Well, I have the perfect prescription my friend.The most important wealth formula is the net worth calculation . Without this, it’s like your bank account is watching the Kardashian Show – just wasting its time.
The equation could not be simpler: Assets – Liabilities = Net Worth
Your net worth is the measuring stick for the wealth you’ve accumulated. It’s the things you own minus the money you owe others. If you owe more than you own, no matter what your salary says, you have a negative net worth (yep – you’re broke). Maximize your assets and minimize your liabilities – piece of cake.
Captain Obvious once told me you want your net worth to be as high as possible. But what qualifies as an asset or a liability? The definition of these two terms is simple, but applying them to daily life can be tricky.
Let’s dig deeper on how the way you use money affects your net worth on your way to wealth creation.
When you owe money to somebody else, that is a liability. Think of buying a car or taking out student loans. They give you a car or money up front, but you are responsible for paying money back to them over time. It sucks the fun right out of your bank account.
Many people spend their lives piling up higher liabilities as their income increases, which is why they never grow their net worth (aka get wealthier). If you minimize your liabilities, you’ll be on the right side of the most important wealth formula (positive!) and on your way to achieving financial independence.
Show me your assets
An asset is something that you own which holds value. More simply, you can trade it for cash or other assets later. Examples include cash, investment accounts, cars and houses (more on this later). The more assets you accumulate relative to liabilities, the wealthier you are.
The problem with some assets is that they lose value over time. A great example of this is purchasing a car. A car is never more valuable than when it’s sitting in the dealer’s lot. Once you drive it off the lot, it loses its value as it gets older and takes on mileage.
Let’s look at an easy example of how buying cars hurts your net worth:
- Purchase a car for $40,000 with a loan
- Make payments on the car each month, immediately increasing your liabilities
- Eventually pay off the whole car
- Rack up 350,000 miles on it, and no one will buy your car
After making all those payments each month, what do you get in return? You have something that gets you from place to place that cost $40k plus interest. The car might have increased your self-esteem and made you SO much more popular, but it did the opposite of maximize your assets. It destroyed your net worth.
What about houses? Those are assets, right?
A house can be an asset because you can sell it for cash. However, it’s a major liability due to the various built-in costs of owning a home like property taxes.
The key for houses is that they tend to appreciate over time, which helps your net worth. If you can sell it for more than what you still owe plus your down payment and the money you’ve put into it (don’t forget about maintenance and those pesky taxes!), it’s a great asset. If the opposite is true, it’s a major liability.
The best way to turn a house into an asset is to use it as an investment property – fix it up, rent it out, and enjoy the cash flow!
Every move you make should build your net worth
The easiest path to wealth creation and reaching financial independence is to:
- Minimize liabilities
- Maximize your assets that grow or sustain value
Assets that historically grow or sustain value include:
- Real estate investments (rental properties, etc.)
- Stock/bond index funds
- Your home (although expenses may trump its value)
If you need help minimizing liabilities, check out how to budget like a wiz. The career building and wealth creation pages on Home at 30 will help you maximize your assets. This page is geared towards helping college students with brand building and loans. If you’re new to investing, I suggest you read about the basics of investing.
Your net worth is your financial livelihood, and that’s why it’s the most important wealth formula you’ll ever find. You’ll never build real wealth if you don’t know what you’re worth.
All opinions expressed on this blog are solely those of Home at 30 and are in no way affiliated with any other organization or institution. The purpose of this blog is to give general education and information about investing, wealth, careers, and college; It is not intended to be professional advice.
Author: Josh Ramos
Josh has paid off $130k in student loan debt in 4 years. By founding Home at 30, he wants to help end the student debt crisis by helping students and young professionals make decisions that will reward them for a lifetime.