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[Fin Talk] Net Worth and Wealth Creation
By Arlyn Tan
When people are asked what is their net worth, some would mistakenly think that this is the inflow of money to the household or the amount of funds left after subtracting the expenses from the income. People may associate their net worth to the capacity to acquire material things which are treated as assets.
The Net worth of a person is subtracting all liabilities from assets. Assets refers to cash on hand, investments in capital markets, property, receivables, and endowments. Liabilities refer to mortgages and debts to credit card & financing companies and banks.
When the net worth is a positive number, a person is perceived to have the ability to manage the flow of funds and consequently have extra money to save or invest. On one hand, a negative net worth means a person is perceived to be living or leveraging on debt.
The usual cause of negative net worth is when the values of the current assets go down temporarily or permanently. The temporary decrease in value can be secondary to the volatility of the stock market or the sudden drop of property prices. The permanent decrease in net worth happens when disability sets in and assets are used for medical needs. There is no other way to recover the medical expenses unless there is a new inflow of funds.
Does it mean that a person is wealthy when he has a positive net worth? The persona of a wealthy individual is unique in the way they manage their assets and cash flow. A wealthy person is able to think long term, see the bigger picture and understand the significance of each asset class in his portfolio. He is also humble to allow experts to help him in preserving the asset value and growing his net worth.
Here are some tips for you to have a positive net worth and work on your way to reaching “wealthy” status.
1. Budget Budget Budget
Too much spending can overheat your financial health. So keep on measuring the speed of outflow and be mindful of your lifestyle. Too much or too little spending on essentials may be misplaced budgeting.
2. Decrease debt to zero.
Setting up liquidity engines like medical or disability insurance and income protection plans can provide buffers to prevent a decrease in net worth or even acquire debts. When you don’t leverage on financial institutions like insurance companies, one needs to be ready for any unexpected scenarios. Projections and calculations on healthcare costs may be underestimated which make families look for sources of funds when long -term critical illness strikes a family.
According to the 28/36 Rule, a household needs to spend only 28% of its gross monthly income on total housing expenses and no more than 36% on debt which includes housing, car or credit card loans.
On top of every person’s goal to be wealthy, many want to avoid the feeling of helplessness in paying debts on time. Consulting an advisor will lessen the impact of unexpected debts to mental wellness.
2. Find multiple sources of income.
Upgrading one’s skills can be a way to earn new sources of income. Freelancing and entrepreneurship are ways to have sustainable income in the short and long term. Online local and global stock investing have become a trend which can allow you to earn investment income. Combine the small and big income from side hustles, regular jobs, and investments to increase the total investable fund.
While net worth is an indicator of one’s wealth, the story behind the numbers will be more important to gauge the financial health of a person. It is a journey that entails time, discipline and constant recalibration of your money management style. If your liabilities are managed to not cause a sudden negative shift in your net worth, then you are still safe. At the core of wealth building and preservation, the capability to maximize opportunities will be dependent on your skill to balance your assets and liabilities.
Arlyn Tan is a Strategic Wealth Consultant. She helps individuals and organizations on how to maximize the value of their money through risk, health & wealth management. Her mission lies in making sure that clients achieve 3 things. First, they reach their milestones on time with sufficient resources. Second, they protect them from the impact of economic losses secondary to unexpected events. The third and most important is that they enjoy meaningful and balanced lives.
LinkedIn/Twitter: Arlyn Tan