How to Budget and Net Worth
Posted on October 1, 2008
Filed Under Free Financial Course |
The goal of this lesson is to teach you how to budget your money and determine your net worth. Understanding your current budget and net worth will give you a starting point to develop a personal financial plan for your future. To determine your financial situation (financial health), you will need to calculate your current monthly budget (and determine how your spending habits relate to that budget) and then you will need to calculate your current Net Worth.
These two measures (along with your credit score which will be discussed in the next article) will determine what you need to do to accomplish your financial goals in 30 days, a year from now, and 20 years from now!
So, let’s start building wealth!
First, what is wealth?
Everyone may have a different definition of what wealth is. To some, it may mean a big house and a private jet; to others, it is the ability to put their children through college and own their home free of mortgages.
Take a minute and think what having wealth means to you.
Whatever your personal definition of wealth is, we want to help you achieve it.
Although our individual definitions of personal wealth may be different, general wealth is defined by your Net Worth.
Net worth is simply the worth of your assets (the things you own) minus the cost of your liabilities (the amount of debt you have). In other words:
Net Worth = Assets - Liabilities
One way to look at net worth is to imagine you sold everything you owned today for its market value. Would the money you make from selling these items be enough to pay off all of your debts with some left over? If so, you have a positive Net Worth!
Eventually, you should want to increase your net worth enough so that this wealth can sustain you through your lifetime and retirement.
How is wealth created?
When you look at the formula for Net Worth (Net Worth = Assets – Liabilities), you will notice that your Net Worth will increase by increasing your assets and by decreasing your liabilities. It is important that you understand how both assets and liabilities affect your net worth. We will show you how to manage both parts of net worth.
First, let’s focus on assets. Not all assets are of equal value in promoting long-term wealth. The real key to creating wealth is controlling wealth creating assets. In other words, assets that will actually increase in value, and thereby increase your personal net worth over time.
Here are some examples of Wealth Creating Assets:
- Your home
- Other Real Estate
- Stocks
- Bonds
- Mutual Funds
- Savings Accounts
- 401(k) & IRA accounts
- Other Investments
Now of course, there are other assets that will not help you create wealth, but that we may still purchase out of necessity, for entertainment, or other reasons. Here are some examples of non-wealth building assets:
- Cars
- Boats
- Bicycles
- TVs
- Furniture
- iPods
The important thing to get from this lesson is that the more money that is spent on Wealth-building Assets versus non-wealth building assets, the faster you will achieve a higher net-worth.
Good Debt vs. Bad Debt
Wealth Building assets also determine what debt is good and what debt is bad. The best situation is to have NO DEBT! Avoid debt if at all possible; treat debt like a bad disease. However, in life, some debt may still be accumulated; despite your best efforts. All debt is not equal; some debt is better than other forms of debt. Good debt is used to purchase wealth-building assets and bad debt is used to purchase non-wealth building assets.
In other words, a loan to purchase a home can be good debt because the home will (usually) increase in value. On the other hand, if you use your credit cards to purchase an iPod or other consumer goods, then this is bad debt because these items will not increase in value, and will often decrease in value (depreciate) over time.
Continue >> Determine Your Net Worth