Managing your financial life involves making a lot of decisions. When the dollars involved are material, you should always think about the repercussions for your net worth. This practice will have a profound impact on your long-term financial well-being.
In Accounting 101, you learn about a balance sheet. A balance sheet is a financial statement that lists your assets, your debts, and your net worth. Your assets are anything you have of value, such as your home, bank account, investments, 401(k), and car. Debts include any outstanding liabilities or obligations such as a mortgage, student loans, car loans or leases, and credit card debts.
Your net worth is the difference between your assets and your debts. In other words, your net worth is an outcome, and you can think of the formula:
Assets – Debts = Net Worth
If the total value of your assets is higher than the total value of your debts, your net worth is positive. If the total value of your debts exceeds the total value of your assets, your net worth is negative.
For significant financial decisions, always consider the effect on your net worth. All else equal:
- If you increase your assets, your net worth goes up — you earn a special bonus at work and invest the money.
- If you decrease your debts, your net worth goes up — you receive a tax refund and pay off debt.
- If you increase your debts, your net worth goes down — you take a vacation and run up credit card balances shopping and eating out.
Your net worth does not depend only on what you earn (income) or on what you have (assets); it also depends on whether you spend more or less than you earn and how you manage debt. Saving and managing your debts should both be priorities. Like boosting your savings, paying down debt has a positive effect on your net worth.
