I always believed that Wealth Building was something “rich” people did. As I have schooled myself in the area of personal finance, I have learned that Wealth Building is not just for the wealthy. It’s for everyone, even a Single Mom, like me. Who knew, right?!?!
There comes a time to stop living like there is no tomorrow and start making financial decisions that will support your longer term goals. These could be to save for a down payment on a home, provide some money for the kids college, save for retirement, a newer car and/or simply to provide a comfortable cushion should life throw a few lemons your way.
None of these items are out of reach as long as you establish your priorities.
Wealth Building begins with a positive Net Worth. What is Net Worth? It is the mathmatical outcome of the value of your Assets minus the cost of your Liabilities.
Assets .v. Liabilities
Anything that is owned that has value, such as a home, auto, cash, art, and investments is an Asset. Assets always have a positive impact to your Net Worth.
A Liability is anything in which money is owed and has negative impact to your Net Worth. The more debt you carry, the more it offsets the positive influence of your Assets.
A spreadsheet adding all assets and making adjustments for liability will provide a clear picture of your Net Worth. In the example below, Assets are listed on the left side based with their present value.
On the right is where all liabilities are listed and valued. Home loans, car loans, student loans and credit card debt are all liabilities. This would also include any outstanding money owed to the IRS or legal fees or liens against your property.
A house is an asset, except for the part of it that is financed. Since this is a debt that will need to be paid (a liability) the asset is offset by the liability. If the house is worth $200,000, but $150,000 is owed, the asset is only worth $50,000 (200,000 – 150,000 = $50,000). Since the money owed is less than the value of the house, the house remains an asset but for only the amount of the equity (value – debt = equity) of the home, $50,000.
On the spreadsheet above, the house value is listed in the Assets column and the Mortgage is listed in the Liability column. The Liability will offset the Value.
If the value of the house (the amount at which it could be sold) is less than the amount owed, then the house becomes a liability. “Upside down” is a favorite term for this scenario.
When the two sides of the spreadsheet are added together Assets – Liabilities = Net Worth, the Liabilities will always devalue Assets dollar for dollar. In this example, the Net Worth is listed at the top right-hand side at $165,500. This person has a positive Net Worth and that is the beginning of building wealth.
Now imagine if that person only had a house debt. Without liquidating any of their assets, that person worked really hard (took a second job, maybe) to pay off their debt and today only had a house payment each month, then their Net Worth would have increased to $210,000 (reducing the liabilities column to only the $150,000 owed.)
A positive number in the Net Worth box is the start of Wealth Building. Why? Well, all things being equal and should someone call in all your debts, you would not be completely broke (assuming you sell all your assets). I recommend that this exercise be done every quarter and if this number is climbing, then you are increasing your assets or decreasing your liabilities and, therefore, are Building Wealth. If this number is declining, then chances are you have increased your debt load.
So, it is to be said that the first steps to a positive Net Worth is to create a budget, remove the liabilities, i.e. debt, and start saving. Your goal each month should be to pay off debt and/or add money to your savings or your investments. Both will have a dollar for dollar positive effect on your Net Worth.
There is no “Get Rich Quick” scheme for building wealth. It takes planning, budgeting, saving and investing. By the way, putting $5 a week toward the lottery is not an investment, nor is it a plan.
At this point in your financial development, investments should be limited to 401(k), IRA, or Mutual Funds. I do not recommend investments in jewelry or art or even property until your Net Worth is in excess of $1M or you are comfortable paying cash for these items.
I will cover more of how to make your wealth work hard to make more wealth in my next blog in this series….. Money and The Single Mom – Investing.
On a Personal Note
I have been working on my financial plan since 2009. At the time, I calculated my Net Worth and have tracked it quarterly for these past 3 years. During that time, I paid off all my debt (except the house) and I am careful not to incur any additional debt by planning purchases and living within my means. I have begun to give to my 401(k) and building my Emergency Fund. As a result, I have consistently increased my Net Worth by at least 5-10% each year. I am building wealth, as a Single Mom, and you can too.
Free Net Worth Spreadsheet – Excel
3 Simple Steps to Building Wealth, Investopedia.com
5 Ways to Build Wealth Automatically, Forbes.com
I recommend the following books for more insight into budgeting and other money matters:
The Total Money Makeover – Dave Ramsey
Debt-Proof Living – Mary Hunt
Next Wednesday – Investing