Most people have at least a vague idea of how much they earn. But not nearly as many people know how much they are worth. Your net worth, simply defined, is the bottom line once your debts have been subtracted from your assets. It's important to know this number because it can help you figure out whether you're on the right road to financial prosperity and security. Click here to calculate your net worth.
Younger people, particularly those who are saddled with student loans and credit card debts, may have a negative net worth while older people, especially those who've saved and invested, may be more likely to have a positive net worth. But a simple strategy to build your net worth over time can make you wealthier at any stage of your life.
The strategy is to reduce your debts and build up your assets, says Ronit Rogoszinski, a wealth adviser at Arch Financial Group in Long Island, N.Y.
"You want to reduce your owe and increase your own, and that's when the adult conversations begin," she says.
Those "adult conversations" have to do with your income and expenses and whether you have any cash left at the end of the month to pay off your debts and accumulate savings.
Cash flow pays debtsIndeed, the first step to building your net worth is to figure out your current financial position: What do you own? How much do you owe? Is your net worth positive or negative?
"You need to write a list of where you spend your money because the only way you are going to reduce what you owe is to stop building it and get rid of it by paying it off," Rogoszinski says.
The "extra" money that's left from your income after you've paid your expenses is called "free cash flow," says Rebecca Schreiber, a financial planner at Solid Ground Financial Planning in Silver Spring, Md. Free cash flow is crucial to building net worth because it can be used to improve your financial position.
"Write down your income and a list all of your expenses. What's left over is your free cash flow," Schreiber says. "This is called a budget -- but don't tell anyone that."
Lock in low interest ratesThe second step is to lock in low interest rates on your long-term debts to protect your future cash flow.
"If you have student loans, call the lender and find out what the interest rate is. Lock in the rate, so your debt cost won't go up as your income goes up," Schreiber says.
Don't assume you're stuck with debts you've already accumulated. Shop around and find out whether you can consolidate or refinance at a lower rate. Protect your credit score to position yourself as a better debt consumer. Don't take on debt you can't afford to repay, and if you've already accumulated too much debt, get help.
"Denial is very expensive," Schreiber says.
'Squirrel it away'The third step is to accumulate savings and other assets.
"Once you have positive cash flow -- you are spending less than you are making and you have money left over -- it could go to reduce your debt and it could also increase your savings," Rogoszinski says.
Or, to use, Schreiber's more colorful description, you can take that extra cash and "squirrel it away."
Over time, that squirreled-away money can be invested in real estate, stocks, bonds, mutual funds and other assets that can appreciate in value.
"Stick with the basics and be patient," Rogoszinski says. "Focus on taking that $100 every month and putting it toward your retirement account ... or put that extra $150 toward your house purchase account."
Decisions that 'don't feel good'Net worth that's positive and growing is a solid road to wealth and financial prosperity. But net worth isn't a get-rich-quick scheme. It isn't sexy, and it doesn't happen overnight. Rather, Rogoszinski says, it takes "a little maturity and self-discipline" and a willingness to sacrifice that fourth vacation or sixth latte in favor of debt reduction and asset accumulation.
"Getting your net worth to be positive requires making decisions that don't feel good, but that ultimately make so much sense and reward you so much more," she says.
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