The Motley Fool Discussion Boards
Personal Finances / Credit Cards and Consumer Debt
|Subject: SpeleoFool's Rules - Net Worth||Date: 11/3/1999 2:01 PM|
|Author: SpeleoFool||Number: 19025 of 308040|
Hi again, Fools.
Today's topic is Net Worth. As I've mentioned before (see Intro to SpeleoFool's Rules, post #18962), Net Worth is one of the cornerstones of my philosophy. So what's the deal? Simply stated, I'm looking toward the finish line, and by focusing on Net Worth I am going to be in the best possible position when I get there.
What is Net Worth?
Net Worth is what you get when you add up the values of all your assets, then subtract the values of all your debts. Honestly, it does not matter how you calculate your Net Worth, so long as you do so consistently. For example, I count my home equity as an asset, but I don't count my mortgage balance as a debt. These two items are a "wash" because my equity grows by exactly the same amount that my mortgage balance decreases. Plus, if I ever sell my house, my mortgage balance "goes away," but my equity does not. And, perhaps most importantly, by not counting my mortgage balance as a debt, I'm not a net $100,000 in the red! :)
Why Net Worth?
I believe that my Net Worth is far more important than how much debt I have. We've been conditioned to think that debt is BAD. While most of the time it is, sometimes it's OK. Supposing their situations (income, housing, etc.) are identical in every way but those listed, who would you rather be in the example below?
Person A - $500 in checking account; $2000 auto loan; net worth = -$1500
Person B - $17,000 in money market account; $15,000 on credit cards; net worth = +$2000
Personally, I would much rather be Person B, even with all that debt. Person B has the option to wipe out those credit cards in one big payment, but Person A has a few more car payments to make. So, should Person B cash out and become debt free? If you answered, "I don't have enough information to make that call," then you're thinking my way. My answer is, "Person B should choose whichever option maximizes Net Worth." And that option, as you should know, begins with a look at Interest Rates (see post #18966).
Depending on the interest rates at work here, Person B's money market account might just make more money than would be lost in interest on the credit cards. In such a case, I would support paying the minimum on the cards and reaping the gains of the MM account. I'll discuss how I'd make this call later, in another edition of my Rules (look for "Debt Priority" or "Debt vs. Investment").
Some of you will undoubtedly be tempted to say that debt is evil and Person B should pay off those cards no matter what. That may be true for you, but it's a statement based on comfort, not math. Although I'll defend such decisions to the end (being comfortable is more important than being rich--the second cornerstone of my philosophy), I also aim to make you more comfortable through understanding the math. In this case, I think an attitude adjustment may help.
Don't think of "zero" as that place that you'll be when you have your debts paid off. Think of "zero" as that place that you are right now--the ground floor. Whether your Net Worth is +$10,000 or -$50,000, you'll be better off by moving on up. Remember, there are two ways to do this: (1) by shrinking debt or (2) by growing assets. You can figure out which makes the most sense for you by starting with a look at interest rates (hint--which is growing faster?). This is where my future Foolish tomes will lead.
Stay tuned, and Fool On!
|Copyright 1996-2014 trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us|