Net worth is what you own (assets) minus what you owe (liabilities). It can either be positive, negative, or zero. Ultimately you don’t want to end up in one of the last two categories. You don’t want to owe more than you own. Obviously that’s a bad situation. That means that someone is always going to be taking a draft from your bank account each month, sending you either email or snail mail statements that you have to pay, or hounding you for not paying on schedule. This situation is sometimes unavoidable when just getting started, but the goal should be to achieve a positive net worth as early as possible and continue to make it grow. The days of having a small bank account and a big pension in retirement are extremely rare. Retirement could happen like that years ago, but that’s a recipe for disaster today.

You have to take charge of your financial security. By getting the Big Rocks right consistently your net worth will grow. This is a very important number that you should be well aware of at all times. Keep up with it periodically so you can ensure the things you are doing are affecting the direction of your net worth in a positive direction. Sure, you won’t get every detail exactly right, but don’t get discouraged and take your eye off of your goal. By watching monthly or so, you’ll either be pleased with your general direction or disappointed in the negative trend of your net worth. These periodic checks and tracking will give you validation and encouragement that you are headed in the right direction. Watching you gain ground in your net worth is very reassuring to a spouse that worry’s a lot about stability.

Positive Net (Smokey)

Smokey Joe did a smoking good job at getting those Rocks right. He lives in small two bedroom house that he bought in his early 20’s for a great price well under market value. He put 20 percent down as a cash down payment and kept his monthly payment less than 25% of his salary with a 15 year mortgage. He got a great deal on the loan as well because he had plenty of means to pay for it in the bank’s eyes. He knew that if his payment would be more that that recommended amount, he’d have less discretionary cash for investing, emergencies, and unplanned expenses. So, whenever he had more cash than he needed for his emergency fund, he would invest the rest or pay extra payments on his house loan whenever possible. He always paid cash for a car. This modest style of living worked really well for Smokey. Some of his friends would make fun of how “cheap” Smokey was, but he didn’t care. He was excited to watch his net worth go from a negative amount to a positive amount in short order.

Negative Net Worth (Average)

Average Joe took a care free style of living and never watched his net worth. He had never took the time to understand it. He “could afford” it. He also kept up with all of his friends and always liked having the cat’s pajamas in whatever he bought. He never really cared that the big rocks were pelting him financially because he wasn’t even aware they existed. Average “bought” a $20,000 car for a great deal with low financing and no money down for 5 years. He tried to buy a really nice house shortly after, but was unable to qualify for the loan. But just two years later he got a big raise and his income finally crossed over the amount where his brand new retail priced house’s payment would meetthe maximum allowed 30% rule of his monthly income financing requirement. But he still couldn’t come up with the required 10% low down payment method because most of his discretionary money was going to his $390 per month car payment. It took him another 2 years to get $20,000 so he could finally qualify for the 10% down payment loan. Shortly after he “bought” his house, he traded his almost paid off car for a “great deal” on a $30,000 financed newer model for 7 years. This new 7 year loan dropped his monthly payments to a more “affordable” payment.

Let’s Math it Up!

Now let’s look at how these two scenarios played out with their net worth. I’ll pick up at the 10 year point. Let’s also put some constants in so we can compare the two. Each house appreciated in value 3% per year which is about average. We assume they keep their habits basically the same. Either long low payment terms or as little debt as possible .

Smokey financed $100,000 house that was valued at $120,000 when he financed his house. He saved saved 20% of the purchase price by waiting for a great deal. He made extra payments and goal was to pay his loan off with his extra payments in 10 years which he did. His home (asset) is now worth $161,269. He did splurge and bought a 10 year old car for $15,000 5 years ago. We’ll just assume that his car lost half of it’s value and now is worth $7,500. So his net worth at year 10 is $161,269 plus his $7,500 car. That’s $168,769.

Average financed $200,000 for for the full retail price of his $200,000 when he financed his house. He couldn’t afford any extra payments because his car was financed as well. He also had to wait approximately 5 years before he qualified for the house**.** Since the first several years of a 30 year mortgage is mostly interest and very little interest, he didn’t really pay down his loan much. Let’s just estimate that his payment schedule got him $12,000 per year of equity in his house. That’s more than he would, but for simplicity we’ll give him that much. So, he owns $60,000 (5 years x $12,000) from his payments plus the original $20,000 (10%) down payment (minimum to qualify for the loan). He owns $80,000 of his $268,763 ($200,000 appreciated for 5 years)…his net worth is -$188,783. He also has another 25 years before he owns his house. He financed a $35,000 car one year ago when he traded in his car that he still owed $5,000. So, he financed his $35,000 car for $40,000. In the year that he bought it, it depreciated 10%, likely much more, so it’s valued at $31,500. Since the loan is new, he’s still upside down in his car. Let’s say he was able to pay it down to $35,000 remaining. That’s being generous. The car’s value $31,500 minus the $35,000 he owes results in a -$3,500 to his net worth. So Average Joe’s total net worth is -$188,783 plus -$3,500. That’s a net worth of -$193,223.

Smokey’s net worth was $168,769. Average’s net worth was -$193,223. Think of Average living on one side and Smokey living on the other side of you. On the surface it looks like Average is doing well. He has the nicest home on the block and a nice almost new car in the driveway. Smokey on the left worries you a little. His modest home is one of the smaller on the block. You’re finally glad Smokey got rid of the old junker and upgraded his car to something that doesn’t look abandoned. But financially, Smokey is really smoking Average in the financial arena. It would take Average $193,223 to get up to a break even net worth and he’s still behind Average! Then it would take him another $168,769 to catch Smokey in net worth. The difference in their net worth is $360,992.

Wandering around and not watching what’s happening to your is a silent killer to your financial goals. I did just that throughout most of my life. It wasn’t until I was in my late 30’s before this became painfully aware that I had a negative net worth. It was a real eye opener. I felt like I was too far behind to recover from my mistakes. The more I started researching personal finance, the more discouraging it got. But I did make a turn. Eventually I learned about the big rocks and how to use them. I started assessing whether purchases were helping or hurting my net worth. I was starting to see progress from the adjustments to how I looked at my personal finance. Getting the big rocks right can really make a huge difference during a lifetime. It’s never too late to start. But it sure is better to start early and avoid the mistakes. In the cases above and just 10 years it’s a $360,992 difference. It only gets worse for Average and better for Smokey over the next 25 years when Average finally pays off his 30 year loan.

One day you’ll be living off of this Net Worth or relying on Social Security for 100% of your financial income. If your net worth is zero or worse negative, you aren’t going to have choices. You’ll be forced to rely on whatever Uncle Sam dishes out.

Don’t be average!