1) Know how Net Worth is Calculated
Net worth is the difference between your assets and liabilities, calculated as: Net Worth = Total Assets – Total Liabilities
While your liabilities are easy to calculate it can be challenging to determine accurate asset values. It is best to make conservative estimates to avoid over-inflating your net worth (which may give you a false sense of financial security).
The one concept that is often overlooked in what makes up net worth is debt. So much emphasis is on building assets to increase net worth, but reducing debt does the same thing and at the same time reduces your exposure to market risk. Reducing debt will not only increase your net worth but allow you to better weather the market cycles while protecting the assets you have acquired.
2) Pay off Your Debt
The money you owe is money that could be used to grow your net worth. Pay off all your debt as soon as you are able, but be aware of penalties that can be applied for early payment (like with mortgages). Identify high-interest debt and target that first, paying off lesser debt along the way.Consolidating your debt by taking out a loan (at a lower rate) to pay down high-yield debt is a tried and true strategy.
The bottom line here is to know what you owe and have a plan for paying it back. Make extra payments where possible and work to reduce your overall debt burden.
3) Live within your means.
There is no get-rich-quick scheme to building net worth. It takes maturity and self-discipline and a willingness to sacrifice to forgo that vacation or latte in favor of debt reduction and asset accumulation.
Growing your net worth requires making decisions that don’t feel good, but that ultimately make sense. It’s rather basic but, spend less than you earn to build your net worth.
4) Compound Interest – Make Your Money Work for you.
What is compound interest? It is interest calculated on the initial principal and also on the accumulated interest of previous periods of an investment. Compound interest can be thought of as “interest on interest,” and will make a deposit grow at a faster rate than simple interest alone, which is interest calculated only on the principal amount.
The rate at which compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods, the greater the compound interest. Albert Einstein said:“Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pays it.” Compound interest is an amazing tool to create wealth that requires patience and is often overlooked by more glamorous and exciting ways to make money.
So don’t underestimate the power of “compound interest” as an investment strategy to grow your net worth.
5) Focus on Equity, not Income.
When you focus solely on making more money every month or year, you are more short-sighted than the person trying to generate wealth through equity in a business or in real estate. It’s not negative to focus on maximizing income, especially when you’re first gaining experience. But, the truly wealthy are the ones with massive equity stakes in businesses and real estate.
Shareholders of companies think more wholly and longer term than income-only employees. Income and net worth amounts are intrinsically linked. However, I’m going to argue that building a sizable net worth is more vital for early retirement/financial independence than generating a high income.
Acquire assets that have the potential to appreciate in value, and those types of assets will depend on your tolerance for risk and your age.
Increasing your net worth doesn’t just happen. By focusing on these five strategies: 1) Know how net worth is calculated, 2) pay off your debt, 3) live within your means, 4) compound interest, and 5) focus on equity not income, you are sure to make progress increasing your net worth.
Do you have a strategy of increasing your net worth? Has it been successful?