After I wrote how to calculate your net worth, I was out with a friend and we were talking about growing our wealth. Throughout the conversation, he continued to focus on growing his income. I had to explain to him that his approach to growing his wealth was flawed.
Why was his approach flawed? Why shouldn’t you focus on income to grow your wealth? What should you focus on?
(Photo Credit: graur razvan ionut/ Free Digital Photos)
Overview of Net Worth
When it comes to growing our net worth, there are two sides to the equation: assets and liabilities. The best way to grow net worth is to make sure we eliminate, or limit liabilities as much as possible and increase our assets as much as possible.
When it comes to liabilities, this means avoiding debt as much as possible. Now, I realize we can’t avoid debt altogether. I personally would never own a home if I didn’t take out a mortgage. So some debt is expected. Do you know What Percentage of Assets and Liabilities are in Your Home?
But when you do have debt, make sure you are taking the steps to pay it off on time or even sooner. For every dollar you decrease your debt, you are increasing your net worth.
Don’t Focus Solely on Income to Grow Your Net Worth
When it comes to assets, the strategy gets a little more involved. Many people like my friend will put all of their energy into growing their incomes. They will work 80 hour weeks to generate a large paycheck.
This isn’t a bad thing, but you also have to make sure you are saving and investing as much of that money as possible. When you do this, you can earn interest, dividends, capital gains and enjoy appreciation as well.
The earnings on your investments will help you grow your net worth more quickly than you can possibly grow your income. After all, you will eventually get capped out on your earning potential. All jobs have a pay floor and ceiling and once you hit that ceiling, you are done. Your only option is to see if another company is paying more for a similar job or move higher up the corporate ladder by taking on another role with more responsibilities.
There is no ceiling to earning dividends and income from your savings and investments. They continue to generate more and more income, year after year as long as you continue saving and investing.
Focus on Savings to Make Your Money Work For You
You should be focusing most of your attention on saving and investing the money you earn. The reason for this is simple: let’s say you put all of your energy into earning $150,000 a year but don’t focus on saving it. When can you retire? The answer is never because you have to keep working so that you have money. You are working for your money.
If on the other hand you save as much as you can and invest it, you can retire at some point. This is because your savings will be generating income and you can also use the savings as income. In this case, your money is working for you.
Which scenario sounds better? Personally, I will take the option of retiring over having to work forever. If you feel the same, then you need to make sure you are not ignoring the saving part of growing your net worth.
I am not saying you should completely ignore earning as much as you can. After all, the more you earn, the more you can potentially save, which means you can retire even sooner than you thought. What I am saying is that you need to focus on both parts of the asset side of your net worth statement. When you can do this, you will start to see positive results.
If you want to be financially free, you have to calculate your net worth. It is a great tool to keep you motivated to grow your wealth and improve your finances. When you do track it, make sure you are not forgetting about growing your assets by saving and investing as much money as possible. Doing this will allow you to grow your net worth much faster than if you simply focused on growing your income alone.