Finance 106 – Golden Rule: Grow your Net worth
Net worth is the ultimate indicator of financial success. If you monitor it and maintain a target growth rate goal, you will really make progress. Net worth is calculated by taking all of your assets and subtracting all of your liabilities. The answer is what you are worth.
As children we have $0 net worth, as we attempt to establish ourselves we purchase necessities and creature comforts to validate our adulthood and independence. At this point our net worth falls to a negative number. At one point we should turn our focus on building our negative net worth until one day we are Thousandaires!
Let’s say you are 26 years old and adding all that you own and subtracting all that you owe, you find your net worth at -$25,000. You bought a car for $20,000 by putting $2,000 down, but one minute later the value of the car is $16,000. So even on what you thought was a new asset is actually a $2,000 liability. Once you start to consider asset appreciation and liability depreciation, you are in a better mindset to make wise financial decisions. You will start to think of each purchase as a help (asset that appreciates in value) versus a hindrance (liability that depreciates in value). You’ll eventually start to look at the Utility value of purchases and determine what true value will it bring to your life and is it adequately priced.
-$25,000 is okay. It’s a starting point and at least you know where you are and you are looking forward. So set a goal of growing your net worth by 10% per year (adjust this % goal per your preference). So next year you need to make decisions that will bring your net worth to -$22,500. See, you are headed in the right direction. Play with the numbers so that your goal makes you a $100-thousandaire at a reasonable age.
Now keeping positive growth year over year is difficult given fluctuations in the market and the change in value of your assets. So you want to shoot for an average annual growth of 10%. So every five years you take the last five years of growth (and declines), add those annual percentages up, and then divide the sum by 5. This will give you an average growth rate.
Remember: Spend less, Invest more
Once again JH delivers simple and sound advice that quenches our thirst for healthy economic prosperity.
Any advice on anything we should be doing differently because of the current economic crisis?
Keep on your grind regardless. If you have security, there is a sale at Macy’s. You should be looking for investment opportunites and going in heavy. In addition to finance 101-106 and learning what numbers to monitor, we all should subscribe to building bridges and strong relationships through upholding strong integrity. This will keep more options open if your company were to layoff. It’s not just what you know, it’s not just who you know, but also what who you know knows about you. See my article of Pyramiding “Complex game of chess”.
What about buying a car vs. leasing one? I’ve gotten alot of mixed advise and I don’t know the true benefits to one over the other?
Large purchases are a no-no until you have a full understanding of your current financial standing. You should know how much you earn, and have expected income planned out. As well, you should know what percentage of your income is “disposable”. Once you have a level of comfort regarding the percentage of funds to go a large purchase, then you are ready.
For example, given your other obligations you may have a current car note of $500 (including insurance). You know that you can afford a note of $650. So when you go into a dealership you will not purchase a car for more than $650 (including expected insurance cost) At the end of your payments you may have a car free and clear that is worth, $11,000. Good deal.
If you lease a nicer car that comes out to $650 a month, and at the end of the 5 year lease, you walk away with no car, no equity and no cash. So the feel good that you received from driving a nice car, cost you $11,000. Was it worth it?
You should have a percentage discount that you are comfortable with prior to setting foot on a dealer’s lot. Know what kind of cars you want. So your options are one of the two (at a 5 year purchase vs. a 5 year lease):
Purchase at $650 or
Lease at $466 (both including insurance, note that insurance on a lease is normally higher)
For example, let’s say the expected value of the car after five years is $11,000. $11,000 divided by 60 months is $183. So in order to lease a car you shouldn’t be willing to give up $11,000. So you’ll want that $11,000 in monthly payment savings. (650 – 466)
Once you understand this concept, you can start to play with the numbers and make better decisions regarding the value you get from driving a nice car vs. saving money on a monthly basis vs. having equity in a paid-off car to sell or roll with no payment.
So the final answer is to lease only for a discount. If you lease for the maximum you can afford, you are getting ripped off. Plan your work, work your plan & floss with the next car.
Thank you for the financial & mental candy. I appreciate it. It helps me regarding building my life from here on out. I’m taking a “Stock Success” class this week & I’m definitely working on building my net worth.