1. Calculating Your Net Worth: Introduction
  2. Calculating Your Net Worth: Important Terms
  3. Calculating Your Net Worth: Why Net Worth Is Important
  4. Calculating Your Net Worth: Making Accurate Estimates
  5. Calculating Your Net Worth: Calculating Your Net Worth
  6. Calculating Your Net Worth: What Your Net Worth Means
  7. Calculating Your Net Worth: Building Your Net Worth
  8. Calculating Your Net Worth: Conclusion

One of the best ways to build wealth is to start early. This allows you to take advantage of the power of compounding – what Einstein called the eighth wonder of the world. To illustrate how powerful compounding can be, we’ll see what happens if you start with one penny and double your savings every day for four weeks.

As you can see in the chart (below), at the end of week one you would have saved a paltry $0.64. At the end of week two you would have saved $81.92. Things aren't looking good. Or are they? By the end of week three, you would have more than $10,000, and by the end of the fourth week, you’d be a millionaire. 

Figure 3  The power, or magic, of compounding.

Is this realistic? Of course not. During the last couple of weeks, you’d have to come up with tens and hundreds of thousands of dollars each day to meet your daily doubling goal. But this does serve as an example of what can happen when you give your money the biggest advantage you can: time. Starting early is the best way to build your wealth and save for retirement. 

The magic of compounding allows you to generate wealth over time and requires only two things: the reinvestment of earnings and time. If you make a single $10,000 investment when you’re 20 years old, for example, it would grow to over $70,000 by the time you were 60 (based on a conservative 5% interest rate). That same $10,000 investment made at age 30 would only yield about $43,000 by age 60, and made at age 40 would yield just $26,000. The longer you put your money to work, the more wealth it can generate in the future. (For related reading, see Investing 101: The Concept of Compounding.)

Avoiding Debt

When it comes to debt, the best defense is a good offense. Avoiding debt is one of the most important steps you can take when trying to improve your financial situation. Consider a mortgage. It’s a monthly expense that continues to exist (on average) for 360 months (30 years). Yikes. While today's lenders might have a more difficult time talking you into more house than you can afford, it’s still very easy to end up in a property that is more than you need, both in terms of price and features.

Imagine if your mortgage payment were $100 less each month, and you put the money you saved into an investment and allowed it to grow. Over the 30 years, you would have contributed $36,000 towards this investment ($100 each month X 30 years), but if you earned 5% on the investment, it would be worth about $84,000 at the end of 30 years. Imagine if you took a mortgage that was $200 less per month.

Recurring monthly expenses also nibble away at potential savings. Oftentimes, you can reduce these monthly charges by calling customer service and asking for a better rate (or better plan): Companies are not going to let you know about any promotional rates unless you ask. It many cases, it’s worth the ten minutes that it takes to call and negotiate a better rate. If customer service tells you the rate is good for one year, make a note on your calendar to call back in one year to negotiate a better rate – again. 

Insurance premiums are another area where you can reduce spending. Sometimes the savings are substantial just for updating your information – you could receive a discount, for example, by letting your home insurance carrier know you have dead-bolt locks and an alarm system. You might also be able to reduce your car insurance by letting your insurer know that you don't commute to work (or that your commute is shorter than it used to be). For both home and automobile insurance, you may be able to reduce your premiums by using the same insurer for both policies (many offer a 5% - 15% discount for combining policies) or by raising your deductibles. Take note, however, that a higher deductible doesn't always make sense. For example, raising your automobile deductible from $250 to $500 might not make sense if it only saves you $5 each year. 

The bottom line here is this: the less you spend, the less debt you’ll have. Controlling debt on the front end – instead of figuring out how to pay down debt once it has accumulated– is a lot easier in the long run. Making a budget – and sticking to it – can help. (For related reading, see The Complete Guide to Planning a Yearly Budget.)

Retirement Income

A well-diversified portfolio of dividend-earning stocks, bonds, mutual funds, annuities and retirement savings plans can help you increase your net worth and provide a valuable income stream during retirement. While it's never too late to start building your nest egg, the sooner the better because time allows the money to grow. In general, younger people can take on higher-risk investments because they have more time to recover from losses.

But keep in mind that people are living longer today, which gives individuals in their 60s and 70s time to bounce back from market dips. The old rule of thumb would have you subtract your age from 100 to figure out the percentage of your portfolio that should be in stocks – instead of “safer” investments like bonds. Today, however, more financial planners recommend subtracting your age from 110 or even 120 instead so that you can continue to build wealth longer and not risk outliving your money. (For more, see Why a 60/40 Portfolio Is No Longer Good Enough.)

 


Calculating Your Net Worth: Conclusion
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