Category Archives: Net worth

Paying down debt

Emergency account funded, now what?

Now that you have your emergency account opened and funded to cover at least three months of expenses, it’s time to start the journey in becoming debt free!

It is certainly worthwhile to continue to contribute to your emergency fund until you reach six month’s expenses, but now we can start to focus on reducing and eliminating debt.

Types of debt

Bad debt

This includes things such as credit card balances (this includes your store credit cards) and auto loans.

Carrying a credit card balance and not paying off the entire amount each month generally results in high interest accumulation that typically compounds each month it remains only partially paid off. This can often snowball into a sizeable sum in a short period of time depending on spending habits. It is recommended that you pay off all credit card balances in full each and every month to avoid interest accumulation. The average credit card interest rate stands at 15.07% with a maximum allowable at 29.99%. Not even the stock market can guarantee returns like that every single year!

Auto loans are also considered bad debt because the value of the car immediately drops when you sign those papers, even before you actually drive the car off the dealership lot. The instant and continued depreciation of a vehicle coupled with a fixed loan amount and a repayment option makes an auto loan a bad debt to carry. You can always buy a solid, used car that will run for years for cheap.

Good debt

Good debt is something that gives back and generates value. This includes mortgages and student loans.

Buying a home and taking on a mortgage does not immediately cause the home to depreciate in value. In addition, it creates value in giving you a place to live with the potential of increasing in value. Mortgage interest paid can also be taken as a deduction if you itemize your taxes when it comes time to file. Good debt.

I’ll be completely honest and say even though student loans are considered good debt, I believe there has to be enough return on investment to consider it a good debt. Taking on 100k in student loans to graduate in a major that results in a career ceiling of 40k salary per year does not seem like taking on “good debt” to me. Student loans have to be reasonable for the associated career upon completion, otherwise it does not create enough value to incur that debt in the first place. Just like mortgage loan interest, student loan interest paid can also be taken as a deduction during tax season.

Start with the highest interest rates

interest rates can snowball debts out of control

Interest rates can snowball debts out of control

Always pay off at least the minimum amount each month towards each debt that you have, otherwise they will charge you with hefty fees that will only increase your debt burden (no point giving them any more money than you have to).

First, calculate the minimum monthly payment for each outstanding debt you have and add them up. This is your total monthly debt repayment. Add this amount to your regular monthly expenses and subtract that from your monthly income. Take whatever amount is remaining or left over and put that towards paying off the debt with the highest interest rate.

If you want, you can even put aside a little bit of what you have remaining towards getting that emergency fund up to 6 months expenses, and then put the rest into paying off that high interest debt.

Once the highest interest debt is completely paid off, take the monthly payment you were making for the first debt and apply it to your second highest interest loan until that one is paid off and continue on. This way, your payment toward reducing debt is the same each month, but you will be reducing your debt load so much faster by snowballing your debt reduction payments down the line from highest interest rate down.

Surprisingly, by paying down debt, you will more than like take your net worth from a negative to a positive amount, and you can certainly give yourself a pat on the back once all your bad debts are completely paid off. If you are interested in learning about net worth, you can take a look at my discussion about whether or not you should be tracking your net worth.

Time to start building wealth

Once your debts are paid off, try not to accumulate any more bad debt. By paying off these debts, it frees up money that can be used to build financial wealth and create stability in your life.

If you are curious, you can check out my investment strategy for 2015 and let me know what you think.

How to increase (or decrease) net worth

increasing net worth

Change in net worth?

Now that we know how to calculate your net worth, it’s time to talk about ways to increase your net worth and increase financial stability.

Please take some time to read a little about net worth if you are unsure whether it is worth calculating and tracking.  It is equally as important to know what will reduce your net worth and what may decrease your financial health.

I think it is important that the “change in net worth” be defined as the changes in assets or liabilities that stay constant for a given period of time. This means your monthly paycheck should only be counted towards net worth calculations after any monthly expenses and the remainder is saved for the future. The future can be a month from now or even twenty years from now, but not within the same paycheck period.

This is considered net income (money coming in minus money going out). This net income is money that should be counted towards your net worth. This is also why net worth is not calculated on a daily basis, but rather a quarterly, or better yet, biannual or annual basis.

Ways to increase your net worth

After all, what’s the point of calculating and tracking your net worth if it’s going to stay constant? The general principle is to increase your net worth as time goes on, and the most straightforward and simplest way to increase your net worth is to put money aside. Whether it be under your mattress, in a bank, in stocks, or a house, money that is put into a valuable asset should be considered in your net worth calculation.

Below are several ways to increase your net worth:

  • Put aside a certain amount from each paycheck into a savings account. This will guarantee money being set aside. It can be used as an emergency fund for 3 to 6 months of expenses, or better yet, if you already have an emergency fund set up, towards investments. The paltry interest rates in savings accounts lags far behind annual inflation, and it certainly makes more sense to put extra money into the stock market, whether you choose to pick your own stocks or invest in a mutual fund, both are superior options for idle cash in my opinion.
  • Invest in your company’s 401k, especially if they have a company match. There are several benefits to 401k contributions, such as tax deferred savings, retirement planning, automatic savings and increased net worth. 401k contributions are taken pre-tax, meaning any money put into your 401k is taken before taxes are taken out of your paycheck. This reduces your taxable income when it comes time to file your taxes. Be sure to note however, you will be paying those taxes when you withdraw from the account during retirement. 401k contributions are also automatic once you set the amount to be taken out every paycheck. This puts retirement savings on autopilot and reduces the burden of retirement planning.
  • Purchase a home. Purchasing a home as a transaction actually does NOT change your net worth either positively or negatively, but rather results no change. With the purchase of a home, you gain an asset (the home) and like the majority of the population, you also gain a liability (mortgage). The asset and the liability in dollar amounts would cancel out, resulting in a net zero change in net worth. The increase in net worth comes when mortgage payments are made and equity is built. The increase in equity built in the home decreases the liability, which in turn increases net worth. (This assumes the fair market value of the home stays constant or increases in price)
  • Paying down debt. Whether it be paying down credit card debt, student loans, car payments, mortgage payments or loan shark debts, the reduction in liabilities increases net worth. Always pay down high interest debt first as those can snowball into uncontrollable debt in very little time.

 

You can take a look at my Investment Strategy for 2015 to see how I plan on increasing my net worth.

Should you be tracking your net worth?

net worth

Is tracking your net worth really that important?

Surprisingly, I haven’t really thought much about net worth as a financial goal to track until recently when it popped up on my radar while surfing the interwebs.

Tracking your net worth can tell you a lot about your financial health and where your finances stand year to year on an overall level. It takes some digging to really get down to the details of a complete financial picture to obtain a more wholesome view of one’s financial health.

What is net worth?

In short, net worth is the sum of your assets minus the sum of your liabilities.

Assets are anything you own – cold hard cash, savings accounts, CDs, stocks, mutual funds, present value of house, cars, etc.

Liabilities are anything you owe – credit card debt, student loan debt, car loans, outstanding mortgage, etc.

To obtain your net worth, add up all of your assets and subtract out all of your liabilities, and there you have it – your net worth in dollars!

Average net worth?

Diving deeper into the world of net worth and assets and liabilities, I was shocked to find out the average net worth for someone under the age of 35 was $6,682 based on a 2011 US Census Bureau report and the 70th percentile was only $33,477.

But perhaps it wasn’t that big of a shocker after all. Most recent graduates would be living at home or renting an apartment. By renting, you build zero equity (ownership) in your home. This is essentially money going out the door doing absolutely nothing to increase net worth. Those that are fortunate enough to purchase a home are unlikely to have money for a 20% down payment on a house. As such, mortgage payments are essentially going straight towards interest, building little equity when first starting out.

Student loan debt is also a big factor in reducing net worth, with the average loan debt getting up to $30k coming out of college, even more after graduate school. Many people will start off their respective careers with a negative net worth, and the feeling of turning that negative into a positive may be one of the best feeling ever.

In that respect, I think it would be worth tracking your net worth – perhaps not every month, but every 3-6 months until you are at a financially happy place. At that time, it is probably just as fine to track your net worth annually.

Is net worth a sign of financial health?

Maybe, maybe not. It really depends on what you’re looking for in calculating your net worth. Knowing your net worth is certainly helpful in determining your financial situation, but it isn’t really a complete picture of your financial health. In order to get a complete picture of your own financial health, you need to take a look at all aspects of your finances both independently and as a whole, including, but not limited to, income, expenses, debts, savings, investments, retirement accounts, emergency fund, etc.

Calculating your net worth on a bi-annual or annual basis certainly allows you to track your ongoing financial strength and whether you’re on the right track to financial freedom, but don’t count on using your net worth as your only value of financial health.

Personally, I like tracking my net worth twice a year just to make sure it is increasing at a healthy pace.

Next, we’ll take a look at how to increase (or decrease) your net worth