People ask: Should I pay off a loan or should I save money? This really becomes a question of net worth. Let’s discuss what net worth is, why it matters, or if it does even matter.
Paying off a loan, also known as a liability, from cash flow increases your net worth by decreasing an amount you owe.
Saving money, setting it aside into an account increases your net worth, increasing the amount you own.
Assets (what you own) – Liabilities (what you owe) = Net Worth
A great first goal as you’re starting out is to have a positive net worth, to own more than you owe.
Here are some examples for ways people increase their worth:
Example 1: GRADUAL
This is probably the most common way to increase your net worth.
Increase Assets: You save money into your retirement accounts each paycheck.
Decrease Liabilities: You pay down your liabilities such as a mortgage or other loans as scheduled and they are paid off over time.
Net Worth Result = Increases gradually as you save each paycheck and pay off loans as scheduled.
Example 2: FAST
This is an example of someone who wants to pay off their debts quickly from their income.
No Change in Assets: You pause your savings into retirement accounts
Decrease Liabilities: You aggressively pay down your liabilities to get rid of them
Net Worth Result = Increases because you are decreasing your liabilities
Example 3: FAST
In this example, again you are paying off debt quickly but using your assets to do so.
Decrease Assets: You use assets to pay off the debt you want to get rid of
Decrease Liabilities: You pay down your liabilities owed
Net Worth Result = No Change in Net Worth
What This Means For You
It’s important to understand as you move money around that it affects your net worth. As you ask the questions of how much to save and when to pay something down, understand how it will affect your worth. In the end, what you own, minus what you owe, is how much money you really have.
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