your net worth to rise (and rise substantially) over the next 10+ years, focus on assets that grow in value:
- Your primary residence
- Rental property
- A business
- Your retirement fund
Focus On, And Grow, Your Net Worth
If you do absolutely nothing to grow your net worth over the long haul, you’ll likely retire with little and be forced to live frugally for the rest of your life. No vacations, no charitable giving, and certainly no extravagant purchases for yourself.
If, however, you’d like to actually live and give in your older age, then your net worth and its growth should be very important to you.
Need a gauge to see how well you’re doing? The average millionaire has 7 sources of income. Regular work income, rental income, interest income, dividend income, side business income, and a few miscellaneous sources.
Is it time for you to step it up and grow your net worth?
Want yet another gauge of your net worth? Check out this popular article I put together a few years ago: Net Worth by Age – How Do You Rank?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.