One of the most well-known measures of wealth is net worth. Net worth is calculated by adding up the value of your assets (stuff you own) and subtracting that amount from the value of what you owe (debts, liabilities). Here’s an example calculation:
Net worth is $850,000 – $420,000 = $430,000
Now, calculate your own net worth using the same process.
The composition of your net worth is critical
Not all net worth is created the same. Just think of all of the combinations to get to $750,000 net worth. Here are just two.
Is one net worth better than the other? Well, that depends upon your personal preferences.
Sue’s net worth is a simple, conservative approach. Mickey’s net worth, on the other hand, is a complex, risky approach. For starters, Mickey has $3.35 million in debt compared to Sue who has no debt. If Mickey’s real estate properties go up in value by 20 percent, his net worth nearly doubles. But if his real estate properties go down in value 20 percent and rents drop off, he could be bankrupt and his net worth would be wiped out. Also, notice that $100,000 of his net worth is tied up in a car, most likely a depreciating asset.
Here are five tips for improving your own net worth.
- Maintain plenty of cash in case you need emergency money so you won’t have to sell assets at a low price. Also, that cash-on-hand allows you to purchase assets for a low price when the timing is right.
- If you’re a risk-taker, keep the proper balance of risky versus conservative assets. In general, high risk, high reward assets should be less than 10 percent of your overall net worth.
- Most importantly, if you’re a risk-taker, bet well! Try not to make stupid investments with that portion of your net worth. Instead, try to find investments that pay off big time in the longer term. When it comes to making risky investments, quick, big wins are very rare. Longer-term wins are more common.
- If you want to sleep well at night, refrain from borrowing too much money. Too much debt is similar to the risk of trying to get quick wins. For example, having to service big debt payments when your cash flow sources dry up is a bad feeling.
- Don’t forget the power of compounding returns. Time is your best friend. Your net worth will grow the most by contributing consistently into retirement and taxable accounts!
I hope that these tips will help your journey of building a net worth that fits your needs.