Which of the following increases your net worth more, putting $1,000 into a savings account, or paying off a $1,000 debt?? The term “net worth” is defined as the amount by which the value of your assets exceeds your debts. It feels good to put money in savings, but paying off your debt has exactly the same impact on your net worth.
When measuring your net worth it’s important to keep in mind that all assets are not created equal. Some assets depreciate, while others appreciate, some suck money out of your pocket while others put money in you bank account.
Consider buying a new car for $30,000, also imagine that you read my prior post Compound Interest, He Who Doesn’t Understand it Pays it, or The Monthly Payment Trap – Fun With Numbers and you’ve decided to pay cash. Now imagine that you drive home from the dealership in your shiny new car. When you get home you immediately decide to update your net worth schedule. Easy right, you simply transfer $30,000 out of the cash row and put it in the car row, no problem, they’re both assets so no impact on your net worth. One issue, as we all know, as soon as you drove that car off the lot it depreciated, or lost value of roughly 10%, and it will continue to lose value until you buy another shiny new car…
Now imagine that you decided to keep driving your old but reliable vehicle and instead took that $30,000, and you made a 20% down payment on a $150,000 rental property instead. Even in a slow real estate market the property should appreciate over time, lets assume 3%. Let’s also assume that the property is rented for a 5 year period covering the mortgage and all costs. What do you think the difference would be in the fair market value of these 2 “assets” would be at the end of 5 years.
|Purchase||Year 1||Year 2||Year 3||Year 4||Year 5|
|Day 1 depreciation||3,000|
|depreciation 5% per year||1,500||1,500||1,500||1,500||1,500|
|Rental Property||Purchase||Year 1||Year 2||Year 3||Year 4||Year 5|
|Net asset value||30,000||36,270||42,767||49,497||56,470||63,697|
Difference in net asset value after 5 years, about $44K, repeat for another 10, 20, 30 years, whats the impact now? If you’re not a fan of real estate, buy stocks, bonds, bitcoin anything that goes up in value instead of down. In the long run, cars, boats, campers etc. rob you of your net worth, we’re talking about hundreds of thousands of dollars over a lifetime. Where’s your retirement? It may be in your driveway, or your basement, or shed. So, drive that crusty old car, some people might think less of you, can your ego handle it? Those people are probably living paycheck to paycheck. I’ve found in my career that it’s often the people that appear to be the wealthiest, that are in fact the poorest. Stop spending to impress others, in the end would you rather appear wealthy or be wealthy?