Have you ever wondered, why do rich people get richer and while the majority of the poor people remained almost as poor as before?
You’ve probably come across this before, maybe your mother was trying to tell you about the very capable daughter your Auntie Jane has because she got a $5,000 job right out of school….. or maybe your childhood friend just had a lottery windfall of $30,000. You see, for most laymen out there, when we think of how wealthy a person is, we tend to think of how much cash he/she holds. Whereas, when you read about the world’s richest people such as Bill Gates, Warren Buffet, Li Ka-shing, etc , notice that nothing is mentioned about how much cash they hold? Here is when you learn a new word “networth”.
In the context of personal finance, networth refers to the market value of all your assets less all liabilities/debts. If you have a huge collection of shoes, or a fleet of sports cars, or the latest tech gadget, these are NOT assets. And while we’re on the topic, note that networth also excludes the value of the house you are staying in. With so many exclusions, what then do you include? Basically, cash and all your investments. Refer back to this article for Aunty Scroogey’s definition of an investment.
Cash doesn’t grow very much (and you probably know that already), and even if it does grow via fixed deposits, it is usually hardly enough to beat inflation. So it is very important that we put our hard earned money into the right type of investments and let our networth grow. The rich folks out there don’t keep a large proportion of their wealth in cash – they make their money work for them through the investments they make.
On the other hand, networth may also be reduced in times of financial turbulence, as witnessed recently . However, these are temporary reductions (temporary could last 1 week, 1 month, 1 year, a few years depending on market dynamics), and when asset values go up again, so will their networth. So…you might ask, are there any investments out there in which you do not need to risk losing your capital? Yes there are. In the next 2 posts, we will be touching on risk concepts and exploring the type of risks that are suitable for each individual.
When those rich folks on the Forbes list sell off an asset they invested in some years ago, they will re-invest their original capital plus profits into something else which they deemed undervalued, that is, something whose current price is below its perceived value. And some years down the road, they just might in turn sell that asset….. and then re-invest the original capital plus profits over again —> this is what we term as capital recycling. As you can see, they never really keep their cash under the mattress, nor in the bank as deposits.
If you are serious about your financial future, this is an exercise for you: calculate what is your networth today. How does that look to you? Are you happy with your networth? Is it growing? Or worse yet, is your networth in negative territory? Have you made plans where to put your cash such that it will grow? Remember that financial planning is not an option, it is a responsibility. We do it not just for ourselves, it is also for those whom we love.