Wednesday, April 18, 2007

The Secret to Building Wealth

Never go for a get rich quick scheme. It's probably a scam. Even if it's not a scam, chances are it's a high-risk long shot that won't pay off. If you need a quick fix for your gambling jones, buy a lottery ticket. You'll probably lose, but at least your money goes to a deserving purpose like public education.

There is, however, a secret to building wealth: keep track of your net worth. In other words, know how much you have. It's the baseline reference point for your financial plan. You can't be sure that you're increasing your wealth if you don't know how much you have.

Maybe you think this is obvious. Maybe you aren't worried because you faithfully put 10% of your salary into a 401(k) account (and, if you're lucky, get an employer match of 2, 3, or 4% of your income). If you're really diligent about saving, maybe you put away some more money in an IRA or in the stock market. But is it really that simple?

Are you running up your credit card balances in order to maintain lifestyle even while you save? Are you tapping into your home equity for your next car? Has your home equity dropped with the recent slowdown in the real estate market? If so, your net worth could be shrinking even though you are building up your retirement accounts. You can figure out if this is happening by calculating your net worth regularly. Knowledge is power. When your level of wealth is backsliding, you can get back on track by increasing the amount you save or easing up on spending.

Net worth is the value of your assets minus the amount of your debts. For retirement purposes, count only assets that contribute to long term financial security. In other words, count things like cash, mutual funds, stocks, bonds and home equity. Don't count things like cars, furniture, clothing and appliances; they depreciate in value and won't add to your retirement savings. But count all of your debts, including debts incurred to buy cars, furniture, clothing and appliances, because all of your debts have to be repaid.

Calculate your net worth at least once every three months. January 1, April 1, July 1 and October 1 are good times to give yourself a financial checkup. If you haven't been keeping track of your net worth, don't be surprised if the first time you do the calculations it turns out to be negative. That's especially likely if you're young and still saddled with school debts and the expenses of starting out in full-time employment. Whatever the number is, don't be discouraged. It's important to know where you stand and to move forward from there. Indeed, the mere fact of determining your net worth will motivate you to improve. That's why it's the secret to building wealth.

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