One of the leading indicators of financial fitness is net worth. It’s possible to have a positive or negative net worth, and the higher the number to the positive side of the ledger, the better. The process for figuring out net worth is actually quite simple. The number is arrived at by finding out the difference between assets and liabilities.
Assets do not include income. A person’s or a family’s net income can impact net worth, but it does not automatically turn into an asset. It’s possible to save or spend money. Money can be spent on assets, and money in an investment account or a savings account would also qualify as an asset. Some of the common assets that will show up in a family’s balance sheet are homes, cars and investments.
Liabilities in the net worth equation are debts. The debts can include student loans, consumer debt like credit card bills or car loans and home mortgages. The higher the debt a person has, the more likely he or she will have a negative net worth. Many people will start out adulthood with quite a bit of debt. This will usually arise from student loans or credit card bills. Later in the life cycle, hefty mortgages will add to the liability side of the balance sheet.
Building Net Worth
Building net worth simply comes from watching expenses and adding to the assets side of the ledger more quickly than making additions to the liabilities side. It’s important to measure success as the process goes along. As debt gets paid off, it is likely that net worth will grow quite rapidly, as long as a major market downturn does not cut into the value of investments.
Over time, it’s proven that the stock market has returned higher values than nearly every other investment class. When it comes time to start building up net worth, it’s a good idea to keep small goals in the short term. This allows for an ability to chart small increments of progress while avoiding the frustration that can arise from looking only at the end goal.
To come to the total net worth number, just add the assets and liabilities up in separate columns. (Some assets can show up on both sides of the equation. A home would be an asset, but it would be offset by any outstanding mortgage debt.) Then subtract the smaller number from the larger. If the liabilities side is larger, this indicates a negative net worth. If the assets side is larger, this would provide a positive net worth.
Building net worth takes time, but it can be worth the journey as financial freedom gets closer.
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