In our last blog we examined how to start a financial plan by using budgets to establish the groundwork for everything else. Just remember that budgets are not the equivalent of a four letter word. They allow all of us to be able to paint a picture of our financial wellbeing and it will also allow us to move forward with our financial plans. Now that you have gathered all of your income and expenses it is time to turn our attention to the next step in our financial plan journey and that is assets and liabilities.
This is known as your personal balance sheet just as the budget would be your income statement. Just as you did with your expenses it is now time to gather information on all of your assets and liabilities. For those of you who may not know assets are things of value that you own outright or are buying through the use of a loan. Liabilities are debts that you owe someone else or a financial institution. As with anything some liabilities are better than others and some should be avoided. A mortgage is an example of a liability that is considered good as it is used to buy an asset that in theory is an appreciating asset meaning it should go up in value over time. While some may consider an auto loan a good liability that is not the case as most autos are not appreciating assets but rather depreciating ones meaning they will lose value over time and in many instances much faster than the loan is being paid off. Credit card debts are always considered a bad liability as they have high interest rates and generally have no asset associated with them. Try to avoid credit card debt if at all possible.
Now there are different types of assets and how they are categorized. First there are liquid assets such as cash in checking, savings, and money market accounts. These assets are kept liquid because we may need to access them in a hurry for everyday expenses or emergencies. These assets are not considered to be tax advantaged as they are not intended to be used for retirement purposes. Next we have investment assets which can be equities, bonds, and real estate intended to be used for income production. These assets can be liquid to a degree such as equities and bonds or illiquid as in real estate. While these assets may be intended for retirement or just wealth accumulation they are not going to be considered tax advantaged. Retirement assets are considered tax advantaged because in most instances they are comprised of your 401(k) plans or individual retirement accounts of various types. These are also going to be considered illiquid at least until you reach age 59 ½ as there are still penalties and taxes associated with withdrawals prior to that age. If you have permanent life insurance that has a cash value that also needs to be considered an asset as would any college savings that may be in 529 plans or brokerage accounts. That pretty much sums up all of the assets of a financial nature.
Assets may also be in a more physical form and in many instances are considered illiquid as they may not be easily converted into useable cash. These include any real estate that is used as a residence and is not meant to be a source of income for you. Real estate can be valued by appraisal or tax assessment. Vehicles such as autos and boats are also considered assets and would be considered at their current value as determined by comparison or through the use of a service such as Kelly’s Blue Book. Collections such as art or coins go into this area as well as they are usually appraised for their value and need special riders for insurance purposes. The furnishings in your home have value and need to be included as assets as well. Determining the value of these assets may be more subjective and is open for debate. But it is better to estimate the value of such items on the more conservative side and always insure these items for actual replacement cost when you purchase your insurance policy for contents or in your renters insurance.
Liabilities are a little straighter forward as compared to your assets. These are basically any debt you may have for any reason. Any unpaid balances on your credit cards appear here. The balance on your mortgage is also a liability as would any unpaid balance on an auto loan is you were to have one of those. Also if you have student loans do not forget to list those as well.
Now the difference between what is in your asset balance and your liability balance is your net worth. If you are prudent and have been managing your finances your net worth will be positive. If the number is negative that means you owe more than you own and we have some extra work that will need to be done for you to achieve financial prosperity. But do not get to down or beat yourself up too bad if you are young there is time to fix this issue and for older people you may want to seek a professional to see about what steps can be taken to get you into a position that your net worth is positive.