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. I 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
- 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:
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.
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Spencer has a BA in Finance, an MBA, and is currently a Commercial Banker advising Business owners on Business and Personal financial issues.