Last updated on February 1st, 2021 at 08:33 am
When I was in my early 20s in college my primary focus was to have sufficient funds for school, living expenditures and monthly expenses. I was lucky to keep my monthly expenses down to remain free of student loans. It was no simple task and had to work 2 jobs to accomplish it while being a full-time student. After college, I concentrated on my career and at the time lived in a city that was not the most rent friendly. I was trying to learn how to traverse the financial landscape but I realized that if I did not use my money wisely to invest in my overall wealth, I would be stuck in this endless cycle of breaking even and never raising my wealth. I buckled down on my budgeting and focused on improving my net worth. Below are 6 things I learned on how to build your net worth.
Know your Net Worth
Before diving into how to boost your net worth, it is vital to know what net worth is and why it is necessary.
The simplest definition of net worth is a sum of all your assets such as your retirement funds, investments, and total asset value minus all debt such as loans, and credit cards. The number left is your net worth.
Total Assets – Total Debt = Net Worth
Knowing your net worth gives you insight how your finances are changing. If you take on debt, how does that impact your overall net worth? If you are to payoff a liability what one should you target that will maximize your net worth? This will help forecast your future net worth and provide some direction on how to grow your wealth. If you are not sure what your net worth is, I recommend that you calculate it out. There are a variety of free tools, especially in budget apps that do this automatically.
Know your Assets
It is important to have a list of all of your current assets and their values. Calculating your net worth does not require knowing the exact value of your assets, but a decent estimate is helpful to know. For example, assets can be:
You might own a home. Perhaps you are lucky enough to have a rental property or a piece of land. Typically, a residential property will increase in value, but having a mortgage will decrease from that amount. The sum owed verses the debt on the residential property is the amount towards your net worth.
Investments can vary from your 401K, IRA, mutual funds or other stocks and bonds. Note that these assets might be taxed which subtract from your actual net worth.
Everyday assets range from automobiles, jewelry, boats or other collectable personal property. Assets such as these can hold value which will help your net worth. Unfortunately, these types of assets are subject to big market swings which can change their value.
Assets value may increase and decrease over time.
Know your Liabilities
This number should be a sum of all of your debt. This will range from mortgages, credit card debt, student debt, car payments, etc. Each one of these will subtract from your liabilities.
With liabilities, we typically associate them to some form of interest rate. It is necessary to know how those interest rates impact your debt and how much of your payment is going to principal verses interest. Sometimes there are ways to help speed up paying off those liabilities such as consolidating debt into a lower interest rate credit card. Maybe refinancing a loan such as an automobile or mortgage to get a lower rate. Sometimes refinancing a mortgage can allow you to take cash out that can apply to debt and will save money in the long run. It is important to know how your liabilities impact your overall net worth.
Set a Budget
The math here is simple, the smaller your expenses the more money will be saved. By setting a budget will not only benefit you in the short term but also with long term wealth. If you do not have a budget setup, it is time to set one up immediately. This will aid in determining what liabilities should be cut, such as a subscription you do not use or maybe find some savings with switching a TV service. Sometimes a budget might call even for more drastic measures, such as selling a car to remove the monthly payment.
Setting a budget will also allow you to strengthen your bank accounts in case of an emergency. Financial emergencies can impact your net worth, so it is important to plan for them. To learn how to prepare for a financial emergency, read our article here.
Pay off Debt
Debt is like a financial vampire to your net worth. Debt, especially with interest, continues to diminish net worth until it is payed off. One strategic move you can do for your net worth is focus on a liability that is the easiest and most impactful to your net worth. Sometimes your mortgage might be advisable to pay off sooner to avoid even more interest. Note to double check that your mortgage does not have payoff early fees.
Building income based on investing is a great idea if executed at the right time and balanced with paying off debt. With investing, it is smart to invest your money into different sources and revenue streams. Could be as straightforward as saving in a savings account, investing in a 401K or IRA. There are other direct ways to invest such as using a robo advisor.
Net worth should not be treated as a number, but more of an overall roadmap. By focusing on raising your net worth in the long run by investing properly, paying down debt and understanding your money, you can increase your net worth.