Ways To Destroy Your Net Worth

By Stephen D. Simpson, CFA | March 14, 2013 AAA
Ways To Destroy Your Net Worth

Net worth is no trivial matter, as it is ultimately the only meaningful measure of personal wealth. There are many good ways to build individual net worth, including earning more, saving more and improving the return on savings and investments, but it's equally important to play a good defense. With that in mind, look to avoid these prime ways to destroy net worth.

Uncontrolled Spending
Net worth is built by making more than you spend and accumulating those savings over time. It stands to reason that it is easy to destroy net worth by spending in excess of your earnings and either dipping into your savings or going into debt to fund your spending. Borrowing to fund rare big-ticket purchases (a home, a college education) is not an example of uncontrolled spending, but accumulating credit card debt in the pursuit of new clothes, a vacation or furnishings are. Disciplined budgets are usually a good preventative measure for uncontrolled spending, as most people are loathe to actually budget for items that they know they really do not need.

Bad Debt
Debt is often described as a major threat to the net worth and future financial health of individuals. While this is true, it is also misleading. Not all debt is equal, and not all debt is equally good or bad.

Accumulating even moderate amounts of credit card debt can quickly grow out of control due to the very high interest rates that debt carries. Likewise, taking on debt to buy a car (a depreciating asset that also demands maintenance and operational spending) is not a good financial move.

It is a different story with educational debt and mortgage debt, though. While it is true that many people have gotten themselves in trouble with excessive student loans or mortgages, it is very difficult for most people to become a doctor, lawyer or executive without expensive grad school degrees that usually require borrowed funds. Likewise, an affordable mortgage for a house appropriate to the person's income is generally no worse than wealth-neutral.

No Savings/Retirement Plan
While keeping spending lower than earnings is critical to accumulating savings, it is likewise very important to have a savings and retirement plan. In the absence of a plan that demands a certain level of savings set aside every month (or pay period), it is easy to increase spending and spend that surplus. Likewise, in the absence of a solid investment and retirement plan, it is easier to fall prey to needlessly risky or excessively cautious investments and undermine the wealth-building process.

Open-Ended Risks
Unanticipated, but unavoidable, spending can devastate a person's net worth. Although it is not possible to avoid every possible bad outcome, individuals can protect their current and future net worth by minimizing the number of open-ended risks in their life.

Not maintaining adequate insurance is an excellent example of an open-ended risk. While young people may believe that they have many years of good health ahead of them, a torn knee ligament or car accident can lead to huge medical bills and serious financial difficulties. One of the prime causes of personal bankruptcy in the United States is medical costs, and going without health insurance represents a sizable risk to a person's net worth. Skimping or skipping on other types of insurance, including homeowner's insurance, can create open-ended risks that could ultimately devastate net worth.

Failure to Maximize Peak Earnings
Nobody expects someone in their 20s to rake in money from their profession unless they are a professional athlete or entertainer. For most people with college educations, the peak earnings period runs from their early 40s into their mid-50s (peak years for those without college degrees tend to start, and end, earlier in life). As such, it is important to maximize that earnings opportunity.

Peak earnings are based in part upon accumulated experience and seniority within your career path. Consequently, a habit of continually changing jobs and professions can significantly harm a person's ability to reach and exploit those peak earnings years. While not all job changes are voluntary and nobody should endure a job they loathe, job-hoppers should understand that frequently moving on may significantly reduce their peak earnings and their ultimate net worth.

The Bottom Line
"First due no harm" may seem simplistic, but when it comes to net worth it is good advice. While there are many solid articles and columns providing advice on how to build net worth, it is equally important to avoid the large pitfalls that can quickly obliterate that hard-won net worth.

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