When we talk about wealth, we never measure only the amount of cash or money one has because this is just one of the many assets one can accumulate, but rather, we are talking about net worth. This is a key metric that signifies sustainable, long-term wealth, which differentiates wealthy people from rich people who only have money until it’s gone.
So, how do we measure net worth? Net worth is simply one’s total assets less liabilities.
Net Worth = Total Assets less Total Liabilities
How Do You Grow Your Assets?
First, we have to understand that there are two kinds of assets: non-appreciating and appreciating assets. Cash falls into the category of non-appreciating assets. It does not grow when you don’t use it. In fact, it actually shrinks in terms of its purchasing power due to inflation. Therefore, while it is important to note that you must always have an emergency fund, it is also just as important to understand that cash will never have more value than it has right at this moment.
In order to get wealthy, you must always make use of assets at the peak of its worth. It is therefore essential to shift your assets to more appreciating assets, such as real estate.
Appreciating assets like real estate, store value and has the potential to increase price over time. Specific to real estate, it also generates additional regular cash inflow when you rent it out. So, you grow your assets both from a value and cash flow stand point.
Should I Always Avoid Liabilities?
Now that we know that the equation for wealth is assets less liabilities, should we always try to minimize liabilities? The short answer is no, as we can actually use liabilities to exponentially grow our assets faster than the cost (interest) of these liabilities. This is what I like to call the power of leverage.
According to Investopedia, leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment.
In the case of real estate investment, when you loan money (liability) in order to grow your assets faster than your liabilities, you are increasing your net worth. The real estate market has been growing at a record rate, with some of my best investments and suggestions to clients growing as much as 30% over the course of its first year. On the other end of the lever, the interest rates currently offered by Philippine banks for housing loans are at historically low rates at around 5-6.5% per annum.
Once we’ve established that the loan gives you a financial net benefit, meaning the benefit of growth of the asset outweighs the cost of the loan, the next question you have to ask is “Can I pay the monthly amortization from a cashflow standpoint?” Therefore, you should only borrow money from a financial institution if you have confidence that you have the capacity to pay the loan on a long-term basis. Read more on the 3 THINGS YOU NEED TO AFFORD A PROPERTY.
Illustrative Example: How Big of an Impact Does Real Estate Investment Have on Net Worth
Let's take a look at the following example. Adam and Dan both have Php300,000 in their respective bank accounts as an emergency fund. They have free cash of Php50,000 per month, net of their monthly expenses. Adam decided to invest this free cash in a pre-selling property at a total contract price of Php5,000,000 and the property will be turned over to him after 3 years. Dan decided to save all of this extra money.
After 3 years, Adam borrowed from the bank to pay the remaining balance of the property. The value of the property has appreciated significantly since he started investing and is now worth Php7,000,000. This is what their net worth looks like now.
When they started, Adam and Dan had the same net worth, but in the relatively short time of three years since Adam began his investment, he has almost double the net worth of Dan, and his investment will only continue to grow.
When you constantly shift your assets from non-appreciating assets to appreciating assets, your net worth will grow exponentially.
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ABOUT THE AUTHOR
Edric Maguan is a successful real estate investor, an experienced and accredited Real Estate Broker of several top developers, and a Certified Public Accountant from University of the Philippines - Diliman. He found his passion in inspiring and empowering people to make the most out of their hard-earned money through real estate investment. Read full biography here.