In an earlier post, I talked about using expense tracking to see where you’re at financially. But income and expenses are only part of the picture. Another aspect is what you own (assets) versus what you owe (liabilities). Please note that I’m using loose definitions here, and I’m only talking about personal assets. Accountants use more complex definitions, and business assets, such as income-producing rental property, are not included. Assets More specifically, assets are things you own that you could sell—for example, furnishings in your home, a car, artwork, musical instruments, your late grandma’s chess set, and so on. Your home itself is an asset if you’re buying rather than renting. Shares of mutual funds or other personal investments count as assets. Cash you have on hand or the cash value of bank accounts are also assets. Your dwelling is not an asset if you rent it. Neither is a vehicle you lease. Rental and lease payments go under expenses, although car leasing is a special case. Liabilities The mortgage you’re paying on your residence is a liability, and so is car loan debt. In these cases, the debt you owe is “secured” by the asset; if you fail to make the payments as you agreed, the assets could be subject to foreclosure or repossession. You might also have other liabilities, such as credit card debt. Credit card debt is primarily “unsecured” debt—for example, you used credit cards to purchase meals out, buy gasoline, pay for a vacation, and so on. Expenditures like these are basically personal expenses, and you’re paying them by taking out a loan from the credit card company at a huge interest rate (average is 16.15%). You promise to pay the company the original amount plus interest. There’s no asset that can be “taken back.” Student loan debt is also unsecured debt. It’s not like the Fed can take back your degree! Plus there’s no guarantee that you’ll even earn a degree. Either way, you have promised to pay. Net Worth The difference between your assets and your liabilities is termed your “net worth.” When people talk about “wealth,” they’re referring to a high net worth. How much income someone makes doesn’t figure in. Here are two hypothetical households with different net worth:
Because household A has no liabilities, A’s net worth is equal to A’s assets. Household B has sizeable liabilities, and so B’s net worth is lower, even though B has more in assets. Put another way, household A is “wealthier.” It’s possible to have liabilities that exceed your assets. Being “upside down” on a mortgage is one example. If you owe more than you own overall, you have a negative net worth. According to the financial-advice company Motley Fool, 16.6 million American households, or 14%, had a negative net worth in the spring of 2017. (I don’t imagine it’s any better now.) What do you think is the biggest contributor to this negative net worth? It’s not mortgage debt, credit card debt, or payday loans, although these do contribute. The largest liability burden in households with negative net worth is student loan debt. This isn’t a problem only for younger generations; an article from Business Insider in 2019 reported that more than 3 million Americans over age 60 collectively owed more than $86 billion in unpaid student loans. That kind of liability can kick the stuffing out of net worth. For more details:
Maurie Backman, “16.6 Million U.S. Households Have a Negative Net Worth—Here’s the Surprising Reason Why.” Motley Fool, May 14, 2017. (Click here.) Kelly McLaughlin, “3 million senior citizens in the US are still paying off their student loans.” Business Insider, May 3, 2019. (Click here.)
1 Comment
Teresa
10/2/2021 01:33:41 pm
Good Explanation!
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