It is very simple to build wealth in theory but it is much difficult to pull off the wealth-building process in practice. The simple rule for financial stability is to ensure that your income is more than your expenses— you’ll do well to save up and invest the difference between your income and your expenses.
However, the philosophy of focusing on income and expenses has made many people to become fixated on increasing their income or reducing their expenses in order to build wealth. Nonetheless, building wealth goes beyond having a high income or being frugal with expenses. The key to actually building wealth is to build your net worth because it provides a more accurate and realistic snapshot of your wealth.
What is your net worth?
You net worth can simply be defined as a measure of your assets minus your liabilities – you can think of your net worth in terms of the things your own less the things you owe others. A more comprehensive view considers your net worth to be the value of things that put money your pocket minus the value of things that take money out of your pocket. Interestingly, the net worth can also be a negative number if the value of the things you owe is more than the value of things you own.
How does your net worth determine your wealth?
Being wealthy is not necessarily a number games because you might earn a six-figure income with millions of dollars in your account and still be in debt. Being wealthy simply means having more money than you really need at any material time. Your net worth shows how much money you own in assets and cash whereas your income only provides insight on how much money you can expect to have at regular intervals.
To calculate your net worth, you’ll need to take some time to review your finances objectively. You can start by adding up all the value of your cash and your money-equivalent assets. Ideally, you’ll total up your savings accounts, checking accounts, retirement accounts, investment accounts and cash in your wallet.
You’ll also need to add up the value of your physical possessions such as a house, cars, jewelries, electronic devices, furniture, and collectible. Miguel Farmer, an analyst at Weiss Finance observes that “when adding you the value of your physical possessions, you’ll need to use the price at which you can sell the items today and not the price at which you bought the items.”
You should then go ahead to subtract the total value of your debts from the total value of your assets. You can know the value of your debts by calling up a copy of your credit report and add up all the payments due on the report. You should also remember to add soft loans from family and friends and other miscellaneous financial obligations you have.
Here’s how to increase your net worth
Your financial stability and well being is a function of your net worth—you’ll have healthy finances if you have a high net worth and you’ll be a few hundred dollars away from debt if you have low net worth. To increase your worth, you’ll need to find ways to increase your assets and work on reducing your debt at same time.
To increase your assets, you should consider pumping up the money you put into your 401(K) or IRA accounts. Increasing assets via traditional retirement accounts is a smart way to increase your assets because they money will grow tax-free. In addition, the money you put into your retirement accounts are tax deductible.
To reduce your debt, you should start by paying off your high interest debt such as credit card debts first. Paying down debt will help you save up more money (in the form of interest) that you can apply towards building your assets.