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I was listening to a podcast the other day called Empire Builders and the hosts shared a statistic that really caught my attention. On average people who rent have a net worth of $5,000. Five thousand! That’s incredibly low.
What is net worth?
Net worth is “the total wealth of an individual, company, or household, taking account of all financial assets and liabilities.” - Google
An asset is something that holds value like a house or a company. A liability is any money you owe or any debts like student debt or a car loan. If you subtract your liabilities from your assets and you have no assets then your net worth will be very very low.
$100,000 Assets - $200,000 Debt = -$100,000 Net Worth
OR
$400,000 Assets - $200,000 Debt = $200,000 Net Worth
Why does it matter?
Income doesn’t mean anything if you have high expenses and a lot of liabilities. Net worth is true wealth and long term financial prosperity vs short term gain. Gaining net worth means you must invest your money in assets (aka things that make you money) vs spending money on liabilities (things that cost you money). Building net worth also means that you are building generational wealth or wealth that will last for generations to come. You are creating a legacy for your family. It also means that you more than likely have a satisfactory amount of money saved up for your retirement.
Renters spend a ton of money every year on housing. Renting is to a house as leasing is to a car. Essentially you are throwing your money away and don’t have anything to show for it at the end of the term. The average apartment for rent in my area is about $1,800 a month. That is about $21,600 a year. If rent increases every year and someone rents for five years that’s over $100,000 in rent in five years. That is a lot of money.
Now imagine you owned that home and you were putting $1,800 a month towards the principle balance on the mortgage. Instead of a $100,000 loss that could be a $100,000 gain in equity. Your home is an asset. You have now built wealth for yourself vs. built wealth for someone else.
What about the housing market crash in 2008? What happens if you buy a home and the value tanks?
Buy more homes. But seriously! If the market was to ever crash again and the value of homes were to drop significantly then buy because history shows that over time the prices will bounce back. You rent that home out and collect cash flow while you own it and wait for it to appreciate it. When it reaches a point of appreciation that you are happy with you can sell it for a gain (this is an oversimplification and there are a lot of things to factor in here like taxes and capital gains).
Quick aside:
I think it’s unwise to 1) live above your means, 2) purchase a home for more than it is worth, 3) put more money into a home than it’s worth, and 4) over leverage.
I think a lot of residential buyers practice the above methods when purchasing a home and it really puts them in a risky financial situation and hurts their net worth. I think we saw a lot of people hurting in 2008 because of poor financial habits. This is why an emergency savings is sooo critical. As a real estate agent I’ve seen it too many times and it hurts me so much because this is a topic I care about a lot. I’m not a financial planner so I can’t really give advice specifically about this topic. However, I’ll write about my thoughts and opinions here all day long!
Back to the story:
The economy is unpredictable and the housing market crash was unlike anything else we’ve ever experienced. The value of homes dropped rapidly in 2008 and as you can see from the graph below they slowly made their climb back up in the years following. Just like holding stocks is important over the long term so is holding real estate. Real estate appreciates over time which is why it is a long term, get rich slowly investing strategy (with some cash flow profits in the interim). Those who were older in age in 2008 and were depending on the value of their home remaining steady for retirement definitely were hurt by the crash. However, depending on one asset alone for retirement is not a smart plan.
I preach in my financial freedom framework the importance of multiple income streams. Having one asset, as in your primary residence, will not substantially grow your net worth. It is better than having no assets and renting but it still isn’t as advantageous as having multiple assets that grow your wealth.
I care about net worth not because I want to be wealthy but because I aspire for financial freedom. To me a high net worth and financial freedom are synonymous. It means not depending on one source of income to support my lifestyle. And most importantly to live the best possible life that I’m capable of and to create true wealth for generations to come.
Net Worth Is Not
There is a common misconception that being wealthy means you have a super expensive car, go on super expensive vacations and have all these expensive clothes and eat at expensive restaurants. This is the opposite of wealth. This is just spending obnoxiously. True net worth is gained through saving, careful minimalist spending behaviors and investing. Eventually, yes once you work hard to obtain a high net worth, you can buy the expensive things. However, true millionaires as portrayed in the book The Millionaire Next Door don’t do these things and that is why they are millionaires and live very comfortably and securely.
What You Can Do
Track your networth regularly
Invest in assets
Don’t spend too much on liabilities
I know this sounds extremely simple but this is a great place to get started. Sometimes keeping it simple and starting is better than over thinking and not taking action.
Thanks for reading through my article. I hope you gained some knowledge and perspective. This article idea came to me one late night around 3 am after waking up from a terrible dream. If you like it drop a note in the comments and let me know. If I get some comments then I will know I need to keep coming up with ideas at 3 in the morning :)
Until next time,
Amanda
Please remember to speak to a financial advisor or accountant before taking action on anything I shared here. I am not a financial advisor or accountant and I cannot speak to your individual situation. I am sharing my own personal opinions in this article and speaking from my own experience.